Supplier Sustainability Assessments in Total-Cost Auctions

0

Author Information : Karca Aral, Whitman School of Management, Syracuse University
Damian Beil, Ross School of Management, University of Michigan
Luk Van Wassenhove, INSEAD

Year of Publication : Production and Operations Management (2020)

Summary of Findings : We analyze the value of supplier sustainability assessments in supplier selection and identify the buyer’s optimal supplier assessment policy given the characteristics of its business environment.

Research Questions : 1) How does the value of supplier sustainability assessments change depending on the buyer's business environment?
2) What is the buyer’s optimal supplier assessment policy?

What we know : Various versions of total-cost auctions are the gold standard in industrial procurement for supplier selection and have been a focal point in procurement literature. However, whether and how to incorporate non-price cost markups (such as results from a sustainability assessment) into the supplier selection process has not been answered so far. This paper takes a step back and address this fundamental issue at the heart of total-cost auctions.

Novel Findings : We characterize the value of supplier assessments in total-cost auctions - for which there has not been a formalization before. The analysis of how the value of supplier assessments change in response to the buyer’s business environment lends itself to some interesting results. Intuitively, the buyer should use sustainability assessments when facing a less sustainable supplier base. However, we find that the opposite may hold, and the buyer may derive higher value from conducting assessments when facing a more sustainable supplier base. We find that the presence of an outside option (e.g., internal production) alters the assessment policy significantly. We also explore other related settings, e.g., when the buyer finds it profitable to assess only a subset of her suppliers, and when the buyer does not ex-ante know how to convert assessment results to cost markups.

Implications for Practice : Sustainable procurement, although recognized by many as one of the most important levers of corporate social responsibility, is limited even within large publicly listed companies. The main reasons for this limited scope are the discretionary nature of sustainable procurement, limitations of guidelines, difficulties in assigning a dollar value to supplier sustainability, difficulties in evaluating the supplier sustainability levels, and supplier sustainability assessment costs. In our research, we identify how and when a firm should use supplier sustainability assessment, while also lowering its total cost. This research offers many implementable managerial insights for businesses on how to improve their own sustainability footprint, build better sustainable procurement policies and consequently lead to more socially responsible outcomes.

Implications for Policy: Corporations recognize the importance of sustainable procurement as one of the most important levers of corporate social responsibility. At the public policy level, many government agencies as well as United Nations identify sustainable procurement as crucial. However, sustainable procurement has so far been limited in practice. This research might help managers implement and improve sustainable procurement policies.

Full Citations : Aral, K.D., D.R. Beil, L. Van Wassenhove. Supplier Sustainability Assessments in Total-Cost Auctions. Production and Operations Management (Forthcoming).

Abstract : Buyers are increasingly pressured to ensure the sustainability of their suppliers, but they are also under pressure for low-cost procurement. To make a more informed procurement decision, a buyer can choose to invest in sustainability assessments, and select a supplier based on their price bids and cost markup terms informed by the sustainability assessments. However, sustainability assessments are costly, and whether to use them is at the discretion of the buyer. Hence, the buyer can instead choose to forgo the assessments and select a supplier based on price only. In this paper, we explore this tradeoff. We find that the value of assessments depends on the buyer’s business environment in some surprising ways. For example, although sustainability assessments are used to identify the suppliers’ sustainability levels, greater ex-ante variability and a decrease in suppliers’ average sustainability levels (e.g., facing a supplier base in a country with looser sustainability regulations) can decrease the value of sustainability assessments. We find that the presence of an outside option (e.g., internal production) alters the assessment policy significantly. We also explore when the buyer may prefer to assess only a subset of her suppliers. Although motivated by the use of sustainability assessments, our results are generalizable to settings where the buyer has the option to invest in total-cost assessments on her potential suppliers’ unknown, non-biddable, differentiator-type attributes.

Karca Aral Wang
Share.

Comments are closed.