Pricing Games and Impact of Private Demand Information in Decentralized Assembly Systems

This paper analyzes decentralized assembly systems under asymmetric demand information and sequential contracting. We reveal new insights on the value of contract type (price-only versus complex), demand information (complete versus asymmetric) and contract sequence (first mover versus second mover) to different players. Our results for the basic model show that: (1) Complex contracts increase the suppliers’ aggregate profit; however, individual suppliers do not necessarily benefit from a complex contracting equilibrium. We identify the conditions under which each supplier benefits from such an equilibrium. (2) Eliminating information asymmetry is not always beneficial for the suppliers as obtaining information may bring only marginal value and hence, may not be realistically justified. Furthermore, a downstream supplier may prefer information asymmetry to complete information, especially when demand variability is moderate. (3) Unless there is a high demand risk, the first-mover advantage is prevalent when the assembler is a price-taker. We extend our basic model to analyze two additional scenarios. First, we study cases where the suppliers may offer contracts of different complexity. Beyond enriching our understanding of contract choice in decentralized assembly systems, such variations enhance the analysis beyond the standard methodology of principal-agent models and utilize solution techniques from optimal control. Second, we analyze the situation where the suppliers may possess different levels of information on demand under complex contracts. We show that an upstream supplier always benefits from a downstream supplier’s superior information. However, the additional information may decrease the downstream supplier’s profit, especially when the forecast variability is low compared to the total demand variability in the system. Our results for the basic model and its extensions confirm that studying interactions between suppliers, specifically under different contract types and information structures, in assembly systems presents rich opportunities for future research.