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...involved contribute to the overall quality of the goods and services they provide, and coordinating quality-improvement efforts becomes one of the key issues. Although researchers in operations management have long realized the importance of operations beyond the walls of a firm and explored various management issues for better coordination along supply chains, research on quality improvement has been largely limited to operations inside the walls of a firm.
In the limited work on quality improvement in supply chains, it is often recommended that firms control their suppliers' quality through supplier selection (or vendor selection) and cost penalties. Under supplier selection, a firm selects its suppliers from a set of candidates, or switches from one supplier to another based on certain criteria such as quality as well as price, capacity, and responsiveness. With cost penalties, a firm signs a quality-sensitive contract with a supplier and, when nonconforming units are detected, penalizes the supplier financially according to terms specified in the contract. Supplier selection and cost penalties, when properly utilized, provide incentives for a supplier to improve its quality. These approaches, although effective, leave quality improvement to suppliers.
In practice, many brand-name companies take more proactive roles in quality improvement. Consider Techtronic Industries (TTI), a leading provider of home improvement and construction tools with a portfolio of well-known brand names such as Home-lite, Milwaukee, and Ryobi. The company has a total of about 60 suppliers located in various cities in China. Typically, TTI provides the design of a product, and a supplier produces the product according to the design specifications. TTI treats product quality as its core competitive advantage and actively seeks the causes of the defects whenever it receives a complaint about a product from a customer. If the problem is attributed to a supplier's imperfections, the supplier is required to correct the problems by repairing or replacing the product. Thus, many suppliers try to improve their quality in various ways. They upgrade the technology and hire skilled employees to improve their production processes. Oftentimes, they also devote resources to acquiring and maintaining ISO 9000 certificates, which attest to their routines and procedures put in place for manufacturing, delivery, service, and support; and ultimately improve the overall quality of their products. However, even if a complaint is resolved, the damage to the product's reputation, and hence TTI's market share, is done. For instance, in the U.S. market, which contributes 80% of TTI's revenue, the Consumer Product Safety Commission collects and publishes defects or failures of electric power tools at its website www.cpsc.gov, which can have a significant influence on customers' purchasing decisions. To ensure high product quality, TTI often forms and sends quality teams to help its suppliers improve their quality. The quality teams train their employees, analyze and improve production processes, sample and inspect finished products, and enhance quality awareness of their senior management. That is, TTI makes direct investments in its suppliers' quality improvement.
Several other companies, including Chrysler, Eastman Kodak, Motorola, Texas Instruments, and Xerox, have jointly established the Consortium for Supplier Training (Trommer 1996). Intel chooses some of its suppliers to participate in its quality programs (Roos 2001). GE sets aside an annual budget of $200 to $400 million for its Six Sigma program, a significant portion of which is for the sole purpose of improving its suppliers' quality via high-impact projects and training programs (Snee and Hoerl 2003). However, little research has been done to understand the roles of different parties in quality improvement and investigate how firms can coordinate quality-improvement efforts in a supply chain. This paper aims to analyze this new approach of investing in suppliers' quality improvement. Specifically, should a firm invest in a supplier's quality improvement and, if so, how much? Will a supplier improve its quality? How do the decisions on quality improvement interact with operational decisions, e.g., ordering and production decisions?
To answer the questions raised from an economic perspective, we consider a supply chain with a buyer and a supplier. The buyer designs a product and owns the brand name, while the supplier produces the product for the buyer. The production process at the supplier can yield nonconforming units, which incur some quality costs that are shared by both parties. Therefore, both parties have the incentive to invest in supplier's quality improvement. In addition, the buyer needs to decide on the size of orders placed with the supplier, and the supplier decides on the production lot size, which affects the number of nonconforming units, and hence the quality costs. Here are our main findings.
1. Being a leader and proactive in quality improvement indeed makes the buyer better off. If the buyer desires a high quality level, he cannot cede the responsibility to the supplier in many cases. The buyer's decision about quality improvement has an impact on the profitability of the supplier and the supply chain. Furthermore, the buyer may want to make his involvement in quality improvement explicit in the contract negotiation phase to encourage supplier's participation.
