Quality contracts with the supplier's private product manufacturability information

In the production outsourcing environment, the manufacturer may also outsource the product design to the supplier. In this case, the supplier determines not only the quality effort during the manufacturing process but also the ease degree of production, which comes into being during the product design process and is referred to as product manufacturability. Both the manufacturing effort and the product manufacturability (either low- or high-type) may be the supplier's private information. In this paper, we examine the manufacturer's separating equilibrium piece rate quality contract (the quality penalty is based on the supplier's absolute quality performance) and tournament quality contract (the quality penalty is based on relative performance) under asymmetric product manufacturability information. With the piece rate quality contract, the supplier with low-type product manufacturability exerts a lower manufacturing effort than the first-best level and obtains the reservation payoff, while the high-type supplier spends the first-best effort and earns a positive information rent. By contrast, with the tournament quality contract, the low-type supplier obtains an information rent, while the high-type supplier only gets the reservation payoff. Finally, we find that the manufacturer prefers the piece rate (tournament) quality contract when the manufacturer believes the supplier is high-type with a low (high) probability by a numerical example.