Costly Enforcement of Quality Standards in Decentralized Supply Chains

Abstract

We consider a supply chain where the quality level can be observed by the buyer(s) only after the purchase is completed (experience good). If the delivered quality is below the levels agreed in the contract, the buyer(s) may take action to seek remedy, but this effort is costly. Obviously, this fact can be exploited by the seller. In the case of a single buyer, we show that the buyer may not be motivated to appropriate all the channel profits but, rather, is able to pay a higher purchase price in order to induce the seller to provide higher quality. The set of purchase prices that support trade split into different regions. We identify regions where counterintuitive behavior is exhibited, for example, the buyer prefers higher purchase price, while the seller prefers lower purchase price. For the case of more than one buyer, we examine and contrast the behavior of two remedy regimes: In the case of individual enforcement, each buyer must work individually to enforce her own quality. In the case of joint enforcement, all buyers benefit from enforcement by a single buyer. We examine the externalities that arise in this supply chain and identify how the market share, enforcement costs and purchase price affect the quality level.