An incentive scheme for true information providing in Supply Chains

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Omega 31 (2003) 63 – 73 www.elsevier.com/locate/dsw

An incentive scheme for true information providing in Supply Chains Martin Feldmann∗ , Stephanie M'uller Faculty of Economics, University of Bielefeld, P.O. Box 10 01 31, 33501 Bielefeld, Germany Received 17 August 2001; accepted 4 December 2002

Abstract This paper examines the problem of how to establish an incentive scheme to furnish reliable and truthful information in Supply Chains. In the current discussion information is typically assumed to be perfect and Supply Chain Partners are presumed to behave altruistically. In our judgement these assumptions are far from realistic. In consequence we assume that opportunistic behavior can emerge and will be accompanied by incomplete and falsi3ed information. Presenting an incentive scheme, we illustrate how a tendency towards true information providing can be constituted in Supply Chains and will be endorsed in the long run. The most important result of this approach is that a substantial change in the information policy of Supply Chains is brought about and a higher level of quality is obtained. ? 2003 Elsevier Science Ltd. All rights reserved. Keywords: Supply Chain Management; Incentive alignment; Groves Scheme; Information management

1. Introduction One important de3cit in the discussion about Supply Chains is the strong dominance of logistical aspects. Questions concerning the coordination of material 9ow or the adjustment of stocks have been placed in the center and only technical aspects of the information processes are addressed [1]. However, this neglects other reasons for information distortion. Though most of the 3rms connected in a Supply Chain remain legally separated, informational symmetry is postulated implicitly and convergence of interests is often presumed. We consider the case that opportunistic behavior will emerge in Supply Chains as it does in other organizations. It is most probable that at least some of the 3rms in a Supply Chain try to realize economic bene3ts at the expense of others. Obviously the companies that behave ∗ Corresponding author. Tel.: +49-521-106-3933; fax: +49-521106-6036. E-mail addresses: [email protected] (M. Feldmann), [email protected] (S. M'uller).

opportunistically will bias their information policy to conceal the actual reasons for their decisions. In the absence of an instrument to exclude opportunistically driven decisions in legally separated 3rms, we have to seek an alternative. Since opportunistic behavior often entails deliberate falsi3cation in the information-providing processes, we focus on this problem. The purpose of the paper is to present an incentive scheme that hinders the 3rms from acting opportunistically, if the concealing instrument of misleading information providing is excluded. The paper is divided as follows: The next section identi3es a certain lack of accuracy, especially as regards the information processes in Supply Chains. Section 3 introduces a new understanding of the organizational structure of Supply Chains and emphasizes the information 9ows. The requirements of information sharing, together with shortfalls in it, are discussed in Section 4. The well-known Groves Scheme, developed for divisionalized 3rms, is summarized in Section 5. As a direct application of this incentive scheme is impractical, Section 6 suggests an incentive scheme merely abutted to the Groves Scheme, making it possible to deal adequately with Supply Chains. The use and characteristics

0305-0483/03/$ - see front matter ? 2003 Elsevier Science Ltd. All rights reserved. doi:10.1016/S0305-0483(02)00096-8

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M. Feldmann, S. M%uller / Omega 31 (2003) 63 – 73

of the new incentive scheme are demonstrated by numerical examples in Section 7.

2. Current state of discussion Supply Chain Management has been extensively discussed in the recent literature without reaching a generally accepted de3nition [2,3]. As the Supply Chain is the obvious object of Supply Chain Management, it must be de3ned at the outset. Some authors [4,5] emphasize the importance of the end users by introducing the term “Demand Chain”, but in the following the more common term Supply Chain is used. According to Hand3eld and Nichols [6, p. 2], a Supply Chain can be characterized as “all activities associated with the 9ow and transformation of goods from raw materials stage (extraction), through the end user, as well as the associated information 9ows”. This poses the question whether the Supply Chain only resumes the idea of logistics or essentially implies a new concept. The North American Council of Logistics Management (CLM), de3nes Logistics as “that part of the supply chain process that plans, implements, and controls the eJcient, eKective 9ow and storage of goods, services, and related information from point-of-origin to the point-of-consumption in order to meet customers’ requirements” [7]. While this de3nition of Logistics stresses the 9ow orientation of linked transformation processes, Supply Chains are additionally discussed in terms of organizational aspects. For instance Christopher [8, p. 15] describes the Supply Chain as a “network of organizations that are involved, through upstream and downstream linkages”. In this sense a Supply Chain consists of legally separated organizations, linked by material and information 9ows. Operating an integrated Supply Chain requires continuous information 9ows, which aKect the key chain processes. These are de3ned by the members of The Global Supply Chain Forum (GSCF) as: • • • • • • • •

