Friday, July 25, 2014

Competing on Quality and Supply Chain Networks

Quality was recognized already by Feigenbaum in 1982 as the single most important force leading to the economic growth of companies in international markets. Also, Buzzell and Gale in 1987 in their book, The PIMS Principles: Linking Strategy to Performance, recognized that, in the long run, quality is the most important factor affecting  business unit's performance and competitiveness relative to the quality levels of its competitors.

So, why are we seeing so many examples of quality failures?

Recent shocking examples have included  revelations, as reported by Bloomberg News, that consumers in both China and Japan of hamburgers, chicken nuggets and other products that they bought from some of the world’s best-known food chains -- including McDonald’s Corp. (MCD) and Yum! Brands Inc. (YUM)’s KFC and Pizza Hut -- were made with spoiled meat.The meat came from a Chinese unit of OSI Group Inc., which is based in Illinois and is a global food processor. Allegations have included also that meat that was dropped on the ground was then scooped up and processed further. 

Or what about the case of Takata Corp., which is the world's second largest supplier of airbags for automobiles. There are ongoing recalls called for by four Japanese car manufacturers and even BMW since the airbag inflator may rupture and injure passengers and may also catch on fire.

And as K.R. Karu eruditely wrote on the Sparta Systems blog on the topic of supplier quality management (and lack thereof): A few years ago, a single supplier of a peanut based ingredient single handedly impacted the entire peanut based food industry.  This company supplied a contaminated ingredient that was used by over 390 separate companies in nearly 4,000 different peanut products, including peanut butter, candies, oils and more.  The results were over a billion dollars in losses to the industry, with peanut butter sales dropping by more than 25%, regardless if the ingredient was used in the product or not.  More important than these financial losses was the danger to the consuming public.  Over 700 people were made ill by this contamination, and there were 9 confirmed related deaths.  The supplier was forced to close their doors, and criminal charges were brought against the executives of this company.

The biggest asset of any company is its reputation and quality failures, as we are seeing now even with General Motors, and the faulty ignition switch, can have lasting impacts and affect the bottom line because of costly recalls.

Quality management and how to compete on quality in a supply chain context are topics that we have been deeply researching over the past several years. Whether it is food or pharmaceuticals or consumer goods such as cars or high tech products, we all want and deserve for our hard-earned cash to have the quality in our products that we expect and have paid for.

Our first paper on product quality, in which we considered a single firm, with a focus on pharmaceuticals, with multiple manufacturing plants and multiple possible outsourcers, was: Pharmaceutical Supply Chain Networks with Outsourcing Under Price and Quality Competition, Anna Nagurney, Dong Li, and Ladimer S. Nagurney, International Transactions in Operational Research 20(6): (2013) pp 859-888. In this paper we captured the cost of disrepute, or the cost associated with a firm's reputational loss due to inferior quality. In this paper the demand for the product was fixed at the various demand markets.

In the next paper, which we have just revised, and expect to hear good news on soon, 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, we captured competition among multiple firms who compete in quantities and quality and also have the options of outsourcing the production and delivery of their products, which are differentiated by brands. Here, again, we assumed fixed demands and also included the cost of disrepute.

In the paper, A Dynamic Network Oligopoly Model with Transportation Costs, Product Differentiation, and Quality Competition, Anna Nagurney and Dong Li, Computational Economics 44(2): (2014) pp 201-229, which was just recently published, we demonstrated how firms adjust their quality levels and quantities over time through a dynamic adjustment process until an equilibrium is achieved. The consumers now respond to the quality levels and quantities of the products through the prices that they are willing to pay for the differentiated products.

And, in a paper, just published last week, Equilibria and Dynamics of Supply Chain Network Competition with Information Asymmetry in Quality and Minimum Quality Standards, Anna Nagurney and Dong Li, Computational Management Science 11(3): (2014) pp 285-315, we investigated, in a supply chain network context, the impacts of information asymmetry. If producers know the quality of their products, but consumers only know the average quality, what can happen? This kind of quality information asymmetry was introduced (but not in a supply chain context) by George Akerlof in his famous lemons paper in 1970 (which was rejected 3 times by journals and finally published and he was awarded the Nobel Prize in Economic Sciences in 2001 for this work). Akerlof's paper is: "The market for `lemons': Quality uncertainty and the market mechanism," Quarterly Journal of Economics, 84(3), 488-500. Akerlof shared the Nobel with Professor Joseph Stiglitz and Michael Spence. In our paper, we show how critical it is for policy-makers to work together on the imposition of minimum quality standards so that the do-gooders don't get cheated in terms of profits and so that consumers also don't lose out.