Abstract. Keywords: information supply chain, market mechanism, outsourcing, demand forecasting

Transcription

1 Journal of the Assocaton for Informaton Systems Specal Issue Collectve Outsourcng to Market (COM): A Market-Base Framework for Informaton Supply Chan Outsourcng * Fang Fang College of Busness Amnstraton Calforna State Unversty at San Marcos fangfang@csusm.eu Zhlng Guo Department of Informaton Systems, Unversty of Marylan, Baltmore County (UMBC) zguo@umbc.eu Anrew B. Whnston McCombs School of Busness The Unversty of Texas at Austn abw@uts.cc.utexas.eu Abstract Ths paper scusses the mportance of an a soluton to separatng the nformaton flow from the physcal prouct flow n a supply chan. Motvate by the neffcent eman forecast cause by nformaton asymmetry an lack of an ncentve among supply chan partners to share valuable nformaton, we propose a racally new framework calle collectve outsourcng to market (COM) to aress many nformaton supply chan esgn challenges. To valate the COM framework, we conser a supply chan wth one manufacturer an multple ownstream retalers. Retalers prvately acqure eman forecast nformaton that they o not have ncentve to share horzontally wth other retalers or vertcally wth the upstream manufacturer. We conser two alternatve market mechansms that can be use to outsource the nformaton-ntensve eman forecastng task for the whole supply chan. The specally organze market can be vewe as a cost effectve way of acqurng qualty nformaton that, at the same tme, algns nvual retalers ncentves to crebly share ther prvate nformaton. We further scuss the real worl mplementaton ssues nclung market esgn an the costs an benefts of propose solutons. Keywors: nformaton supply chan, market mechansm, outsourcng, eman forecastng * Sal March, T.S. Raghu, an Aay Vnze were the acceptng quest etors. Ths paper was submtte on January 3, 7 an went through two revsons. Volume 9, Issue 3/4, pp. 98-8, Specal Issue 8 Volume 9 Issue3/4 Artcle

2 Collectve Outsourcng to Market (COM): A Market-Base Framework for Informaton Supply Chan Outsourcng. Introucton Unarguably, eman forecastng plays a crtcal role n supply chan management. Companes now nvest aggressvely n software an consultng n orer to acqure more relevant nformaton an prouce better forecasts. However, n current practce, supply chan partners nepenently manage ther forecastng actvtes an are extremely unwllng to sclose ther forecasts to other supply chan partners n orer to mantan ther own compettve avantages. The overall supply chan oes not beneft from nvual companes nformaton acquston. Even though researchers have aresse the benefts of nformaton sharng n supply chan management, how to prove the chan partners wth the correct ncentves to conuct ther eman forecastng actvtes n a more cost-effectve way an n a way that benefts the entre supply chan remans a challengng task. Ths paper proposes a general framework to nuce collectve nformaton acquston an eman forecast sharng usng market mechansms. We suggest that outsourcng the forecastng actvty to a ecate market can mprove effcency an wllngness to share, an we call ths novel framework collectve outsourcng to market (COM). In a supply chan, the uncertan market emans of nvual frms are usually rven by some macro-level, nustry-relate or economy-relate envronmental factors. Invually manage eman forecasts cause supply chan neffcency n three ways. Frst, supply chan partners nvest repeately n acqurng hghly correlate eman nformaton, whch ncreases the overall cost of eman forecastng. Secon, the qualty of nvual forecasts s generally sub-optmal, snce nvual companes have only lmte access to nformaton sources an lmte ablty to process them, whch results n less accurate forecasts an neffcent ecson makng. Thr, but not least, frms vary n ther capablty to prouce goo qualty forecasts. Sgnfcant nformaton asymmetry leas to strategc plays an has been reporte to be the man reason for many coornaton falures, such as the well-known bullwhp effect (Lee et al., 997). In ths paper, we propose an nnovatve way to reorganze the eman forecastng process so as to beneft the whole supply chan. Our propose COM soluton conssts of two key elements. Frst, we propose that companes collectvely outsource the process of eman forecastng, especally the correlate part of the eman, to a specalze nepenent thr party. The thr party can unertake the task, manage the buget an consultng resources for the companes, an ntegrate avalable peces of nformaton nto an overall accurate forecast. Secon, we propose that the nformaton thr party aopt market mechansms to create ncentve-algne nformaton sharng among the supply chan partners, prove trust nse the supply chan, an aggregate sperse nformaton from varous nformaton sources. The