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Quality Improvement Incentives and Product Recall Cost Sharing Contracts

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Author Info

  • Gary H. Chao

    ()
    (College of Business, Kutztown University, Kutztown, Pennsylvania 19530)

  • Seyed M. R. Iravani

    ()
    (Department of Industrial Engineering and Management Sciences, Northwestern University, Evanston, Illinois 60208)

  • R. Canan Savaskan

    ()
    (Managerial Economics and Decision Sciences, Kellogg School of Management, Northwestern University, Evanston, Illinois 60208)

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    Abstract

    As companies outsource more product design and manufacturing activities to other members of the supply chain, improving end-product quality has become an endeavor extending beyond the boundaries of the firms' in-house process capabilities. In this paper, we discuss two contractual agreements by which product recall costs can be shared between a manufacturer and a supplier to induce quality improvement effort. More specifically, we consider (i) cost sharing based on selective root cause analysis (Contract S), and (ii) partial cost sharing based on complete root cause analysis (Contract P). Using insights from supermodular game theory, for each contractual agreement, we characterize the levels of effort the manufacturer and the supplier would exert in equilibrium to improve their component failure rate when their effort choices are subject to moral hazard. We show that both Contract S and Contract P can achieve the first best effort levels; however, Contract S results in higher profits for the manufacturer and the supply chain. For the case in which the information about the quality of the supplier's product is not revealed to the manufacturer (i.e., the case of information asymmetry), we develop a menu of contracts that can be used to mitigate the impact of information asymmetry. We show that the menu of contracts not only significantly decreases the manufacturer's cost due to information asymmetry, but also improves product quality.

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    File URL: http://dx.doi.org/10.1287/mnsc.1090.1008
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    Bibliographic Info

    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 55 (2009)
    Issue (Month): 7 (July)
    Pages: 1122-1138

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    Handle: RePEc:inm:ormnsc:v:55:y:2009:i:7:p:1122-1138

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    Web page: http://www.informs.org/
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    Related research

    Keywords: reliability; quality control; contracts; product design; supply chain coordination; information asymmetry;

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    Cited by:
    1. Iida, Tetsuo, 2012. "Coordination of cooperative cost-reduction efforts in a supply chain partnership," European Journal of Operational Research, Elsevier, vol. 222(2), pages 180-190.
    2. Dionisia Tzavara & Adrienne Héritier, 2011. "Quality and Environmental Regulation: Verifying Compliance along the Supply Chain," RSCAS Working Papers 2011/16, European University Institute.
    3. Xie, Gang & Wang, Shouyang & Lai, K.K., 2011. "Quality improvement in competing supply chains," International Journal of Production Economics, Elsevier, vol. 134(1), pages 262-270, November.
    4. Yim, Andrew, 2010. "Quality Cost and Failure Risk in the Choice of Single versus Multiple Sourcing," MPRA Paper 27858, University Library of Munich, Germany.
    5. Li, Yongjian & Xu, Lei & Li, Dahui, 2013. "Examining relationships between the return policy, product quality, and pricing strategy in online direct selling," International Journal of Production Economics, Elsevier, vol. 144(2), pages 451-460.
    6. Dionisia Tzavara and Adrienne Héritier, 2011. "Quality and Environmental Regulation: Verifying Compliance along the Supply Chain," EUI-RSCAS Working Papers 16, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
    7. Han, Chaodong & Porterfield, Tobin & Li, Xiaolin, 2012. "Impact of industry competition on contract manufacturing: An empirical study of U.S. manufacturers," International Journal of Production Economics, Elsevier, vol. 138(1), pages 159-169.

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