Customer relationship management; Customer service management; Demand management; Order ful3llment; Manufacturing 9ow management; Procurement; Product development and commercialization; returns [9, p. 72];

Even if these 9ows can appropriately be summarized as Logistics Chains [10, p. 39], the discussion of Supply Chains does not stay on this level. On the contrary it focuses on an integrated view of coordination and optimization of inter-organizational 9ows [1]. The repeatedly stressed consideration of processes and activities is expressed in the Supply Chain Operations Reference (SCOR)-model of the Supply Chain Council (SCC).

The model consists of a system of standard processes [11]. As an important part of the model detailed metrics for some determined performance attributes as well as best practices and their features are presented. Nevertheless the allocation of diverse processes to organizational units remains unconsidered. As Mentzer et al. [12, p. 4] point out, a clear distinction needs to be drawn between Supply Chains and the management of Supply Chains; yet Supply Chain Management and its functions are not even mentioned in the SCOR-model. Due to this omission, we have to discuss which functions are left for Supply Chain Management. According to Stadtler [13, p. 9], Supply Chain Management could be understood as an enhanced logistics conception. He de3nes “Supply Chain Management as the task of integrating organizational units along a supply chain and coordination materials, information and 3nancial 9ows in order to ful3l (ultimate) customer demands with the aim of improving competitiveness of a supply chain as a whole”. According to the 3ndings of Mentzer et al. [12, p. 17], Supply Chain Management has a twofold task: a functional and an organizational. The former “encompasses all the traditional intra-business functions”, while the latter is seen as “the implementation and process of S[upply] C[hain] M[anagement] across three or more companies”. In discussing the second, neither Mentzer et al. [12] nor the SCOR-model assign this task to an organizational unit. Since the SCOR-model lays claim to the possibility of a centralized decision-making, it ignores the fact that even parts of the problems in every company are NP-hard. Even if the structure cannot be directly adopted—as the organization of a Supply Chain is not well characterized as being hierarchical—the principles and techniques of hierarchical planning and coordination [14,15] ought to be mentioned. Moreover a centralized decision-making might even be undesirable. Supply Chain Partners should use their specialized information and know-how for making their decisions ‘on the spot’. But for a better decision-making, the “information and know-how [should be] shared openly among members” [13, p. 13]. Clearly, sharing information and warranting its quality is obviously a contribution required of every Supply Chain Partner [16,17]. However, no instructions are given how to realize this, nor it is mentioned how the correctness of the transferred information is to be ensured. 3. Organizational structure and information processing in Supply Chains From a certain perspective Supply Chain Management offers the indispensable service to the Supply Chain Partners that supplements their Logistics Chains and enables them to become a Supply Chain. Therefore, the existence of a Supply Chain Management is an essential component of every Supply Chain. Furthermore and in contrast to existing approaches, we consider the Supply Chain Management as a

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65

Supply Chain Supply Chain Management Customer SCPartner

SCPartner

SCPartner

SCPartner

Fig. 1. Information-9ow and coordination in the Supply Chain.

separate module, an independent organizational unit. There are two main possibilities to establish this unit: either each Supply Chain Partner delegates some members of its senior staK to become ‘Supply Chain Manager’ or the task of the Supply Chain Management is delegated to a company providing services [6]. To underline the speci3c quality of the Supply Chain, the interacting activities are faded out in Fig. 1. The information-providing and coordinating processes are emphasized and a new de3nition of Supply Chain is provided: A Supply Chain can be considered as a system: it consists of the Logistic Chains of the Supply Chain Partners and is augmented by the Supply Chain Management in order to ful3ll customer needs. According to Shannon [18], a system is a structure of entities having attributes interacting with activities creating events that change the state of the system. In the Supply Chain two groups of entities exist: the Supply Chain Management and the Supply Chain Partners. To emphasize the coordination task of the Supply Chain Management every partner is connected with the Supply Chain Management by an information channel (Fig. 1). The direct 9ow of information between two partners is to be monitored and moderated by the Supply Chain Management to ensure that up-to-date information is available to all partners. Note that in contrast to the Logistics Chain the availability of information is enhanced to cover all partners, instead of staying locally bordered. The 9ow of information covers the key chain processes in both directions: the customer and the supplier side [12]. To concretize this 9ow, private information and the reported values are distinguished from one another. Each organizational unit, i.e. the legally separated partners and the Supply Chain Management, owns internal corporate data, which are only known to the speci3c unit [17, p. 385]. To give an example: as the private information of the Supply Chain Partner we can consider the rate of employee turnover, rate of customer complaint, sensitive cost data. The private information of the Supply Chain Management is that which is generated by them and used for planning and controlling the key chain processes. In a more detailed description, the attributes of the entities Supply Chain Management and Supply Chain Partner