ea of aoptng outsourcng to nuce effcency s not new n supply chan practce. In a technologcal envronment characterze by rap nnovaton, orgnal equpment manufacturers (OEMs) outsource asset-ntensve proucton to contract manufacturers who cut OEMs costs, free up captal, an mprove prouctvty. Another nnovatve busness process outsourcng (BPO) applcaton s Venor Manage Inventory (VMI), wheren venors (the external servce provers) who specalze n specfc functonal areas perform those functons for a company more effcently at lower cost. Lkewse, the concept of BPO n supply chan management woul shft nformaton ntensve processes to external servce provers, wth the ntenton of mprovng ecson makng n frms wth lmte nformaton processng capabltes (Man et al., 6). Our propose COM framework buls on ths tren an suggests that outsourcng can collectvely mprove nformaton qualty n the nformaton sharng process an facltate supply chan coornaton. In our COM framework, supply chan effcency can be acheve both by economes of scale an by tappng the expertse an nvestments of a servce prover who focuses solely on that process. In aton, the collectve outsourcng framework requres frms to commt to nformaton sharng va the market rewar mechansm, whch s a challengng task when the eman forecast s prouce n-house. As to the mechansm that can be use to manage market-type relatonshps an encourage 99 Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

3 Fang et al./collectve Outsourcng cooperaton an effcency n the process of supply chan nformaton outsourcng, the precton market s one vable concept. Cowles (933) conclue that expert forecasters coul not mprove the accuracy of forecasts erve from the actons of a market, an other research fnngs have generally supporte ths concluson. In aton, some recent applcatons have valate the role of markets n effectve nformaton aggregaton, nclung nnovatons n fnancal markets, bettng on sportng events, an precton markets. Partcularly, a precton market s an emergng market type that s esgne wth the sole purpose of forecastng future events. Precton markets trae specally esgne contngent contracts whose payoff epens on the outcomes of certan future events. These markets are usually set up as onlne futures markets an have trang processes that essentally resemble those of exstng stock exchanges such as contnuous tme ouble auctons. Traers buy or sell contngent contracts base on ther prvate prectons of the future value of the contracts (.e., the outcome of future events). The market prce of the contngent contracts fluctuates accorng to the traers actvtes an ntegrates all the traers prectons nto an aggregate forecast. Prototypes of such markets were use n prectng the most recent presental electon outcome (the Iowa Electronc Market, an forecastng move sales (Hollywoo Stock Exchange Market, (Please refer to Wolfers an Ztzewtz (4) for a comprehensve revew of precton markets.) Hewlett-Packar has alreay poneere busness applcatons n sales forecastng an now uses nternal precton markets n several busness unts (Foroohar, 3). A hanful of large companes, such as IBM, Mcrosoft, an For, are eager to on market experments that utlze ther prectve power. The mpact of precton markets on scence an busness s becomng more an more event. In aton to the ouble aucton mechansms mentone above, some researchers have suggeste other types of precton markets where contngent contracts are explctly prce before the market opens. The prce takes nto account the fact that the traers nee to ncur costs to acqure goo nformaton, an the market rewars the traers f the nformaton s, n fact, of goo qualty. Chen et al. (, 4) have use logarthmc rewar functons to show that the market (combne wth other esgn features) can ntegrate nformaton when traers are rsk-averse or when traers nformaton has some correlaton. Fang et al. (7) have suggeste a specal famly of quaratc rewar functons that can reveal not only the traers prvate forecasts but ther belefs on forecast accuracy. Such a market mechansm can be aopte when traers have heterogeneous abltes an nonneglgble costs to acqure an process nformaton. Although fferent market rewar structures can be constructe to acheve the specfc nformaton acquston an aggregaton obectves, choosng the unerlyng market nstrument s a nontrval task. Guo et al. (6) have suggeste the use of a futures contract wrtten on a macro-level nex that wll affect the eman of all the retalers n a supply chan settng. The nnovatve ea of creatng a macro-level nex for the supply chan eman forecastng purpose has far extene the scope of current precton market applcatons. Ths paper extens Guo et al. (6) to a collectve outsourcng framework an carefully stues the role of the nformaton thr party n esgnng, managng, an mplementng proper market