Excessive Competition and Supplier Non‐Performance Risk: Trade‐offs in Reverse Auctions

Supplier non‐performance is an ever present problem for an original equipment manufacturer (OEM) buyer and past survey‐based research has shown that increasing supplier competition adversely affects their performance. Using a reverse auction setting in which supplier competition is determined by number ( n) of participating suppliers (bidders), we show how buyer's exposure to supplier non‐performance risk is influenced by n. In particular, we characterize conditions under which supplier non‐performance risk is increasing in n. We then formulate a buyer's decision on the optimal n for uniformly distributed costs that allows it to resolve its cost vs. risk trade‐off. We further investigate other strategies like dual sourcing, better screening, and lower threshold on acceptable bids, that the buyer can use, together with limiting n, to limit non‐performance risk and control its overall procurement cost. Managerially, our findings indicate that an OEM buyer procuring non‐strategic (non‐critical) components could increase its exposure to supplier non‐performance risk by leveraging too much competition, especially among small entrant suppliers. In such situations a buyer can manage its input cost and risk by limiting supplier competition.