What happens to a supply chain when the supplier, retailer, or both prioritize achieving their goals?
Professor Lucy Chen (National University of Singapore) and Professor Tang Qinshen (Nanyang Technological University) investigated this issue in their paper, ‘Supply Chain Performance with Target-Oriented Firms’. Their research sheds light on how the profit of the supply chain and its constituent companies are affected by target-oriented behaviour. According to Professor Qinshen, their work contributes new knowledge to the literature on supply chain coordination, as little research has examined how firms' goal attainment behaviours impact decision-making and performance.
Target-oriented vs. risk-neutral
The paper examines how a target-oriented retailer and/or supplier affects the profitability of a supply chain. It considers a supply chain with one supplier who sets the wholesale price and one retailer who responds with an order quantity. The wholesale price is substantially lower than the retail price and refers to the price charged for a product sold in bulk to the retailer, as opposed to what is charged to consumers.
In a supply chain, the two firms, —the supplier and the retailer, —can be risk neutral or target oriented. A risk-neutral supplier (retailer) decides the wholesale price (order quantity) to maximise their expected profit. In comparison, a target-oriented supplier (retailer) sets the wholesale price (order quantity) to maximise the ability to achieve their profit target. For target-oriented firms, the researchers adopted the CVaR-satisficing measure to evaluate a firm’s ability to attain a target.
“The CVaR-satisficing measure is utilised to inform managers and decision-makers of the firm’s risks or determine the order quantity needed to reach their target. Based on the firm’s target, the measure can determine whether one must be conservative or ambitious to achieve the target set”, said Professor Qinshen.
The paper analyses four types of settings or scenarios wherein a supplier and retailer are target oriented (T) and/or risk neutral (N). For example, TT means that both the supplier and the retailer are target-oriented.
Is it better to be risk neutral or target oriented?
Well, the benefits to being risk neutral or target oriented differ for suppliers and retailers. In this case, the researchers found that a supplier or retailer is always hurt by its target-oriented preference but can benefit from its trading partner’s target-oriented preference. For instance, a risk-neutral supplier can sometimes reap profits if the retailer is target-oriented (NT), while a target-oriented supplier always performs better with a target-oriented retailer (TT) than a risk-neutral retailer (TN).
They also discovered that when both firms are target-oriented (TT), a decentralised supply chain can have a better expected profit than a centralised system. However, a centralised supply chain is preferred when both firms are risk neutral (NN). Above all, whether a firm and supply chain can benefit from having a target-oriented partner depends on how ambitious the retailer or supplier is in setting the target.
The Dark Side of the Supply Chain
Despite the many benefits of being target oriented, this approach can put a firm in a less favourable position than their trading partners or leave them open to exploitation by their trading partners. For instance, a target-oriented or risk-neutral supplier will set a higher wholesale price for target-oriented retailers because it knows its retailers will order more quantities to reach their target profit.
Hence, the retailer or supplier should adopt the target-oriented decision criterion cautiously and consider strategies that might prevent them from being manipulated by their suppliers or retailers. One way is for the retailers to reveal an outside option or alternative supplier.
Professor Qinshen commented, “By revealing their outside option, it signals to the suppliers that the retailers have several other suppliers or sources. Hence, the suppliers cannot manipulate the retailers by setting a higher wholesale price as the retailers can always switch to their alternative or backup suppliers.”.
Retailer type misidentification
Another strategy retailers can consider is to hide their target-oriented preference from their suppliers. This results in retailer type misidentification as the supplier believes their target-oriented retailer is risk neutral and vice versa.
First, let us consider scenarios where the supplier is risk neutral. If the risk-neutral supplier mistakes their retailer as being risk neutral, the researchers found that the supplier will set a lower wholesale price when the retailer’s order quantity is higher. This suggests that the retailer will benefit from this misidentification, whereas the supplier will be hurt by the retailer. When the risk-neutral supplier wrongly identifies their retailer as target-oriented, the supplier will act differently to how they would with a risk-neutral retailer and set a different wholesale price. However, the retailer will respond in a risk-neutral way; hence, it will not benefit either party or the supply chain.
Next, the researchers compared scenarios where the supplier is target oriented. When a target-oriented supplier mistakenly treats the retailer as risk neutral, the supplier sets a lower wholesale price, resulting in a larger order. Interestingly, suppliers and retailers can sometimes be better off when this happens. Conversely, when a target-oriented supplier mistakes the retailer as being target oriented, the wholesale price is higher, and the order quantity is lower. Notably, a target-oriented supplier can sometimes benefit from this misidentification.
“While it is common for businesses to aim for specific goals or targets, our research cautions decision-makers about the potential risks of this approach, as it can be exploited by their trading partners. However, from the perspective of the whole supply chain, a company’s focus on targets can improve efficiency”, said Professor Qinshen on the implications behind his research.
Note: This research paper was published by the Manufacturing & Service Operations Management, on 3 December 2021.
Tang Qinshen is an assistant professor in the Information Technology & Operations Management (ITOM) division at Nanyang Business School, Nanyang Technological University. He joined ITOM in 2020. Prior to that, he was a research fellow at the Institute of Operations Research and Analytics, National University of Singapore.
This research paper is a joint work with Professor Lucy Chen from the National University of Singapore.