abstract
A conventional wisdom in industry and academia is that firms suffer from decentralized procurement. In this paper, we demonstrate an important and counter-intuitive benefit of procurement decentralization in a common setting where a firm with multiple divisions procures a durable good from a supplier. We start with a two-period model and obtain analytic equilibrium results on the supplier’s wholesale prices, and the firm’s procurement quantities and profits under procurement centralization and decentralization. These results show that the firm’s profit will benefit from decentralization if and only if the product is durable. We further show that the profit improvement always increases in durability and the number of divisions. To generalize the basic model with two periods, we design an iterative algorithm to compute the equilibrium results for any number of periods. Our extensive numerical simulations show the robustness of our analytic results and managerial insights.
6. Conclusion and future research
Industry practitioners and academic researches usually hold the convention wisdom that centralized procurement is better for firms. Decentralized procurement is typically viewed as underperforming because of disparate interests and mutual conflicts. This paper proves that such convention wisdom may be false. In particular, our study demonstrates that decentralization can actually prove to be useful when a firm with multiple horizontal divisions procures durable goods from an external supplier. With durable goods, there comes with time-inconsistency dilemma, which has been extensively studied in the literature (e.g., [15,30]). In this paper, we show that the dilemma of durable good procurement can be alleviated by seemingly inefficient division conflicts. Specifically, when a firm procures durable goods to sell them in distinct retail markets, it is better off to leave these decisions to respective division managers. Though the supplier generally tries to increase the wholesale prices to fight back, decentralized procurement strategy will encourage each division to purchase more in earlier periods and less in later periods as wholesale prices decrease. As a result, right sales quantities in each period end up with lower pricing between the firm and its supplier.
Our findings have several implications for durable goods procurement. First, our findings suggest that as long as the product is durable, horizontal decentralization can significantly enhance the profit of a firm with multiple divisions. This is a more practical means than contracts and arrangements as organization forms (centralization vs. decentralization) are more readily established and credibly observed. Second, our results highlight that the benefit of decentralization always increases in durability and the number of divisions. To some degree, this may strengthen the firm’s willingness to invest in durability and market segmentations, and thereby improving customer services. Third, our results suggest that some mechanisms of restricting sales quantities by pricing or strictly initial one-time supply may not achieve positive effects on firm’s profitability. Excessive restrictions on quantities will increase firm’s cost. However, although decentralization is appealing from the perspective of durable good procurement, we also stress that full decentralization is not desirable.
