Reexamination of all-or-none inspection policies in a supply chain with endogenous product quality

This note studies the optimal inspection policies in a supply chain in which a manufacturer purchases components from a supplier but has no direct control of component quality. The manufacturer uses an inspection policy and a damage cost sharing contract to encourage the supplier to improve the component quality. We find that all-or-none inspection policies are optimal for the manufacturer if the supplier's share of the damage cost is larger than a threshold; otherwise, the manufacturer should inspect a fraction of a batch.