Supplier bottleneck and information dissemination

Abstract

This paper investigates the capacity decisions of complementary suppliers who produce different components of a final product. The suppliers solicit private forecast information from a buyer who has more precise information regarding the market as compared to the suppliers. In this context, the lowest capacity built among suppliers—termed as effective capacity—represents the bottleneck of a supply chain, which in turn determines the throughput of the entire channel. The standard analysis based on full rationality posits that the capacity decisions of suppliers are based on their prior belief of demand, with no consideration of the buyer's information dissemination or the number of peer suppliers. We test the predictions experimentally, and our laboratory observations reject the prediction of rational model. Then, we develop a behavioral model based on suppliers' heterogeneity in the processing of demand information provided by the buyer. Our behavioral model indicates that suppliers lower their capacity levels when the number of suppliers increases, thereby exacerbating the supplier bottleneck. While the buyer may exaggerate the market demand to ensure abundant supply, interestingly, the inflation can benefit suppliers by increasing their capacity levels. In this manner, the inflation of the buyer can serve to mitigate the supplier bottleneck, thereby resulting in a win–win outcome for both the suppliers and the buyer.