solutons. Ths paper also examnes the contons uner whch frms can use pre-prce bettng markets to prouce relable an accurate prectons n fferent busness envronments. More specfcally, we scuss an alternatve market esgn emonstrate n Fang et al. (7) to aress fferent nformaton elctaton an aggregaton challenges uner fferent nformatonal assumptons. Our maor contrbuton can be brefly summarze as a new supply chan outsourcng ntatve enable by an nnovatve market-base nformaton revelaton an aggregaton mechansm. We specfcally focus on one mportant challenge n the nformaton supply chan esgn the eman forecastng process that s tratonally conucte n-house an s vewe as prvate knowlege an a source of compettve avantage. Our market esgn proves supply chan partners wth an attractve venue to mplctly outsource ther eman forecastng functons. The COM framework s vewe as a cost effectve way to collectvely outsource such an nformaton-ntensve task an acheve consensus among supply chan partners n truthful an effectve nformaton sharng. Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

4 Fang et al./collectve Outsourcng The rest of the paper s organze as follows. Secton revews relate lterature. Secton 3 outlnes our COM framework. We frst llustrate the market mechansm esgn an emonstrate the value of collectve outsourcng n the nformaton supply chan usng a framework aopte by Guo et al. (6). We then exten our moel to a fferent nformaton scenaro usng an alternatve bettng market esgn propose by Fang et al. (7). In Secton 4, we compare the two market esgns an scuss the market mplementaton ssues. We conclue our paper n Secton 5.. Relate Lterature Extensve work n the supply chan lterature has aresse the problem of asymmetrc nformaton an the mportance of nformaton sharng. For example, the well-known bullwhp effect (Lee et al., 997) refers to the nformaton storton n the supply chan ue to separate ownershp of nformaton. It has been vewe as a maor source of neffcency n forecast-rven strbuton channels, an nformaton sharng has been wely recognze as a soluton to allevate the bullwhp effect (Chen et al. ). Cachon an Fsher () showe that full nformaton sharng lowers supply chan total cost by. percent, on average. Snce eman forecastng s a sgnfcant part of the nformaton sharng process, Avv () explore the beneft of sharng forecasts of future eman. L () showe that the nformaton leakage concern scourages retalers from sharng ther eman nformaton wth manufacturers. Therefore, how to mplement truthful nformaton sharng, an n partcular, eman forecast sharng, remans a challenge. The exstng supply chan lterature has explore varous esgn possbltes for complcate contracts among chan partners hopng that self-ntereste retalers wll see that t s n ther best nterests to release ther prvate nformaton. Whang an Zou (3) propose to use spot market trang of commotes as an opportunty to share nformaton about eman uncertanty an reaust nventory postons. Shn an Tunca (6) stue a varety of contract forms an conclue that some tratonal contracts, such as wholesale prce contracts, quaratc contracts, an two-part tarffs, lea retalers to over-nvest n ther eman forecasts when they are competng for market eman n a Cournot fashon. As an ncentve-compatble soluton, they propose a so-calle market-base contractng, where each retaler s prce epens not only on her own orer quantty but also on the orer quanttes submtte by other retalers. Ther propose soluton resembles a VCG (Vckrey, 96; Clarke, 97; an Groves, 973) type payment rule that tes the prce one pays to the total eman for the prouct (Bergemann an Välmäk, ). Each retaler nees to conecture correctly others orers to ece her optmal quanttes. Ths assumpton s too emanng, f not entrely unrealstc, n real contract esgn an mplementaton. There are three potental problems wth the contractng soluton. Frst, the exstence of an ncentvecompatble contract s senstve to how the nformaton s strbute among the retalers. In fact, all of the papers above assume that retalers are homogeneous n both ther ablty to acqure nformaton an ther ex-ante eman strbuton. It s not clear whether ther results can be generalze to heterogeneous retalers. Secon, n orer to acheve truthful nformaton sharng, the manufacturer has to wrte an enforce nvual specfc contracts contngent on the orers from all partcpatng retalers, whch unarguably complcates the contract management ssue. Snce the nformatonrevealng equlbrum requres a large number of partcpants, the contractng cost wll be prohbtve. Thr, the soluton attempts to manage the nformaton flow along wth the physcal prouct orers. It generally focuses on collectng nformaton from supply chan partners an gnores the fact that there are outse sources that may prove better nformaton n a more cost-effectve way. Snce the tratonal supply chan s manage n a close-loop communty, the contractng soluton lacks the flexblty to acqure an aggregate all the avalable nformaton relevant for ecson makng. In contrast, our approach emphaszes the mportance of an nepenent nformaton management scheme n the supply chan. We ntrouce an nepenent thr party that manages a precton market to trae a macroeconomc nex whose future payoff epens on the realzaton of a macro factor correlate wth the supply chan eman forecast goal. The ea of trang a macro nex s consstent wth observatons that a frm s eman has a strong correlaton wth some fnancal nex Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

