Darden School Professor Shows How Hiding Information Helps Business Rivals

CHARLOTTESVILLE, Va., March 25, 2011 /PRNewswire-USNewswire/ -- Is knowledge always power when it comes to beating out the competition? Not necessarily, according to Darden School of Business Professor Gal Raz. His research, "Supply Chain Sourcing under Asymmetric Information," shows that when small suppliers keep their cost information private, they actually give power to bigger suppliers competing with them for the same contract. His work appears in a recent issue of the journal Production and Operations Management.

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Typically, large suppliers and small suppliers compete with each other over contracts to sell components to manufacturers. Raz and his co-author Ozalp Ozer, associate professor at the University of Texas at Dallas School of Management, introduce their study using the example of Intel, a technology giant, competing with the small and lesser known SigmaTel, for Apple Computer's business. Apple Computer Inc. was developing a new, flash memory-based iPod several years ago and needed a supplier for the device's flash memory chip. In order to win the contract, Intel had to consider Apple Computer's contract option with SigmaTel before making an offer.

The dynamics behind pursuing the contract with Apple Computer would be different for each supplier. SigmaTel could grow their reputation by working with a company like Apple Computer and the work would constitute most, if not all, of SigmaTel's business. This would give Apple Computer the upper-hand in negotiating the contract terms. Intel, on the other hand, would be able to share their expertise at a cheaper cost to Apple Computer and the work required would constitute only a small portion of Intel's business. This would place Apple Computer in a less advantageous position during contract negotiations.

"We look at the problem through the lens of the large supplier who wants to win the contract," says Raz. "We study various information scenarios to determine the impact of having information about the small supplier's production costs and the manufacturer's processing costs on the big supplier's strategy."

They examine the questions: What is the optimal contracting strategy that the larger company should follow? How does the information about the small company's production cost affect the profits and contracting decision? How does the existence of a company like SigmaTel affect profits?

"One finding was that the big supplier benefits when the small supplier keeps its production cost private if the manufacturer's processing cost is public or if it is private but likely to be high," Raz says.

This is the case because when the smaller company keeps its costs private, the position of its much larger competitor is strengthened.

"The big supplier can anticipate the manufacturer's potential benefit for having the small supplier. Hence, the big supplier designs a sole-sourcing contract that leaves the manufacturer with a profit larger than it would have under any contract with the small supplier," Raz adds.

The team also found that while the bigger company benefits from the smaller one keeping its cost private, the total supply chain profits are independent of whether or not this cost information is private. Rather, this fact impacts the division of profits between the large supplier and the manufacturer, making the larger company better off and the manufacturer worse off.

"We found the results quite interesting, because it seems logical that having the most information possible would be better," says Raz. "But that isn't always the case."

Therefore, small suppliers may not be doing themselves a favor when they keep their cost information private. By the way, in 2006, SigmaTel did lose the contract with Apple Computer to Intel along with substantial market value. In 2008, SigmaTel was acquired by Freescale Semiconductor.

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SOURCE University of Virginia's Darden School of Business