Friday, August 9, 2013

Supply Chain Game Theory and Product Quality -- It's About Your Reputation

Quality of its products is the basis of a firm's reputation.

And, needs for improvements in product quality drive innovation.

Quality is what we, as consumers, seek in the food that we eat, the clothes that we wear, the toys that our children (and, perhaps, even we) play with, the latest high tech products that we crave, the life-saving and prolonging medicines that those in need take, the cars that we drive, the planes that we fly in,  the homes that we live in and the appliances that we use, and, of course,  the air that we breathe.

As supply chains have become more global the news about quality product shortcomings around the world is reaching beyond borders and is shocking from the Bangladesh disasters and fast fashion to the adulteration of milk and infant formulas   to the heparin adulteration which led to a pharmaceutical identity crisis, to the mysterious food-borne illness from lettuce served at Red Lobster and Olive Garden, to name just a few. Moreover, the manufacturing processes themselves may lead to the worsening of the quality of the air and the environment as has been well-documented, especially, most recently in China..

Many firms are identified by their products and their products are their brands. 

Game theory can illuminate not only which supplier a firm should select but also whether to outsource or to manufacture/produce the product in-house and the associated impacts on costs, revenues, and profits.

But game theory can help firms to do even more in terms of quantifiable analysis and evaluation and this is why game theory is so powerful. It enables us to  quantify the loss in a firm's reputation through a disrepute cost if the quality of the delivered product is substandard.

It is essential to capture the possible loss in reputation as we have done in two papers. In the first paper, we focused on the pharmaceutical industry, and in the second, we captured competition among firms with outsourcing options, which is applicable to many different industries. In the latter, firms compete in quality and the firms that they possibly outsource to compete in prices and quality, as well. However, it is the original firms' reputation that gets damaged if the outsourced product is lower in quality.

The first paper noted above is  Pharmaceutical Supply Chain Networks with Outsourcing Under Price and Quality Competition, Anna Nagurney, Dong Li, and Ladimer S. Nagurney, in press in the International Transactions in Operational Research. Here we assume that the original firms have perfect quality, whereas the firms that they outsource to compete on quality but they seek to maximize their profits.

The second paper is  A Supply Chain Network Game Theory Model with Product Differentiation, Outsourcing of Production and Distribution, and Quality and Price Competition, Anna Nagurney and Dong Li. In it, we propose both static and dynamic supply chain network game theory models, whose solution provides each original firm with its optimal in-house quality level as well as its optimal in-house and outsourced production and shipment quantities that minimize the total cost and the weighted cost of disrepute, associated with lower quality levels and the impact on a firm’s reputation. The algorithm that we propose and implement tracks the dynamic trajectories in discrete time of the evolution of the product flows, quality levels, and prices over space and time until the equilibrium state is achieved. We provide numerical examples that illustrate the model and computational framework.

Also, in our paper, A Dynamic Network Oligopoly Model with Transportation Costs, Product Differentiation, and Quality Competition, Anna Nagurney and Dong Li, in press  in Computational Economics, we developed a new dynamic model of Cournot-Nash oligopolistic competition that includes production and transportation costs, product differentiation, and quality levels in a network framework. The production costs capture the total quality cost, which, in turn, can also represent the R&D cost. With better R&D, firms may ensure that the consumers get the quality that they expect and deserve.

The above supply chain game theory models that we have constructed also allow for policy evaluations and the investigation of such a question as:  What if a government would impose a minimum quality standard for a type of product?

Pretty cool how game theory can illuminate so much in terms of operations in the real world!