Managing Social Responsibility in Multi-tier Supply Chains

We consider a three level supply chain in which a Tier 2 supplier sells to a Tier 1 supplier, which in turn sells to a downstream (Tier 0) firm. The Tier 2 supplier potentially violates social and environmental standards, resulting in harm to the Tier 0 firm. Both the manufacturer and Tier 1 supplier can exert effort to improve the responsibility of the Tier 2 supplier. We show that the manufacturer’s optimal strategy is one of extremes, consisting of either direct control (only Tier 0 exerts effort) or delegation (Tier 1 is induced to exert effort by Tier 0). The former strategy is potentially less efficient than the latter, but avoids the moral hazard problem inherent in delegation. Under the manufacturer’s optimal strategy, we find that increased pressure from external stakeholders (consumers, NGOs, and governments) can decrease supply chain responsibility when the manufacturer shifts from a direct approach to a delegation approach. Lastly, we demonstrate that appropriately designed non-compliance penalties charged to the Tier 1 supplier or the manufacturer when a Tier 2 violation occurs can both coordinate the supply chain and eliminate perverse responses to external pressure, though such penalties may face challenging hurdles to implementation in practice.