Art of the Supply Chain Deal

A negotiation model developed at the University of Maryland’s Robert H. Smith School of Business shows how supply chain networks can improve efficiency when manufacturers have different valuations or willingness to pay for the same component parts.

Yi Xu, associate professor of operations management at Maryland Smith, and Alper Nakkas from the University of Texas at Arlington describe their findings in Production and Operations Management.

Supply chains work best when buyers and sellers are matched effectively to trade and share the surplus. The goal is finding the equilibrium prices, where demand matches supply.

If all manufacturers have the same willingness to pay for a component part in limited supply, then the process is relatively straightforward. Sellers can push prices up to the homogenous valuation, and get all surpluses of the trades.

The bargaining process becomes trickier when manufacturers have different interests or willingness to pay for the same component part, and have different business relationships with sellers. The authors identify two main reasons why the discrepancies may occur.

First, manufacturers sometimes need the same component parts but not for the same reasons. “The end products could be totally different products or they could be similar products that have different values and margins and target different segments or markets,” the authors write. “As a result, the manufacturers’ valuations — or willingness to pay — on the component are different.”

Second, business relationships sometimes differ. Physical distance, geopolitical restrictions, technological compatibility and social ties all impact buyer and seller relationships.

Negotiators must adjust for the differences. “The suppliers cannot simply push the prices to a uniform level to capture all surpluses of the trades anymore because the manufacturers are now differentiated from each other in their valuations,” the authors write.

Their model confirms the importance of considering valuation heterogeneity when seeking supply and demand balance in complex supply chain networks. It also shows something else.

“Bargaining actually takes place in smaller subnetworks in a general supply chain network because firms may selectively bargain with a subset of firms with whom they are linked,” the authors write. “In other words, firms may strategically ignore some of their links in the network that are not useful for them to get a better deal.”

Finally, the model shows the importance of strong business relationships among buyers and sellers when valuation heterogeneity exists. “For a supply chain network to be efficient, we find that manufacturers with high valuations must be well connected,” the authors write.

Read more: The Impact of Valuation Heterogeneity on Equilibrium Prices in Supply Chain Networks, by Alper Nakkas at the University of Texas at Arlington and Yi Xu at the University of Maryland, is featured in Production and Operations Management.