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Risk Ownership in Contract Manufacturing

McDonough School of Business, Georgetown University, Washington, D.C. 20057
College of Management, Georgia Institute of Technology, Atlanta, Georgia 30308
Technology and Operations Management, INSEAD, 77305 Fontainebleau, France
su8{at}georgetown.edu
beril.toktay{at}mgt.gatech.edu
enver.yucesan{at}insead.edu

We consider a supply chain where a contract manufacturer (CM) serves a number of original equipment manufacturers (OEMs). Investment into productive resources is made before demand realization, hence the supply chain faces the risk of under- or overinvestment. The CM and OEMs differ in their forecast accuracy and in their resource pooling capabilities, leading to a disparity in their ability to minimize costs due to demand uncertainty. We consider two scenarios in which this risk is borne by the OEM and CM, respectively. We determine which party should bear the risk so that maximum supply chain profits are achieved. We investigate the effectiveness of premium-based schemes in inducing the best party to bear the risk, and conclude that they function well despite information asymmetry when double marginalization is not very high.

Key Words: information asymmetry; risk ownership; contract manufacturing; resource pooling
History: Received: April 1, 2002; accepted: November 16, 2006.