Design and Analysis of Two-Stage Procurement Processes with Competitive Suppliers

This paper considers the typical two-stage sourcing problem faced by a manufacturer who has made the strategic decision to outsource the manufacturing of a key product to one or more competing suppliers. We develop a model of this two stage process in order to better understand how the manufacturer can design the sourcing process to enhance profitability by (1) designing the qualification stage to ensure that the firm only sources from qualified suppliers and (2) encouraging competition among the suppliers in the supplier selection and order allocation stage. Of particular interest are the interactions between the two stages of the sourcing process, i.e., the impact that decisions regarding supplier qualification have on the process of supplier selection and allocation. We start by considering a model in which the buyer has perfect information on supplier qualification. For this model, we study how the buyer should set the qualification standards in order to maximize her profits, which include both procurement costs and the costs associated with insufficient supplier quality. We then extend this model to consider a setting in which the buyer has imperfect information on supplier qualification and thus must exert costly effort to learn about supplier capabilities. We seek to determine the optimal qualification standards, the optimal amount of effort to be exerted in the qualification process and the appropriate tolerance for error in the qualification process, and to understand the complex interactions between these decision variables.