Delegation vs. Control of Component Procurement Under Asymmetric Cost Information and Simple Contracts

A manufacturer must choose whether to delegate component procurement to her tier-1 supplier, or control it directly. Due to information asymmetry about suppliers’ production costs and the use of simple quantity discount or price-only contracts, either delegation or control can yield substantially higher expected profit for the manufacturer. Delegation tends to outperform control when (1) the manufacturer is uncertain about the tier-1 supplier’s cost and believes that it is likely to be high; (2) the manufacturer and the tier-1 supplier know the tier-2 supplier’s cost or at least that it will be high; (3) the manufacturer has an alternative to engaging the tier-1 and the tier-2 suppliers, such as in-house production; and (4) the firms use price-only contracts as opposed to quantity discount contracts. These results shed light on practices observed in the electronics industry.