A quality game between producer and supplier: The effect of the contract terms and the quality related variables on product quality

This paper examines the effect of the producer–supplier quality contract parameters and the magnitude of the quality related variables on the quality of the final products. Our analysis focuses on the parties' equilibrium behavior in a quality game environment where the supplier should choose among the two production technologies, one requiring high cost but producing high quality parts and the other requiring low cost but producing low quality parts and where the producer should decide whether to do the inspection of the parts. The game framework is employed to depict the potential conflicts existing between the producer and the supplier because the producer can not observe the supplier's choice and each party wants the other to bear the cost of producing high quality products. In our model, we specifically consider the competitive situation where the producer competes with a firm producing the same product. We employ the market share attraction model to incorporate the competitive situation and completely characterize the equilibrium by using the Nash equilibrium concept for the game solution. Our results show that the equilibrium depends on the contract terms and the magnitude of the quality related variables. Compared to the non-competitive situation, the probability of producer's inspection and the probability of supplier's choosing the high quality technology increases in a competitive situation. This is true even when the competitor's quality is lower than the producer's lowest. As a result, the quality of the final product increases in a competitive situation. And as the failure cost borne by the supplier increases, the probability of choosing the high quality technology increases and the probability of inspection decreases. The net effect of this results in the decrease of the final product quality.