A Three-Stage Supply Chain Investment Model under Asymmetric Information

Specific supply-chain investments are vital in achieving faster lead-time performance and more competitive costs. In practice, such as in the highly leveraged telecom sector, the coordinating original equipment manufacturers (OEM) often delegate the upstream coordination of suppliers to contract manufacturers. This can be justified by informational advantages or economies of scale. However, the rationale of such schemes has also been challenged by analytical work on three-stage chains, leading to open questions. In this paper, we study the organizational and contractual choice of a supply chain coordinator (say an OEM) to either control or delegate the investment decision of some shared resource (say dedicated machines, information or product standards, etc) to a contract manufacturer (CM) or to an upstream supplier in a three-stage supply chain. The analysis derives closed-form results for the economic performance of three scenarios under asymmetric information on investment cost: direct contracting with an integrated CM-supplier, decentralized contracting to tier-1 suppliers and centralized contracting to tier-1 and tier-2 suppliers. The results show that the observed practice to delegate investments to tier-1 and possibly tier-2 suppliers leads to relatively poor performance due to under-investments. The superior arrangement is the centralized conditional model, where the OEM forces coordination among upstream suppliers by offering conditional financing. We close the paper with an analogy to the Boeing 787 supply chain and some discussion about the assumptions and applicability of the model.