Traceability and Reputation in Supply Chains

Recent food safety events have raised concerns about adoption of traceability systems. The paper studies the question of when and why a supply chain should invest in an upstream traceability system that allows identifying which supplier is responsible for quality defects due to insufficient (non-contractible) effort when firms interact repeatedly. The downstream firm and consumers observe imperfect, lagged signals of input and output quality. Without appealing to exogenous cost for a traceability system, it is demonstrated that in deciding whether to maintain information regarding product origin, firms face a trade-off. On one hand, the downstream firm is tempted to condone limited upstream shirking or resort to an experimentation strategy to identify the upstream shirker when products are not traceable to their firm of origin. On the other hand, the downstream firm is tempted to “vertically coordinate” shirking in the provision of quality when products are traceable. Colluding with a subset of upstream firms is more attractive when the downstream firm can tell whether a product originates from a shirking or non-shirking firm. Firms achieve greater joint profits when products are not traceable to upstream suppliers if (1) the ratio of the cost savings from upstream shirking and downstream shirking is neither too large nor too small or (2) the probability with which the downstream firm detects input defects is not too large or (3) the consumer experience is a sufficiently noisy signal of quality. It is also shown that the returns to more precise inter-firm monitoring can increase or decrease after the adoption of a traceability system depending on information generated by consumer experience.