are of interest. Typical attributes of a partner are: ‘completion times’, ‘failure rates’, etc. To enable the Supply Chain Management to ful3l its coordination task, every partner reports values of certain predetermined attributes. During this transfer process data are aggregated and possibly forged. Attributes reported to the Supply Chain Management are e.g. ‘reported mean lead times’, ‘reported failure rates’ etc. The Supply Chain Management receives these values, integrates them to its private information sphere, and decides on the information provided to all partners. Again values of attributes are transmitted, but now the recipient is the Supply Chain Partner. In view of this cyclic procedure Fig. 2 is named information cycle. As Fig. 2 focuses on the information cycle linking only one Supply Chain Partner and the Supply Chain Management, the process of information provision in the whole Supply Chain is depicted in Fig. 3. Initially partner 2 transfers information—as described in the information cycle—to the Supply Chain Management. Next the management processes the data and transfers them back. Note that the predetermined attributes can be partner-speci3c ones. To coordinate the activities along the Supply Chain attributes may diKer between immediate partners. For example, the main coordinating attribute according partner i and partner i + 1 may be the ‘mean lead time’, while the main attribute linking partner i + 1 and partner i + 2 may be the ‘rate of rejects’. In Fig. 3 this is done by indexing the attributes. Already some important advantages become obvious: • The organizational separation of Supply Chain Partners and Supply Chain Management stresses the aspects of coordination and information providing. • It allows a deeper understanding of contributions and incentives. • The organizational separation enables a better description of the data structures involved and their processing. • It underscores the diKerentiation between private information and reported values. Thus the problem of furnishing forged information becomes clearly discernible thanks to the non-identical values of some corresponding attributes of the private and reported sphere of a partner. • The whole chain is well characterized as a unit. Its state is changed by the activities of all members of the Supply Chain. The state can be measured by values of attributes

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Information Providing & Falsifying Supply Chain Management

Reported Values

Private Information

Interface

Interface

Private Information

Reported Values

Supply Chain Partner

Information Providing & Falsifying Fig. 2. Information cycle.

like its market share, consumer satisfaction, ability to deliver, variation of expected versus realized quantities, etc. • The prospect of a Supply Chain wide database is established. 4. De cits in the information processing The necessity of coordination requires the partners to release information for instance on the following aspects. Beside the orders of Supply Chain Partners, their expected throughput time and failure rates, the agreements between Supply Chain Partners, also regular maintenance of machines or serious machine breakdowns might be of interest. Diverse reasons for de3cits in the release and transmission of information can be cited. The 3rst group includes technologically motivated reasons. Even if harmonized interfaces for data interchange like EDI or EDIFACT already exist, these standards should not be overrated. Values of attributes of Supply Chain Partners can be misapprehended in the course of the information processes, simply due to the fact that Enterprise Resource Planning (ERP) systems are not primarily conceived for the exchange of data between diKerent companies. Thus Advanced Planning Systems (APS) should be used, whose application in enterprises is however limited to date. The automatic information-providing systems are still in the development process and it is improbable that all Supply Chain Partners will install identical systems. Additionally, identical data structures do not exist if partners are members of more than one Supply Chain. The second group of reasons originates in the speci3c organizational structure of the Supply Chain. As mentioned above, the 3rms typically do not abandon their legal separation and economic independence when they become Supply Chain Partners. Therefore, a third dimension of interests has to be regarded: there are Supply Chain interests which exacerbate the problems caused by the well-known intra-3rm

