A negotiation-based algorithm to coordinate supplier development in decentralized supply chains

•We study how to coordinate supplier development in a decentralized supply chain.•An optimal control problem is formulated to rigorously characterize the solution.•We show that indirect supplier development causes inefficiency in supply chains.•The system-wide optimum can be achieved using direct supplier development.•We present a negotiation-based algorithm to coordinate the investment decision.

In this paper, we study supplier development in a decentralized supply chain with a single manufacturer and a single supplier. Because supplier development usually requires relationship-specific investments, the allocation of investment costs is a critical issue faced by participating firms. Referencing the relational view, we first investigate the effects of relationship-specific investments on the efficiency and effectiveness of supplier development. Next, we formulate and solve a continuous time optimal control model characterizing the decision to invest in supplier development and show that the supplier's incentive to participate in supplier development critically depends on the manufacturer's share of investment costs. The findings of our numerical analysis indicate that although the subsidy can lead to significant improvement in supply chain performance, subsidizing a constant share of investment costs is not always economically reasonable from the manufacturer's point of view. Thus, we provide a negotiation-based algorithm that assists the manufacturing firm in gradually increasing the share of investment costs to ensure an efficient level of subsidy, resulting in both perfect supply chain coordination and a win-win situation.