The Role of Governance in Supply Chains

1. The Role of Governance in Supply Chains Paulo Gonçalves MIT System Dynamics Group 30 Wadsworth St., E53-358A Cambridge, MA 02142 Phone 617-258-5585 paulog@mit.edu

2. Motivation • Intel faces enormous challenges in managing its supply chain • Must produce the right products at the right time in the right amount • In environment of rapid growth, increasingly complex technology, short product life-cycles, long manufacturing cycle times and high demand variability • At the same time, Dell the supply chain leader can require • Just-in-time delivery, short windows for order changes or cancellations (and no penalties) • High supplier flexibility in product customization

3. The problem • Traditionally strong supply chain players have used their leadership position to own advantage • Self-interested actions can increase own benefits at the expense of other players • Manufacturers would like to ensure a steady flow of orders and maximize volume purchases • Retailers would like to minimize inventory holding and obsolescence costs, maintaining quality level • Locally rational behavior can lead to inefficiencies

4. Research Questions • Does it always make sense to act in a narrowly conceived self-interested way to try to maximize profits in a supply chain? • Under what conditions does cooperation and risk sharing among supply chain players make sense? • What cooperative policies in a supply chain are most appropriate to improve firms’ performance?

5. Purpose and Goals • To develop a system dynamics model addressing the issue of governance in a real supply chain that incorporates several features of real supply chains often not considered in models in other literatures, including: • Explicit behavior rules, instead of myopic and intertemporal optimization • Inventory shortages and capacity constraints • Double ordering dynamics and lost sales dynamics • Locally available and distorted information • To develop a set of policies to improve system performance

6. Relevant Literature • System dynamics • Beer game dynamics (Forrester) • Experimental research (Sterman, Diehl & Sterman, Croson) • Microeconomics • Industrial Organization (Spencer, Williamson, Hart) • Game theory, incentives and contracts (Tirole) • Operations management • Multi-echelon inventory management (Clark &Scarf, • Supply chain management (Lee at al.,Cachon & Lariviere)

7. Dynamic Hypothesis • Narrowly conceived decisions, which are locally beneficial and boundedly rational, aimed at maximizing firm performance may, in a highly complex system, generate unanticipated side effects that are not in the best interest of the firm.

8. The Approach • Develop small concept models for comparative purposes providing • Deep understanding of limitations and assumptions of exiting models in other literatures • Basis for integrated model and realistic conditions • Test integrated model in one or two case studies • PC Industry: Intel - Dell • Consumer goods industry: P&G - Walmart

9. A microeconomics perspective Double Marginalization • Focus on the financials, complete neglecting the physics • Feedback poor, no dynamics, stationary demand • Unlimited capacity, no delays, perfect information (price and demand), fully rational behavior, single period maximization

10. An Operations Management Perspective • Relaxing old assumptions makes models more realistic, still very complicated. Approach allows: • Decentralized control • Multiple decision makers • Locally rational behavior • Leading to inefficiencies dealt with contractual arrangements to improve system performance • Specifying decision rights: RPM, Quantity fixing • Pricing schemes, minimum purchase • Quantity flexibility, buy-backs • Allocation policies, lead times • Quality