divergences of manager interests and companies’ interests. In this situation of divergent interests associated with asymmetric information, the question of how to ensure a bene3cial decision-making for the whole system Supply Chain arises. Inextricably connected with this question, a third group of reasons complicates the setting and comprises those reasons that are motivated by opportunistic behavior. The behavior of the parties involved can include cheating to enforce their own advantages. The following two scenarios demonstrate how opportunistic behavior may emerge and will be accompanied by incomplete and forged information: Scenario 1: Consider a partner G, who can use the capacity of machines either to produce goods to be sold externally at high pro3t or to produce with moderate return the quantity ordered by the partner H. If G decides to use the capacity externally, the ability to make a timely delivery in the Supply Chain is jeopardized. To hide the actual reasons for the late delivery, partner G pretends there has been some production retardation. In consequence partner G will deliver late and pay some penalty for non-performance to partner H. Note that this penalty only aKects the direct neighbor H. Nevertheless, the late delivery of partner G forces the remaining Supply Chain Partners I; J; : : : ; N to balance the lateness by their joint eKorts. Scenario 2: To attain an eKective coordination of the different 9ows, the Supply Chain Management depends on the degree of reliability of the reported data. The values of the attributes have to be carefully calculated and should be the result of detailed planning activities. Consider now what happens if partner G eschews the operating expenditure of installing an adequate information-processing and planning system. Typically, this breach of agreement will be hidden and partner G will claim the data to have the promised quality. If discrepancies occur, they will be explained as resulting from some non-predictable causes. In consequence the remaining partners are in an insecure position. The data

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Supply Chain Management

Reported Values of Attributes

Supply Chain Partners

67

Private Information

{Attr.1.1; Attr.1.2;....}

{Attr.2.1; Attr.2.2;....}

Private Information

Private Information

Partner 1

Partner 2

{Attr.n.1; Attr.n.2;....}

........

Private Information Partner n

Fig. 3. Information provision triggered by partner 2.

provided by partner G are often misleading, and therefore the remaining Supply Chain Partners have to react. They will generate some slack resources, like high safety stocks, etc. Altogether the inadequate quality of data causes additional and avoidable expenditures in the Supply Chain. With regard to these scenarios, one important question is, how to mitigate the problem of untruthful information or incomplete reporting. For this purpose the term untruthful information can be de3ned as the deliberate deviation from the data a decision maker used for his own informed decisions. As a result of the special organizational structure no hierarchically based directions can be established to warrant the truthfulness of reporting: the superordinated headquarters as a coordinating unit is missing. Otherwise, the spontaneous rearrangement by a price mechanism comparable to a coordinating tool in the scope of market organization is missing, too. This reveals the organizational structure of the Supply Chain to be a hybrid one [19]. Considering the decision structure in Supply Chains in more detail it can be recognized as a polycentrical one, i.e. local decision making units do exist. The parallels in the organizational structure of divisionalized companies (headquarters versus site managers) to the structure of the system Supply Chain (Supply Chain Management versus Supply Chain Partners) become obvious. Comparing hierarchically organized companies with this structure it is evident that divisionalized 3rms particularly operate polycentrically as well [20, p. 170– 184]: decision rights are delegated to the site managers of the decentralized divisions. In this situation the possibility of divergences in headquarters’ and divisions’ interests combined with opportunistic behavior may raise diJculties. If the allocation of scarce resources must be carried out by the headquarters, an incentive scheme is necessary to ensure the true delivery of information. Correspondingly, the maintenance of a Supply Chain needs general contractual conditions [21] to guarantee openly shared information and know-how [13]. Considering a supplier–buyer relationship (as the smallest possible Supply Chain), Corbett and Tang

[22] show by means of a principal agent approach how contracts could improve the performance of the Supply Chain. An extensive review of Supply Chain contracts is given by Tsay et al. [23] and Voss and Schneidereit [24]. They sum up as follows: “the literature still mainly analyzes contracts where two partners or partners at most two stages, either one upstream or one downstream from a given company, are considered” [24, p. 272]. Since these contracts are obviously incomplete they have to be supplemented by incentive schemes [25,26]. 5. The Groves Scheme To handle problems of allocation, various incentive schemes have been presented [27–30]. The so-called ‘Groves Scheme’ was originally developed by Vickrey [31], Clarke [32] and Groves [33], who explore the allocation of public inputs. The mechanism was transferred by Groves [34] and Groves and Loeb [35] to solve budgeting problems in divisionalized 3rms. In this context, its application is still under discussion [36–43]. The Groves Scheme has the property of motivating each manager to truthfully reveal the division’s pro3t so the headquarters can realize pro3t maximizing allocation. Due to the fact that these incentive schemes have their seeds in the 3eld of research on contracting approaches, in particular the principal agent theory, managers could be considered as agents, while the headquarters could be identi3ed as the principal. A review of approaches which have been developed with reference to the Groves Scheme is presented in Table 1. All models listed in the table are static (s), with a single exception: a dynamic (d) model developed by Kunz and PfeiKer [40]. The underlying data can be deterministic— as in most of the models—as well as stochastic [36,38,43, 45,47]. Some of the models include the so-called eKort of the divisions manager. The eKort comprises the job performance of the divisions manager in particular [36,38, 39,41,43,45,46]. Additionally, the resources mentioned can

