The economic impact of inter-organizational information systems on supplier-manufacturer relationships: the interaction of industry structure and IOS design.

• Author: Plice, Robert K.
• Position: Report

1. INTRODUCTION

   1.1 Motivation and Research Question

   The increasing use of Internet-enabled technologies for integrating supply-chain information systems has been accompanied by efforts to develop online marketplaces, business-to-business (B2B) exchanges, and other varieties of inter-organizational information systems (IOS). The establishment of these electronic marketplaces--in addition to improvingefficiency and reducing search costs--has implications for competition and the distribution of market power. One reason for these economic effects is that an IOS can moderate the impact of asymmetries in the distribution of information between buyers and sellers. This paper develops a theoretical model to explore such information-related effects of IOS design in a setting characterized by varying levels of competition on both the upstream (selling) and downstream (buying) sides, but with the buyers relatively concentrated in comparison to the sellers. From an industrial- organization standpoint, this situation is typical of a supply chain where outsourced subassemblies are brought together at a manufacturer's site. This often occurs in durable-goods manufacturing industries, where oligopolistic downstream manufacturers purchase heterogeneous inputs from distinct supply industries.

   Manufacturers and their suppliers have numerous motivations for establishing an electronic marketplace in this environment. One objective is to facilitate the efficient exchange of trade-related documents; another is to reduce inventory requirements by tightly coupling the manufacturers' and suppliers' production systems. If the IOS is capable of simultaneously handling trading functions for multiple buyers and sellers, it introduces the possibility that consolidated information--collected at the centralized trading platform--can be shared, thus revealing transaction prices and quantities simultaneously for all market participants. We explicitly focus on the economic effects that may arise from such information sharing, and hold constant any efficiencies in searching or inventory reordering.

   The social and economic consequences of establishing an IOS in this setting has been the subject of extensive discussion within regulatory agencies and the business press(Foer, 2001; Federal Trade Commission, 2000). One controversial issue is that an IOS may make information regarding who is trading with whom and at what price available to either the buyers or the sellers, and that participants might use it to enable cartels within their industries. Thus, an IOS might facilitate collusion and give rise to anticompetitive outcomes by constraining output levels and increasing prices. This clearly runs counter to the intent of anti-trust policy. However, there is another information-related effect that is not unambiguously negative from a social-welfare perspective. This stems from the ability of an IOS to moderate the pricing power that sellers gain by having private information regarding their own costs. We will consider the interaction of these two impacts and develop an overall view of the social-welfare implications of centralized information collection and disclosure by an IOS. This approach will give insights that are more nuanced than would be obtained by considering the anti-competitive possibilities alone, and will lead to the conclusion that a blanket anti-trust prohibition on centralized information collection and disclosure may have the unintended consequence of reducing output levels and increasing prices. Such an anti-trust stance might serve to reduce, rather than increase, social welfare.

   To see how an IOS might moderate the impact of the suppliers' private cost information, consider the market setting examined in this paper, where the IOS facilitates trading in complementary goods. An oligopolistic downstream manufacturing industry procures inputs from a number of upstream supply industries, each of which has an exogenously given industry structure. To simplify the analysis, the suppliers' marginal costs are taken to be constant with respect to output quantity but variable over time. The manufacturers' problem is to coordinate their purchases from the suppliers of complementary goods. To produce one unit of the final product the manufacturers must purchase an assembly kit, which consists of a set of distinct parts acquired from the upstream supply industries. Ideally, after procuring the kits and assembling them into units of final product, there should be no parts left over and both the manufacturers and their suppliers should be operating at profit-maximizing output quantities (as determined by their respective marginal costs and the demand functions they face). We apply the term market clearing to a level q of final output at which these conditions are satisfied.

   If the manufacturers knew the cost structure and the nature of competition within each supply industry, they would be able to solve this problem analytically. Without such knowledge, however, they must make use of what they can observe from the market. That is, as the suppliers' marginal costs unfold over time, the manufacturers must observe changes in the quantities of parts that come forth at various prices and use that information to make adjustments to their own output levels. The inefficiency attendant to the manufacturers' inability to calculate directly a solution to the coordination problem will entail some penalty, which will be borne by the manufacturers themselves, by their suppliers, or by the downstream consumers of the final product. The model presented here will provide a means of evaluating the distribution of this penalty and will illuminate the value obtainable from an IOS when used as a mechanism for coordinating supply-chain purchases of complementary goods.

   The following research questions summarize the focus of our investigation:

   * What IOS information collection and distribution policies are consistent with the establishment of a market-clearing equilibrium level of output?

   * In the presence of private cost information, how does an IOS affect prices, trading quantities, and social welfare?

   * How does the level of industry concentration among manufacturers and suppliers interact with these outcomes?

   We turn next to a brief review of existing literature in this area. In Section 2 we then develop a model of manufacturer-supplier interaction that captures the industry setting and the nature of the coordination problem. In Section 3, we use the model to show that an IOS can be designed to solve the coordination problem, and we characterize the equilibrium solution. We then characterize the equilibrium conditions that must hold under any alternative solution to the coordination problem without an IOS. In Section 4, we analyze these results, comparing the welfare of manufacturers, suppliers, and society when coordination is accomplished with an IOS to coordination without an IOS. Additionally, we examine the effects of industry concentration on these results, and show how different IOS information-collection and disclosure policies can change the outcomes. In Section 5 we provide some interpretive insights regarding IOS design, ownership, and regulation.

   The analysis will show thatan IOS can lead to increased welfare for manufacturers and for downstream consumers when correctly designed, but that the impact on suppliers will vary depending on the relative levels of industry concentration. The information-collection and disclosure policy of the IOS is key to achieving these results. With too little disclosure the social-welfare benefits of the IOS are not realized, and with too much disclosure the welfare of the manufacturers, suppliers and society will be reduced rather than improved.

   1.2 Relationship to Existing Literature

   Previous research has highlighted the importance of information-sharing in interorganizational systems. Lee and Whang (2000) describe ways in which information sharing between trading partners can have beneficial implications for supply-chain management, including coordinating the output decisions on the upstream and downstream sides to mitigate the bullwhip effect (Lee et al., 1997). Other papers have modeled the effects of sharing information about market demand between retailers and upstream suppliers(see, e.g.: Bourland et al., 1996; Chen, 1998; Gavirneni et al., 1999; Lee et al., 2000). These papers find information sharing to be beneficial. However, they do not deal with the effects of private information regarding suppliers' marginal costs, nor do they focus on the impacts arising from industry structure on the upstream and downstream sides. The majority of the papers focus on vertical information sharing by using a serial system that is isolated from horizontal competition or horizontal information transmission. Moreover, these analyses are not aimed specifically at the kind of information that may be collected and revealed by an IOS due to its nature as an intermediary that matches buyers with sellers of complementary goods.

   Research studies that focus explicitly on information sharing and its interaction with industry structure include Gal-Or (1986), who shows that when duopolists have unknown private costs, information sharing is a dominant strategy under Cournot competition while information concealment is a dominant strategy under Bertrand competition. Shapiro (1986) analyzes a setting closely related to that of this paper, namely one in which oligopolists have the option of joining a trade association that allows them access to rivals' private cost information. The results are consistent with Gal-Or, showing that cost-information sharing among rivals is a dominant strategy and that they would join an association that enables it. Significantly, however, consumer surplus is reduced by information sharing even as total surplus is increased, implying that producers are better off. In these prior studies, the...