Network adopts incentive contracts to reveal an unreliable supplier’s

Network
robustness and decentralized system are two important issues for the
integrating supply chain manager to manage when engaging in virtual
manufacture. In the social aspect, suppliers’ trust and fear affect network
performance (Škulj, et al. 2014). In supply chain
management, risk management in a decentralized system is crucial. In the real
world, the integrating supply chain manager—the distributor—manages his suppliers’ difficulties to
enhance his social preferences and therefore the business model based on
networks—virtual manufacture—is potentially robust. Conversely, virtual
manufacture for the distributor who is as a network orchestration is sustained through mitigation of
the supplier’s supply risks and resolving the difficulty in supplier’s
production (Li & Fung, 2017).

To complete a new product order from
a brand owner in a supply chain, a distributor is often faced with the dilemma
of sourcing quantities from an entrant supplier. An entrant SME supplier, with
lower cost in production, is privileged with respect to its cost and production
information regardless of whether it is a sourcing member in a distributor’s
“sourcing pocket.” In addition, a SME supplier inherently lacks funds when
receiving an order from the distributor. From a distributor’s perspective, when
receiving an order from a brand owner, he necessarily helps the SME supplier
borrow funds and considers supply risk, a term that refers to the
characteristics of an unreliable supplier; additionally, the distributor
applies a second reliable supplier as dual sourcing strategy for mitigating the
supply risk of the unreliable supplier. Thus, the distributor builds a credit guarantee mechanism with dual
sourcing strategy that the distributor adopts incentive contracts to reveal an
unreliable supplier’s attribute to manage the distributor’s supply risk.

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Li and Fung (www.lifung.com) is a well-known company that provides consumer goods design,
development, sourcing and distribution services. The company built its global
network to create an efficient and effective supply chain that provides
high-volume, time-sensitive goods to brand owners worldwide. Past, Li &
Fung buys the raw materials processed in the supplier’s factory, meanwhile
supervisors sent by Li & Fung monitor the production in supplier’s factory
such that Li & Fung is able to run business in “smokeless factory”
(Magretta, 1998). Quoting 2016 annual report from Li & Fung (Li & Fung,
2016): “In 2016, we continued to shift the strategic focus of our compliance
work from offering auditbased services to remediation and capacity-building
services.” The transition on the strategy in Li & Fung is more aggressive
and agile such that Li & Fung considers the supplier’s deficiency and try
to solve it. To resolve cash-constrained SME supplier’s difficulty, Li and
Fung, being as guarantor, is more familiar with supervising suppliers who borrow
funds from a financial institution; therefore, the financial institution and
members of the supply chain—such as suppliers and brand owners—benefit from the
customer value provided by Li and Fung. From Li and Fung’s perspective, when
the company helps its suppliers borrow money to fulfill the order that it has
outsourced, the characteristics of those suppliers—which likely are small and
medium enterprises (SME)—must be assumed by Li and Fung.

The SME sector plays an important
role in economic growth, especially in Asian countries. SMEs also create a
considerable number of employment opportunities and generate a certain impact
on a country’s economic development. The
Economist has noted that India’s many SMEs are a key driver of economic
growth and national advancement (The Economist, 2010). Thus, SMEs have a
considerable macroeconomic impact in most Asian and developing countries is
considerable. In microeconomics, the role of SMEs in these countries is often
as a supplier dominated by his buyer—a distributor—in a supply chain: the SME
is a follower; on the other hand, SMEs as a price taker attracts buyers
outsource the order in lower cost. Although cost-effective SMEs are attractive
and sought by a distributor who is as a leader or orchestrator in a supply
chain, a distributor may resolve SMEs’ difficulty and investigate its SME
supplier’s characteristics to mitigate a distributor’s supply risk.

Despite these positive
contributions, SMEs often suffer financial difficulties. An SME does not need a
large amount of capital to establish itself, but it may not have sufficient
working capital when it begins to process orders. Shortage of funding in a firm
not only decreases the buyer’s order quantity but also slows the firm’s
development (Rantanen, 2011). Therefore, finding a way to support SME financing
is an enterprise operation, a supply chain operation and a national economic development issue.

As a high-risk and low-profit
borrower, SMEs rarely obtain loans from financial institutions unless they have
a considerable amount of credit (Ahmed and Chowdhury, 2009; Srinivasa Raghavan
and Mishra, 2011). The natural characteristics of SMEs almost involve acquiring
a substantial amount of credit to obtain loan funds. To overcome this obstacle,
an SME may find methods for funding. In this study, with a funding shortage or
capacity constraint supplier, a credit guarantee mechanism is established in which a distributor with a great
deal of credit guarantees an unreliable but cost-effective supplier that money
will be found.

From the distributor’s (buyer’s)
perspective, supply risk is an issue of concern in supply chain risk. Among the suppliers,
characteristics such as disruption rate, fulfillment rate, and cost vary
because of the suppliers’ core competence in their industries. The supplier’s
production process may suffer from defect such that the unit production cost
varies (Yang et al., 2009) and the output may not satisfy the buyer’s order
before deadline. To obtain benefit from an unreliable but cost-effective supplier,
a distributor is suggested to mitigate the risk of delivery quantities from the
supplier such that the distributor reveals the attribute of a supplier.
Disclosing the supplier’s attribute not only benefits distributor in operation
level but also aligns with corporation’s strategic level. For example, William
Fung (Li & Fung, 2017), Group Chairman in Li & Fung, has announced that
vast connection of suppliers enable Li & Fung to resolve the brand owner’s
orders and to provide better customer values under Li & Fung’s new
Three-Year Plan (2017-2019). In our research, we focus on discussing suppliers’
tactical plans for order allocation related to the variety of supplier
disruption and cost uncertainty in managing both operational and disruption
risk. The distributor representing Li and Fung engages in various executions of
his strategy based on the variety of his suppliers’ characteristics.

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