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Table 1 Review of the Groves Scheme

Groves (1976) [34] Green/LaKont (1977) [44] Groves/Loeb (1979) [35] Harris/Kriebel/Raviv (1982) [45] Cohen/Loeb (1984) [46] Bamberg/Locarek (1992) [47] Banker/Datar (1992) [36] Locarek/Bamberg (1994) [37] PfaK/Leuz (1995) [38] Budde/G'ox/Luhmer (1998) [39] Kunz/PfeiKer (1999) [40] Luhmer (1999) [41] Kistner (2001) [42] Hofmann/PfeiKer (2001) [43]

Static/ dynamic

Deterministic

s s s s s s s s s s d s s s

x x x x x x x x x

Stochastic

x

x

x

x x x

x

To present the mode of action of the Groves Scheme the following notation is used:

m = (m1 ; : : : ; mn )

x x

x x

• informational asymmetries exist between the headquarters and the division managers; • the divisions compete with regard to a centrally administrated resource; • the relationship between the headquarters and the division managers is characterized by a divergence of interests; • the actors are assumed to behave opportunistically.

mj (bj )

Restricted capacity

Collusion

x

be both restricted and unrestricted. Recently, the resistance to collusion among diKerent divisions managers was explored. For this purpose Kunz and PfeiKer [40] expand this discussion by using a dynamic model. To complete the description of the table, the scope of application has to be speci3ed. The Groves Scheme was developed primarily to manage the allocation of unspeci3ed resources (r) [34]. Further approaches study the capital allocation (c) and in particular the budgeting within a company. The Groves Scheme has been applied to the planning of the production programme (p) by Luhmer [41], and to the allocation of emission allowances (e) by Kistner [42]. To stress the main focus, (a) indicates those contributions studying applications, while (f) denotes fundamental research. In this context Hofman and PfeiKer [43] address the cost of implementation of the Groves Scheme. All variants are substantially based on the approach of Groves and Loeb [35]. They used four basic assumptions:

n gj (bj )

EKort

number of divisions indexed j=1; : : : ; n; realized pro3t of division j if budget bj is allotted; reported pro3t-function of division j to the headquarters; vector of the n reported pro3t-functions;

x

x x

x x x x

x x x

x

x

bj (m)

Application

Main focus

r r r c/r c c r r r r c p e r

f f a f a a a/f a f f f a a f

budget allotted from the headquarters to the division j, subjected to the reported pro3t-function m of all divisions; cost function; speci3es the costs of the headquarters per period.

c(·)

The reward of the managers lj is a linear increasing function lj = j + j ABj with j ¿ 0 of the assessment basis:    ABj = gj (bj (m)) +  mi (bi (m)) i=j

−c

 n 

 bj (m) :

(1)

j=1

The reward consists of a 3xed amount j , the realized pro3t of the division j and the reported pro3ts of the other divisions which are weighted with a constant j . The headquarters determines j and j independently of the report mj . This permits them to regard divisions-speci3c realities or market conditions. The division managers get an incentive to realize maximum pro3t to increase their assessment basis and with it their reward. For reasons of motivation and fairness the realized pro3ts of the other n − 1 divisions have no bearing on the assessment basis of division manager j. The main result of the Groves Scheme is that it enforces not only the taking of optimal local decisions to maximize the division’s pro3t but also the ‘truthful’ communication to the headquarters. Reporting mj (·) = gj (·) is the dominant strategy, i.e. it is optimal if every division manager informs the headquarters truthfully, independently of the reports of the other managers [35, p. 228]. This becomes evident by the following presentation of the assessment

