Coordinating Supplier Under Agency Effects

The paper [51] considers the agency effect and provides an example where supplier and buyer coordination affect set-up cost at the supplier. The buyer requires a product from the supplier at a fixed rate D per unit time. Demand is met from finished-goods inventory maintained by the supplier. Shortages are not allowed. Production is assumed to be instantaneous, but there is a production set-up cost and an inventory-holding cost, both incurred by the supplier. 

In this context, the buyer is the principal who pays for the work and decides how much to help the supplier. The supplier is an agent who knows specifics regarding production and his capability (which is unknown to the buyer). The set-up cost depends on the buyer s specifications, which in turn, depend on the buyer s resource commitment, x, and on the supplier s set-up capability, p. Thus the unknown supplier s capability creates an agency problem. The agent chooses the production lot size and thus influences buyer costs. The set-up cost will be denoted by The supplier s decision is the production lot size, X2- The 

The supplier will choose the optimal lot size x that minimizes his costs. Thus the corresponding supplier cost would be /2DhK xi, f)). Suppose that the setup consists of a number of steps, N x, (fi), that depend on agreed-upon product specifications and supplier capability. In addition, suppose that the cost of each step depends on suppliet capability, s 4 ), i.e., K x, 4 ) = N x, 4 ) X s 4 ). 

Given the description above, buyers would tend to provide more assistance in a substitutes relationship than in a complements relationship. This is the result in [51]. The example above su ests that buyers should consider the tradeoff between involvement with the supplier and its impact on the information rent, i.e., the difference in cost performance across suppliers with different capabilities. If buyer involvement flattens the cost curve across suppliers, that is, decreases cost differences across supplier capabilities, the relationship is one of substitutes, and it may 

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