5 Fang et al./collectve Outsourcng (Gaur an Seshar, 5). However, fferent from the preexstng publcly trae macroeconomc nex, we allow the trang nstrument to be constructe an talore to the supply chan-specfc eman forecast nees. Uner our framework, eman uncertanty nformaton can be reveale early an be ncorporate nto the supply chan partners contract specfcatons. Our soluton s robust to both the nformaton an physcal structures of the supply chan. That s, we allow retalers who have access to varous sources of nformaton to partcpate n an beneft from the trang platform because the nformaton flow s manage nepenently by a thr party an oes not ntertwne wth retalers physcal orers. The precton market also has the ablty to ncorporate outse nformaton. The COM framework suggests a new busness process outsourcng an reengneerng approach that shes some lght on managng the nformaton supply chan. The ea of busness process outsourcng s supporte by the lterature n transacton cost theory, frst cone by Coase (937) an later generalze by Wllamson (979). It posts that certan economc tasks wll be performe by frms, whle others wll be performe by the market, epenng on the transacton cost of proucng an strbutng partcular goos or servces. Cost reucton an qualty mprovement are cte as the most mportant motvatons for BPO (DRomualo an Gurbaxan, 998). Informaton technologes have greatly reuce communcaton costs an ncrease nterorganzatonal coornaton effcency, whch make t possble for frms to source busness processes from remote locatons (Hagel an Snger, 999). The lterature has further suggeste that frms wth lmte nformaton processng capablty nee to employ BPO to collect an elver qualty nformaton for ecson makng (Man et al., 6). In our propose framework, the precton market plays an mportant role n aggregatng an ntegratng sperse nformaton sources. Precton market mechansm esgn s an emergng research area wth much potental n the busness worl. There are two fferent streams of research explorng how to construct the precton market. One type of precton market s structure smlar to the stock market, where contracts contngent on the outcomes of future events are actvely trae. Fama (97) postulate that prces n such compettve markets reflect all avalable nformaton. Ths s tratonally known as the Effcent Market Hypothess (EMH). The theoretcal founaton of the EMH concept s base on ratonal expectatons equlbrum (REE) moels (Muth, 96). In general, ths stream of lterature, represente by market mcrostructure moels (Glosten an Mlgrom, 985; Kyle, 985), analyzes prce nformatveness by lnkng prces to nvual trang behavors. Recently, research has focuse on the relablty of the market prce as a precton vehcle (Spann an Skera, 3; Wolfers an Ztzewtz, 4). Expermental results suggest that prces perform well as forecasts regarless of the specfc characterstcs of the precton market (.e., the effectveness of market prce as the precton evce s nepenent of the types of events to be precte, whether the trang asset s vrtual or real money, etc.). The forecastng capablty of prce appears to be better than that of exstng benchmark methos such as opnon polls (Berg et al., 5) or surveys of experts (Chen an Plott, ). Therefore, the precton market can be use to elct partcular nformaton of nterest wth great accuracy. In aton, precton markets are recommene to serve as ecson support tools to a effectve ecson makng n organzatons uner varous busness envronments (Berg an Retz, 3). Another research stream evates from a zero-sum market game (n whch nforme traers wth qualty nformaton earn postve expecte profts at the cost of unnforme traers who o not possess goo nformaton) an lnks the market compensaton mechansm wth the cost of nformaton acquston. To our knowlege, Osban (989) was among the frst n ths research stream to explctly ncorporate agent learnng costs nto a forecast elctaton moel. The analyss suggests that organzatons that operate on a nee-to-know prncple can reuce plannng costs an control plannng effcency so that forecastng expertse s selecte from among a hanful of capable nvuals. Chen et al. (, 4) scusse ncentve mechansms to aggregate ecentralze nformaton wthn a small group to forecast the probablty of a future event. Fang et al. (7) propose a novel bettng mechansm to forecast the future value of a busness subect when forecasters have heterogeneous ablty to acqure sgnals wth fferent precsons. Such a mechansm can motvate partcpants to ncur certan costs to acqure relevant nformaton. Decentralze nformaton s aggregate effcently, as the relablty of each forecast s utlze to Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