M. Feldmann, S. M%uller / Omega 31 (2003) 63 – 73

basis: ABj = [gj (bj (m)) − mj (bj (m))]  n  n    + mj (bj (m)) − c bj (m) : j=1

(2)

j=1

The incentive follows from the 3rst part [gj (bj (m)) − mj (bj (m))]. Obviously, if the reported pro3t is higher than the realized pro3t the assessment basis decreases. Alternately—if the reported pro3t is lower than the realized pro3t—the allotted budget and consequently the potential realizable pro3ts are reduced: the assessment basis decreases again. Against this background the overall pro3t of the 3rm will be maximized, since the jointly utilized resource was purchased and allocated with respect to the actually realized pro3ts of the divisions. The use of the Groves Scheme in the area of Supply Chains seems to be suitable for improving the information quality. But this devolution causes some problems. The 3rst diJculty results from the problem of how to identify principals and agents in Supply Chains with more than two parties: • Each supplier can be interpreted as a principal in regard to his buyers [22]. But in a Supply Chain with more than two parties these buyers are suppliers and vice versa. Therefore, a company A is simultaneously principal for company A + 1 and agent for company A − 1 moving upstream or downstream the Supply Chain. • Supply Chain Management cannot take the part of the principal, as there is no authority and no hierarchical in9uence on the decisions made by the Supply Chain Partners. Supply Chain Management has to ful3l a coordinating task, which only succeeds if the Supply Chain Partners accept this function. • Supply Chain Management cannot take the part of the agent, as this agent has simultaneously as many principals as there are partners in the Supply Chain. In contrast to the work of Bernheim and Whinston [48], these principals are not independent in their realized pro3ts, due to the sequential structure of the Supply Chain. In consequence neither the principal(s) nor the agent(s) can clearly be identi3ed, as the structure of the Supply Chain with more than two parties does not correspond to the principal agent relation. If current research focuses on the problem [22], the following shortfalls have to be mentioned [24]: • A supplier–buyer relation is considered, i.e. only the smallest possible Supply Chain (two parties) is investigated [23]. • The existence of one dominant (focal) party is assumed. • Contracts can only cover a few facets of the problem. The second diJculty results from the absence of joint pro3t. The ‘pro3t of the Supply Chain’ is a hypothetical construct

69

and not equal to the sum of the pro3ts of the Supply Chain Partners. The only way to measure the pro3t of the Supply Chain as a whole would be to compare the situation a priori (Logistic Chain) versus a posteriori (Supply Chain). Nevertheless, a mutual dependency among the Supply Chain Partners with regard to their individual pro3ts does exist, but due to the hybrid organizational structure, the Supply Chain Management does not have its own fund. A third diJculty results from the fact that the only joint resources are information. But in contrast to ordinary resources the use of information by one party does not diminish its availability to other parties. Therefore, information cannot act the part of the joint resource, which is generally stipulated in the Groves Scheme. If such a jointly utilized resource does not exist, no competition for a scarce resource exists. But in association with the mutual dependencies, the Supply Chain Partners have common objectives, e.g. the reduction of inventory, the reduction of rejects rates, the reduction of delivery times, the adherence to delivery dates and the expansion of the market share of the Supply Chain. Thus one possibility might be to replace the missing joint resource with one of the common purposes. In the following some modi3cations of the Groves Scheme for use in Supply Chains become necessary. The resulting mechanisms will be an incentive scheme which is merely abutted to the Groves Scheme. 6. An incentive scheme applied to Supply Chains In this section an example of how to develop a realizable incentive scheme is given, one which deals adequately with the hybrid organizational structure of the Supply Chain. To avoid the arbitrariness of a 3xed time horizon, we use order-based incentives. Note that each of these orders is an aggregated one that can include numerous similar items. In consequence every partner is simultaneously bounded by diKerent order-based incentives. The main idea is that every partner j = 1; : : : ; n has to settle a 3xed payment of contribution Zj , which can be increased by a variable penalty. Zj can be paid monthly or order related. The sum of these ‘Supply Chain contributions’ and penalties is utilized as follows: • Supply Chain Management is salaried

(lSCM ) and the residue of the contribution sum R = j Zj − lSCM is reallocated to the partners with regard to their percental deviation of expected value xje and realized value xjr of an attribute. • If the percental deviation of a company exceeds , a penalty has to be paid. For the sake of simpli3cation let  = 100. The level of the penalty depends on the magnitude of deviation. The penalty is allocated to the 3rms that have not caused any deviation at all. With regard to the kind of information asymmetry we act on the assumption of pre-contract information [36,38,43]. The time line, given in Fig. 4 clari3es this setting.

