Supplier Incentives and Resource Constraints under Uncertainty

Sudhi SESHADRI, Singapore Management University


Procurement in environments of cost uncertainty and asymmetric information require special arrangements such as the linear incentive contract. Usually the buyer is motivated to make investments that can relieve temporary supplier resource constraints during the procurement. Special problems arise, however, due to interactions between investments in suppliers and the risk-incentive trade-off achieved by the incentive contract. A cost signaling model is proposed to overcome these problems, where a supplier offers an equity share in the profit from the incentive contract to the buyer in return for a priori investment. The equity share signals the supplier's private cost information, and forms the basis for the buyer's investment decision. Under equilibrium the buyer can expect to recover the entire amount provided to the supplier through his or her share of the profit.