Contracts in a procurement supply chain with intermediation: Combating collusion in price competition

Abstract This paper provides a novel explanation for collusion between two procurement service providers (PSPs) and investigates effective contracts to collapse tacit collusion. By analyzing a benchmark contract with compensation designed solely by a retailer, we find that compensation alone has no effect on intensifying PSPs' competition such that the PSPs still fully control the total service fee by increasing/decreasing the commission fee imposed on manufacturers. To effectively abate collusion, we propose two potential tactics to intensify PSPs' competition: setting a reserve price and introducing a direct sourcing channel. We find that both are effective in combating PSPs' pricing power. The underlying force is that both tactics create credible threats to walk away from this transaction with PSPs, and hence, both incentivize PSPs to lower the total service fee. However, the retailer reduces total welfare to improve its own profit: (a) when the retailer sets a strategic reserve price and the product's value in the market is moderate or (b) when the retailer introduces a direct channel but its search capability is weak. By comparing these two proposed contracts, we find that the retailer should introduce a direct sourcing channel when the product's value is high.