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M. Feldmann, S. M%uller / Omega 31 (2003) 63 – 73

Production t0

t1

t2

Evaluation of private information

Conclusion of contracts: e xj are provided to the SCM; Zj is paid

Providing of information by the SCM

Delivery; Realization of r xj ; Evaluation of the deviation; Payment of fine to SCP2 if required t2(2+n)

t3

…

t4

SCM is saleried; R is reallocated

Fig. 4. Time Line of the model.

In t0 the Supply Chain Partners evaluate their private information. In t1 every Supply Chain Partner places a contract with the Supply Chain Management and the two adjacent parties upstream and downstream the Supply Chain. The expected values of attributes of critical key chain factors are reported to the Supply Chain Management and the payment of contribution Zj is eKected. In t2 the Supply Chain Management analyzes this information and provides it to the Supply Chain Partners. In t3 the production of Supply Chain Partner 1 takes place and goods are delivered to the Supply Chain Partner 2 in t4 . The realized values xjr are evaluated. In this context it is very important to distinguish clearly between the two kinds of penalties involved. On the one hand there may be the 3ne which has to be paid to the next Supply Chain Partner if for instance the expected due date is missed or a smaller quantity is delivered than has been 3xed in the contract. On the other hand there may be the penalty which has to be paid additionally in the case of signi3cant deviations. Production and delivery will be repeated until the end of the Supply Chain is reached. If we consider n Supply Chain Partners, in t2(2+n) the Supply Chain Management is salaried and R is reallocated. The aim is to award those companies having no or small deviations and to 3ne those having large deviations. The philosophy of the incentive scheme is thus to substitute the reward with a reallocation of contributions and penalties for every order along the Supply Chain. For the sake of simplicity we stick to the ‘one attribute case’ and the ‘one order case’ only. The assessment basis ABj is 3xed as the ratio of the absolute value of the deviation and the expected value of the attribute. From  = 100 arises: ABj =

|xje − xjr | : xje

(3)

Note that positive and negative deviations are treated equally, as in both cases the remaining Supply Chain Part-

ners have to readjust their plans. If a company j causes no deviation, ABj equals zero. If deviations smaller than or equal to 100% occur, ABj is greater than zero and smaller or equal to one. If a deviation exceeds 100% the ABj becomes greater than 1 and the additional penalty has to be paid. These penalties and the remaining sum of the Supply Chain contributions R are used to reward all those partners who have reported reliable data, i.e. whose deviation was zero. To demonstrate the procedure in detail, the compensation function lj , i.e. the reallocation of contribution and penalties, is calculated as follows:   1n R(1 − ABj ) ∀j|ABj ¿ 0;

lj = (4)  1 R[(1 − ABj ) + i ABi ] ∀j|ABj = 0 n (ABi ) i

 with (ABj ) =

1

if ABj = 0;

0

else:

(5)

In the upper part of the compensation function lj , those 3rms which have reached a positive assessment basis, i.e. have caused a deviation, are considered. Note that in an extreme case (ABj ¿ 1) the company j will not receive any compensation lj , but it has to pay the additional penalty for excessive deviation. Moreover, if all Supply Chain Partners provide false information, the salary

of the Supply Chain Management will increase by R · j ABj . In consequence, there is an additional incentive for the Supply Chain Management. In the lower part of the compensation function lj , those 3rms which have caused no deviation, i.e. have reached an assessment basis that equals zero, are considered. The indicator function (ABj ) is used to count the number of companies which have not caused a deviation. The expression in squared brackets is necessary to reallocate the Supply Chain contribution plus the withheld amount of those companies whose ABj is greater than zero and smaller than one plus the penalties of those 3rms whose ABj exceeds one.