6 Fang et al./collectve Outsourcng wegh each pece of nformaton. Wth specal attenton to the cost of nformaton acquston, Fang et al. showe that the bettng market nees to be externally subsze to nsure that every traer s approprately reware an, consequently, truthfully reveals her prvate nformaton. Ths paper buls an mproves upon recent nnovatve research outcomes n the nformaton systems an supply chan management fels. We scuss the esgn an mplementaton of fferent market mechansms n the COM framework an am to avance our unerstanng of both the opportuntes an challenges n managng the market-base nformaton supply chan. 3. The Collectve Outsourcng to Market (COM) Framework 3. The General Framework In a ynamcally changng marketplace, both the manufacturer an the retalers nee to effectvely forecast prouct eman to reuce ther operaton overhea. However, nvually, each frm has lmte capablty n ts eman forecastng. If each of the retalers chooses an outsourcng venor to help wth the eman forecast, they have to nvually negotate the outsourcng contracts. ot only o they lack the necessary negotaton power, but there s no guarantee that they wll be able to fn a qualty servce prover. By collectvely outsourcng the eman forecastng functon to a specalze thr party servce venor, retalers can realze economes of scale an be assure of nformaton qualty. Retaler Retaler Suppler Physcal prouct orer flow Informaton flow Retaler n Informaton Sources outse the chan Informaton Thr Party (Market) Fgure. The COM Framework To emonstrate our collectve outsourcng ea, we aopt a typcal supply chan framework wth one upstream manufacturer an multple ownstream retalers. Such a framework has been wely aopte n recent stues of supply chan coornaton (e.g., Guo et al., 6; Shn an Tunca, 6; Wang an Zou, 3). Fgure llustrates our general ea of separatng the nformaton flow from the physcal prouct orer flow. The nformaton market acts as an nformaton thr party that s capable of elctng an processng nformaton from a varety of sources. Rather than negotatng a complex outsourcng contract on a one-to-one bass, the nformaton thr party esgns a stanar traable contract an operates a market n whch agents nvually etermne ther respectve outsourcng nees. To be specfc, the traable contract specfes a rewar structure that s contngent on the future value of a macro economc factor that rectly affects all retalers future market eman an, therefore, s relate to ther forecastng nees. We call the macro factor the retal nex. The nput to the nformaton market can come from sources both nse an outse the supply chan. Frst, nvual retalers usually obtan prvate forecasts about the retal nex that are more accurate than those of the manufacturer, whch may result from ther closer observaton of the market. Aggregaton of such nformaton can form a qualty forecast that s better than any nvual 3 Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

7 Fang et al./collectve Outsourcng precton. Secon, the nformaton market can collect atonal relevant nformaton from sources outse the supply chan. That s, the market can be opene to outse traers uner certan contons so as to attract more valuable nputs. The aggregate nformaton reveale n the market can be use to a the ecson makng of both the manufacturer an the retalers. To acheve ths, the contract must be esgne to rewar traers accorng to the accuracy of ther nformaton after future uncertanty s resolve. Those wth better nformaton wll be encourage to prove nputs an can expect to earn postve payoffs. There are several mportant benefts of outsourcng to the nformaton thr party. The frst beneft s ts superor ablty to process nformaton an prouce qualty forecasts. The market has the ablty to attract, analyze, an ntegrate all relevant nformaton. It can exten the range of nformaton elctaton beyon the physcal supply chan bounary an hence ncrease ts precton power. The ablty to absorb useful nformaton from sources outse the supply chan s a unque feature of our moel that s beyon the scope of tratonal supply chan coornaton research. Secon, the COM framework can properly algn ncentves from fferent partes through ts rewar mechansm. Snce the retalers who make better prectons can expect hgher payoffs, the