Dual sourcing in the presence of quality uncertainty when consumers are fairness concerned

Abstract

Dual sourcing, a strategy frequently employed by original equipment manufacturers (OEMs), may result in ex-post quality heterogeneity among the final products. This heterogeneity is typically a result of the unpredictability of the production processes of various suppliers. When ex-post quality heterogeneity exists, a customer may feel unfairly treated when she pays the same price but gets a lower-quality product than that received by a peer customer. Our paper will investigate how these issues interact and impact the supply chain parties. In this study, we examine a supply chain in which an original equipment manufacturer sources from two suppliers and sells the final products to customers with peer-induced fairness concerns. The suppliers are ex-ante identical but may be ex-post heterogeneous with respect to the realized quality (either high or low) and quantity levels, with the quantity heterogeneity resulting from yield uncertainty: their production processes are unreliable and modeled by correlated proportional random yields. The suppliers compete on wholesale price for the OEM's order and the OEM decides the order quantities to each supplier. Customers are fairness-concerned and incur psychological disutility if they pay the same price as their peers but receive a product of inferior quality. We find that, when the degree of fairness concern becomes higher, the OEM is more willing to source from a single supplier. Moreover, suppliers' wholesale prices are non-increasing in fairness concern, and in particular, wholesale prices will be equal to their marginal cost in the end. Interestingly, as the consumer's fairness concern increases, we show that the consumer surplus first decreases and then increases.