Experimental & Behavioural Economics Seminar - Professor Elena Katok (UT Dallas)

Title: Supplier Competition and Cost-Saving Incentives

Abstract: We consider suppliers exerting cost-reduction effort before competing in a procurement auction that has reservation prices set by a buyer. The theoretical study of Li and Wan (2017) suggests that supplier competition may or may not lead to lower supplier effort, depending on the effort observability, while making supplier effort observable always reduces effort, hurting the buyer’s profits. Following this study, we empirically investigate suppliers’ effort decisions as well as buyers’ reservation price, considering the impact of supplier competition and effort observability. We find that buyers exhibit social preference behaviors: Compared to the theoretical best reply, reservation prices are too high in the case of unobservable effort, and they are too flat, even increasing under dual sourcing, in response to observable supplier effort. In addition, supplier competition has a positive behavioral effect on supplier effort; that is, facing competition, suppliers invest more aggressively than needed based on the equilibrium strategy. Both buyers’ behavior in reservation prices and suppliers’ competition behavior in effort choices drive up supplier effort, indirectly and directly.