Procurement for Assembly Systems Under Supply Uncertainty: Optimal Mechanisms

We study effective mechanisms for a manufacturer (buyer) to procure components of an assembly system under asymmetric information (including private costs and unobservable effort) and supply uncertainty. For each component, the buyer has access to an unreliable supplier whose production cost is private, input effort is unobservable, and production yield is uncertain. Further, both the buyer and the supplier have access to a more expensive but reliable supply source. The supplier also has access to a salvage market for any leftover quantity of its component. Each supplier maximizes its profit from sales to the buyer and the salvage market minus the production cost. We seek an optimal mechanism for the buyer to maximize its expected profit, that is, revenue from the assembled product minus payments to suppliers and reliable supply sources. We develop an optimal and practically convenient screening mechanism under which the buyer offers each supplier a menu of contracts and the supplier self-selects its choice. We also modify our screening mechanism and establish its optimality in a generalized setting in which production costs are yield-contingent, the prices charged by the reliable sources are stochastic, and the salvage values are also stochastic.

Supplemental Material: All supplemental materials, including the code, data, and files required to reproduce the results, are available at https://doi.org/10.1287/opre.2022.0542.