www.foodtechnology.co.nz 21
The best
practice
directs us to
performancecontingent
contracts.
contracts might not be the right choice
in this case, as the main focus is not
on screening missing information but
rather on incentivising the supplier to
exert higher efforts. It might be equally
impractical to induce higher efforts by
paying more for them, as they are often
unobservable.
The best practice directs us to
performance-contingent contracts.
These contracts specify different
payments to the supplier based on the
quality of the output rather than on
its efforts. Under this contract, higher
quality usually correlates to higher
payment, while low quality may incur
penalties.
It is not easy to craft the optimal
contract. On the one hand, the payment
to the supplier should increase rather
steeply in relation to quality so that
the supplier finds it profitable to work
harder to achieve a higher payment
level. On the other hand, a risk-averse
supplier may reject the contract if the
range of possible payments is too wide,
because the final outcome is also a
function of a number of random factors
beyond the supplier’s control.
Overall, managing supply chain quality
requires choosing the appropriate
contracts and calibrating those
contracts to make sure they work as
intended. It creates the right incentives
for everyone to improve the supply
chain and facilitates the implementation
of all the ‘six Ts’ of the food supply
chain: traceability, transparency,
testability, time, trust and training.
Timofey Shalpegin is lecturer and
curriculum director for operations
and supply chain management at the
University of Auckland Business School.
supplier chooses the contract with high
price and short lead time, it obviously
means the supplier expects the lead
time to be short in most cases, and so
this supplier might be a right choice for
the long-term relationship.
When designing the menu of contracts,
one needs to keep in mind that the
options should be such that the supplier
finds at least one of them profitable
and the supplier chooses the option
designed for that specific type of
supplier. Needless to say, each contract
should contain at least two parameters
such as price and time in the above
example.
Moral Hazard
The second problem is how to make
sure the supplier works hard to improve
its quality. Theory often refers to this
problem as moral hazard. A menu of
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