quanttatve rewar wll nuce retalers to express ther own prectons base on the best of ther knowlege. In aton, the market-base outsourcng contract can beneft all partes by reucng ther agency costs. Agency costs refer to the atonal efforts an costs ncurre n managng contractual relatonshps such as montorng the outsourcng venor s behavor an algnng the actons of the outsourcng venor wth the nterests of the clents. On the one han, the performance of the thr party servce prover s guarantee by the effectveness of the market s nformatonal role. The commtment to creble nformaton sharng s acheve automatcally by the market s ablty to aggregate nformaton through the market prce formaton process. The market outcome s nepenent of the acton an self-nterest of the thr party venor. On the other han, the thr party venor s neutral n the supply chan. By nteractng wth the nformaton thr party, supply chan partners can avo the potental for gamng an strategc concerns. Therefore, our propose COM framework can aress both the process uncertanty n supply chan management an relatonal uncertanty n tratonal outsourcng contract esgn. Recent stues on precton markets prove us wth several mechansms to conser n our COM framework. Ths paper scusses two maor trens n precton market mechansm esgn an the ssue of choosng the approprate mechansm uner fferent supply chan forecastng envronments. 3. A Smple Supply Chan Framework In ths secton, we mathematcally formulate the one-manufacturer-multple-retaler supply chan to scuss the forecastng neffcency n a ecentralze supply chan envronment. Then, n Sectons 3.3 an 3.4, we scuss the canate market esgns propose n Guo et al. (6) an Fang et al. (7), respectvely. In Secton 3.5 we compare the two esgns an scuss other potental market mplementatons. Appenx C proves a summary of all the mathematc notatons use n Sectons 3. through 3.5. Assume that there are geographcally strbute retalers who orer a homogeneous prouct from a manufacturer. Each retaler faces uncertan market eman that can be expresse as a lnear functon of a macro factor, X, representng the systematc rsk wth an entcally an nepenently strbute error term ε capturng the osyncratc rsk for retaler : D = a + bx + ε, =, L,, where a an b are retaler-specfc parameters that are common knowlege n the supply chan. We assume X ~ ( s, τ ), ~ (, ) ε are both normally strbute. We further assume that each retaler can prvately observe a nosy sgnal s of the future value for τ ε Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8 4

8 Fang et al./collectve Outsourcng the macro economc factor, X = x. Specfcally, we assume that s x δ also entcally an nepenently strbute, ncatng the forecast error. = + where δ ( ) ~, τ Ieally, f all retalers share ther prvate forecasts truthfully among themselves an wth the manufacturer, they wll form a common belef on the uncertan macro factor X,.e., τs X { s, τ } ~ =,. Ths aggregate forecast sharng scenaro (nexe by a ) proves = τ τ = = us wth a full nformaton benchmark soluton to evaluate the collectve outsourcng effcency. Another benchmark scenaro s a fully ecentralze supply chan moel wthout forecast outsourcng (nexe by ). In the ecentralze moel, the nformaton assumpton s that nvual retalers can only utlze ther own sgnals to make orer ecsons. The manufacturer, however, has no prvate sgnal an can only rely on the common pror belef ~ (, ) X s τ. We moel the supply chan as a manufacturer Stackelberg game as follows. The manufacturer announces a wholesale prce w ( = a, ). All retalers smultaneously orer an amount Q base on ther own avalable nformaton set F, for =, L,. Specfcally, let r be the retal prce. Retaler s proft uner scenaro s ( ) Π Q w = rmn Q, D w Q, for =, L,. In the secon stage, the retaler chooses an orer quantty Q to maxmze her expecte proft, base on her a nformaton set F, where F = {( s, s, L, s )} an F = { s}. The retaler s ecson problem can be expresse as: Max E Π ( ) Q w F, for =,,. () Q Let c be the unt proucton cost. The manufacturer s proft ( ) Π = w c Q. In the frst stage, the manufacturer maxmzes her expecte proft by choosng the wholesale prce w base on her expecte orer quanttes from the retalers, contonal on her own nformaton set F, where {( )} a F = s, s, L, s an F =. The manufacturer s ecson problem s: Max E ( w ) F Π. () w To evaluate the effcency of the supply chan coornaton, we efne EΠ = = s EΠ for = a, to represent the expecte supply chan proft, whch s calculate as the sum of profts gane by all the chan partners uner the respectve supply chan scenaros. Proposton : The expecte supply chan proft n the aggregate scenaro s hgher than that n the a ecentralze scenaro,.e., EΠ > EΠ. Proposton shows that fully share nformaton helps mprove overall supply chan effcency by allowng chan partners to make better ecsons. It also llustrates an outstanng supply chan coornaton problem n a ecentralze ecson makng envronment. Therefore, from a socal In fact, the sgnal can be of any lnear combnaton of the macro factor. For example, s s = α + α x + α δ. We can always transfer such a sgnal s to a stanarze s α % = = x + % δ, % α δ = δ α. where α 5 Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

