Controlling a supplier’s subcontracting decisions through contractual enforcement or economic incentives

Hubert Pun and H. Sebastian Heese

International Journal of Production Research, 2015, vol. 53, issue 1, 127-140

Abstract: Suppliers often subcontract part of their workload to other suppliers, and manufacturers might suffer severe consequences if they do not anticipate their suppliers’ incentives to subcontract. In this paper, we study the case where a manufacturer outsources two tasks to a top-tier supplier. The manufacturer must decide whether it should design a contract that enforces that the different tasks are completed by the appropriate suppliers, and when it is preferable to use economic incentives to manipulate the top-tier supplier’s subcontracting behaviour. We find that when the cost difference between suppliers of different tiers is small and the correlation between the risks associated with the two tasks is minimal, the manufacturer can benefit from designing a contract that ensures the preferred subcontracting behaviour, if the cost of enforcing such a contract is not too high. However, when such enforcement cost is substantial, the manufacturer might be better off manipulating the top-tier supplier’s economic incentives.

Date: 2015
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DOI: 10.1080/00207543.2014.939242

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