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If more than one attribute has to be considered, the incentive scheme can easily be adopted to deal with diKerent deviations simultaneously. Due to the fact that it is valid to 3x the amount of contribution according to individual attributes, those which are supposed to be more important can be allocated a higher contribution. This enables the Supply Chain Management to take order-individual weighting factors into consideration. 7. Characteristics of the incentive scheme As demonstrated above, the Groves Scheme has the property of combining two major incentives. The site managers are motivated to realize maximum pro3t and to report truthfully. In our modi3cation the 3rst incentive is taken into account indirectly. Supply Chain Partners have an intrinsic motivation to behave eKectively, as the performance of the Supply Chain in9uences strongly their own performance. If a company should decide to consistently report false values, our incentive scheme will not have a positive impact on providing the smallest possible values. But the other Supply Chain Partners and the Supply Chain Management will not accept a performance which is inferior to the performance known (best practice, earlier periods). Therefore an inherent incentive to perform well is given. If in addition the reward of the Supply Chain Management depends on the overall performance they will choose those attributes that are most critical to report. In consequence there is an incentive for the Supply Chain Management to identify the critical key chain processes and to compare the performance of each partner to the best practice. As a result of the existence of the Supply Chain Management as an independent organizational unit, they will pursue the objective of minimizing ineJciencies in the Supply Chain. The second incentive is taken into account by the Supply Chain contribution and the modi3ed assessment basis. To present the mode of operation, a numerical example for the one attribute case is given. It is supposed that R equals 700,000 and that the seven Supply Chain Partners expect and realize the values xje and xjr shown in Table 2. By a comparison of the lj , important characteristics of this incentive scheme are presented. In the 3rst scenario, given in the upper part of Table 2, the deviations of 3ve partners equal zero. Partners 6 and 7 cause some deviation, thus their reallocated amount is reduced with regard to the extent of their deviation. The retained amount of (100; 000 − 73; 333:33) + (100; 000 − 66; 666:67) = 60; 000 is allocated to the 3ve partners who have reported reliable data, thus their lj is 112,000. Comparing these outcomes to those given in the second part of Table 2, two modi3cations have been made. Partner 5 causes a deviation that is greater than 100% and has to pay the additional penalty of 13,333.33. As the deviation of partner 7 is 100%, no compensation at all is reallocated to this partner. The retained amount of (100; 000 − 73; 333:33)

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Table 2 The calculation of ABj in two scenarios Partner

xje

xjr

ABj

lj

1 2 3 4 5 6 7

10 20 12 10 15 15 3

10 20 12 10 15 19 4

0 0 0 0 0 0.2667 0.3333

112000.00 112000.00 112000.00 112000.00 112000.00 73333.33 66666.67

1 2 3 4 5 6 7

10 20 12 10 15 15 3

10 20 12 10 32 19 0

0 0 0 0 1.1333 0.2667 1.0000

159999.99 159999.99 159999.99 159999.99 −13333:33 73333.33 0.00

plus 200,000 plus the penalty of 13; 333:33 = 213; 333:33 is allocated to the four partners who have reported reliable data, thus their lj are enlarged to 159,999. The comparison shows: • The compensation of partner 6, whose deviation was not changed, is not aKected by the variation of deviation of the other partners. • An increase (decrease) of deviation leads to a proportional decrease (increase) of the compensation amount. • A tendency towards true information providing is constituted and is endorsed in the long run. In summary, only the Supply Chain Partner who provides true information can be sure of receiving 1=n R. If a Supply Chain Partner causes some deviation, the reallocated amount is reduced with regard to the extent of this deviation and those who have reported reliable data are awarded. Therefore, truthful information provision is a dominant strategy. Besides it is evident from formula (4) that the reward to the Supply Chain Management will increase if and only if all partners provide false information.

8. Conclusion In this paper the Supply Chain is de3ned as a system consisting of Supply Chain Partners and a separate organizational unit, the Supply Chain Management. The information-providing processes are discussed and reasons for de3cits are summarized. In this context the problem of deliberately reported falsi3ed data is highlighted. It can no longer be disclaimed that the problem of divergences of interests combined with informational asymmetries and the possibility of opportunism aKect the quality of

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information provided in Supply Chains. Therefore, instruments are needed to face this problem. On the basis of the organizational separation of Supply Chain Partners and Management the closely related structure and some parallelisms to problems of delegation and control in divisionalized companies are demonstrated. Due to the fact that existing incentive schemes are not adaptable, an incentive mechanism merely abutted to the well-known Groves Scheme is presented. This approach makes it possible to deal with the organizational structure of the Supply Chain and results in a tendency towards the provision of true information. This approach oKers an encouraging prospect for further research as “it is still open how much information companies are willing to share if more partners [than two] are included” [24, p. 272]. Furthermore it should be possible to incorporate companies specialized in managing Supply Chains, if the Supply Chain Management is well characterized as an independent organizational unit. To establish a ‘third part’ Supply Chain Management could be a major incentive, as the know-how of eKective Supply Chain Management would be shared.

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