MY SAY
CONTRACTS IN FOOD
SUPPLY CHAINS
The role of contracts in food supply chains can be
complex but selecting the right suppliers with the right
incentives is imperative, says University of Auckland
Business School expert Timofey Shalpegin.
In recent years, New Zealand
food supply chains have been
experiencing increasing pressure
for higher quality standards. The
number of food product recalls in
New Zealand more than doubled in
2017, and food products accounted for
more than one-third of the total product
recalls. At the same time, the number
of product recalls in other industries
largely remained stable.
The immediate reasons for recalls
vary but typically include undeclared
allergens (such as gluten, milk and
peanuts) or contamination with foreign
objects or bacteria. Although the root
causes for recalls can be more difficult
to investigate, one can usually attribute
them either to the internal quality
control failure or the supplier quality
problem. While businesses generally
understand how to improve their own
quality control process, it might be
rather challenging for them to make
sure their suppliers do the same.
The problem is not brand new. It’s
already been 10 years since the
development of the ‘Six Ts’ of supply
chain quality management in the food
20 SEPTEMBER 2018
industry. In a nutshell, this framework
claims it is important to make sure each
component or ingredient is traceable
to its origin, suppliers have their
documentation transparent, quality can
be tested in a timely manner, supply
chain members trust each other and
suppliers receive sufficient training.
Addressing each ‘T’ obviously
helps resolve quality issues, but it
requires substantial efforts from
every member of a supply chain.
The cornerstone problem is that not
everyone in the supply chain shares
the same incentives. There are two
main problems to solve related to the
incentive misalignment in a supply
chain: The first is to select the right
suppliers, and the second is to ensure
the suppliers have the right incentives.
Information Asymmetry
Selecting the right suppliers is
difficult because of the information
asymmetry. The true quality of the
supplier’s products alongside other
key information is known only to
the supplier itself. It might prove
to be excessively costly to perform
the necessary tests to reveal that
information for each potential supplier.
The most obvious solution is to rely
on ‘signalling’ mechanisms, as the
theory of incentives frames it. For
example, high-quality suppliers find it
beneficial to signal their quality through
certificates, awards or other customers’
reviews. While reading these signals
requires minimum effort for the buyer,
there are still possible concerns related
to the authenticity of reviews, value of
awards, and so on.
The more active and sometimes more
reliable approach to resolve information
asymmetry is ‘screening’. It implies
offering a supplier a menu of contracts
to choose from. If the menu is designed
properly, the supplier’s choice will
reveal the necessary information. For
example, suppose the missing piece of
information is the supplier lead time; as
this can be highly variable, the buyer
cannot infer the lead time based on
a single or a few deliveries, while the
supplier knows the long-time average.
The trick is to offer several contracts
with different levels of payment and
different specified lead times. If the
"The first is
to select the
right suppliers,
and the second
is to ensure
the suppliers
have the right
incentives."
THE TEMPRECORD DIFFERENCE
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