2. At most one party needs to invest in quality improvement, but limited resources such as budget or technology may make it necessary for both parties to exert quality-improvement efforts. At high quality levels, better management of operations (e.g., production lot sizes in our setting) may be preferred to direct investment in quality improvement.
3. Supplier selection should be based on suppliers' quality levels as well as the buyer's share of the quality costs. A low-quality supplier could make an effort to improve her quality if selected and thereby relieve the buyer of the need to make an investment. If the buyer's share of the quality cost is relatively high, he may instead prefer a high-quality supplier even if this requires him to take over the quality improvement effort.
4. If the buyer needs more than one supplier to fulfill his customer demand, and all suppliers are identical, he should allocate his demand to as few suppliers as possible to minimize his operational and quality-improvement efforts. That way, the buyer can focus his investments on fewer suppliers and a supplier is more likely to exert quality-improvement efforts if she is allocated with a higher demand.
The remainder of this paper is organized as follows. We review the relevant literature in the next section. In [section]3, we analyze decision making in both the integrated and decentralized setting and provide managerial insights gained from the analysis. We further explore decision making and managerial insights under various scenarios in [section]4 followed by concluding remarks in [section]5.
2. Literature Review
There exists a significant amount of literature that addresses quality issues arising in production and inventory systems. Most of the work assumes that the average yield of a production process is given (see Yano and Lee 1995 for a review of the early work, Wang and Gerchak 1996, Nahmias and Moinzadeh 1997, Bollapragada and Morton 1999, Grosfeld-Nir et al. 2000, and Rajaram and Karmarkar 2002 for some recent work). Among those that explicitly model the generation of nonconforming units, Porteus (1986) studies a batch production process that, in each production run, may deteriorate and yield nonconforming units. He analyzes two means for quality improvement, reducing the speed of deterioration and reducing the setup cost of each production run. Rosenblatt and Lee (1986) consider a similar problem and examine how imperfections in a production process affect the decision on batch sizes. In their subsequent work, Lee and Rosenblatt (1987) study restoring a production process from deterioration by inspection and maintenance mechanisms. Porteus (1990) takes into account an inspection delay, i.e., a time delay in obtaining the result of each inspection, and analyzes its impact on batch sizes and inspection schedules. Lee (1992) considers wafer probe operations in semiconductor manufacturing with the objective of minimizing congestion on a critical resource, and illustrates the trade-off between the setup cost and the quality cost.
There is a growing literature on quality management in supply chains. Reyniers and Tapiero (1995) study the impact of a contract on a supplier's quality level and a buyer's inspection policy in both a noncooperative and a cooperative game. Tagaras and Lee (1996) investigate the trade-off between quality and costs in vendor selection, as well as the interaction between the quality of input materials and that of internal manufacturing processes. They argue that vendor selection should be dependent on internal operations. Starbird (1997) studies the impact of a buyer's inspection policy on its supplier's quality level and identifies conditions under which the supplier's optimal quality level is zero defects (i.e., 100% conformance). Baiman et al. (2000) analyze how information available for contracting affects the efficiency of a supply chain, in which the supplier is responsible for quality enhancement and the buyer for quality appraisal. Lim (2001) considers a supply chain in which a producer purchases parts from a supplier but has incomplete information about the supplier's quality level. She shows that the producer can design a contract to maximize its profit while deriving true information about the quality level. However, none of the papers allows a buyer to invest in its supplier's quality improvement, which is the focus of our research.
3. Model Description
We consider a buyer who designs a product and owns the brand. He offers a contract to a supplier that will produce the product and deliver it directly to retail outlets or the buyer's warehouse. The supplier's production process is imperfect and can yield nonconforming units. There are quality costs associated with each nonconforming unit, which may include the cost of customer goodwill loss, shipping and handling costs, and material and labor costs. The supplier who is responsible for the manufacturing of the product often bears most of the warranty costs. The buyer as the brand owner suffers due to the damage to his reputation and future market share for each nonconforming unit sold in the market. (1) In practice, the supplier may attribute certain quality problems to the buyer's design of the product and insist that the buyer share certain warranty-related costs in the event of a nonconforming item, while the buyer may associate the same problems with the supplier's production and transportation systems and demand a...
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