Supplier Centrality and Auditing Priority in Socially Responsible Supply Chains

Problem definition: A key question in socially responsible supply networks is as follows: When firms audit some, but not all, of their respective suppliers, how do the degree centralities of the suppliers (i.e., the number of firms to which they supply) affect their auditing priority from the viewpoint of the firms? To investigate, we consider an assembly network consisting of two firms and three suppliers; each firm has one independent supplier that uniquely supplies to that firm and one common supplier that supplies to both. Academic/practical relevance: Most supply networks are characterized by firms that source from multiple suppliers and suppliers that serve multiple firms, thus resulting in suppliers who differ in their degree centrality. In such networks, any negative publicity from suppliers’ noncompliance with socially responsible practices—for example, employment of child labor, unsafe working conditions, and excessive pollution—can significantly damage the reputation of the buying firms. To mitigate this impact, firms preemptively audit suppliers although resource and time considerations typically restrict the number of suppliers a firm can audit. Consequently, it becomes important to understand the impact of the degree centralities of the suppliers on the priority with which firms audit them. Methodology: Game-theoretic analysis. Results: Downstream competition between the firms drives them away from auditing the supplier with higher centrality, that is, the common supplier, in equilibrium, despite the fact that auditing this supplier is better for the aggregate profit of the firms. We show that this inefficiency is corrected when the firms cooperate (via a stable coalition) to jointly audit the suppliers and share the auditing cost in a fair manner. We also identify conditions under which joint auditing improves social welfare. Managerial implications: We have two main messages: (i) individual incentives can lead firms to deprioritize the auditing of structurally important suppliers, which is inefficient; (ii) the practice of joint auditing can correct this inefficiency.