9 Fang et al./collectve Outsourcng welfare perspectve t s essental to construct ncentve mechansms that effectvely attract all retalers to partcpate n the sharng paragm a collectve nformaton supply chan outsourcng. The real challenge, however, s that altrustc sharng rarely exsts n real worl settngs. In the followng, we scuss our propose market-base mechansms to aress such funamental ssues as where the ncentves come from an how to nuce chan partners to share ther prvate nformaton truthfully. 3.3 Outsourcng to an Inex Market In ths secton, we scuss the nformaton market mechansm esgn usng the framework propose n Guo et al. (6). We show the nfluence of the market-base collectve outsourcng on supply chan eman forecastng accuracy an ts effect on the overall system effcency. Guo et al. (6) propose a publcly trae macro nex an prove the effcency mprovement of the overall supply chan uner certan crcumstances. One mportant assumpton n the Guo et al. moel s that the supply chan has a symmetrc nformaton structure, where all the retalers have smlar abltes to prouce ther forecasts, yet no one s pvotal. That s, τ = τ δ for =,,,. Most exstng lterature that stues the supply chan coornaton assumes a symmetrc structure for tractablty. We aopt ths conventon here to erve our maor nsghts. In Secton 3.4, we relax ths assumpton an scuss the possblty of esgnng a market mechansm to aggregate heterogeneous sources of nformaton. The nex market operates lke an open book call futures market (Fan et al., ). Partcpants can buy or sell contngent contracts that pay $x f the future true value of the macro factor X = x. The current market prce p s etermne base on the partcpants respectve sources of nformaton. Market trang aggregates the ntally locally avalable forecast nformaton as f partcpants engage n collaboratve forecastng proects uner the market coornaton. Ths s our COM scenaro (nexe by = m ). The supply chan partners ecson problems have the same form as escrbe n Secton 3.. The only fference s the avalable nformaton. In the secon stage game, when a retaler orers from the manufacturer, she can not only look at her prvate sgnal s, but also can refer to the nex market prce p to fn more nformaton about other market partcpants perceptons of the future macro economc envronment that wll affect the eman. Therefore, the nformaton set s expresse as m F = { s, p}, for =,,,. In the frst stage, the manufacturer makes a ecson base purely on the nex market prce. That s, F m = { p}. In the followng, we scuss how the market prce p ncorporates ecentralze nformaton The Inex Market Prce Whle the market prce s etermne by the market clearng mechansm that coul vary accorng to fferent market mcrostructures, we focus on one type of market structure where the market maker respons to the aggregate net orer by takng an opposte poston. We assume that the market maker oes not have any prvate nformaton. Thus, to prevent economc loss, the market maker sets the nex prce as the expecte value of the future payoff gven the current aggregate net orers n the market. We assume that there are M rsk-neutral nforme traers n the market, whch s compose of retalers an traers from outse the supply chan. That s, M = +. We o not stngush among nforme traers forecast abltes. That s, we assume all nforme traers n the market, nclung retalers, observe s = x + δ, δ ~ (, τ δ ), for =,,, M. But ths smplfcaton wll not affect the maor moel nsghts. We also assume that some unnforme traers submt a ranom, exogenous aggregate net orer ω ~ (, τ ω ). ote that the nosy traers assumpton ncorporates all the unprectable elements that may come from market partcpants ranom lquaton emans Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8 6

10 Fang et al./collectve Outsourcng or rratonal behavors. Smlar assumptons have been use throughout the fnance lterature. The concept of Ratonal Expectatons Equlbrum (REE) s the key theoretcal concept that explans how nvual traers nformaton gets ntegrate nto the market prce. We prove the efnton of REE n Appenx A. The followng proposton states an nforme traer s equlbrum trang strategy an shows how the sperse nformaton s aggregate n the equlbrum market prce. Guo et al. (6) prove a complete proof of the results. Proposton : There exsts a unque lnear ratonal expectatons equlbrum (REE) n whch ) An nforme traer aopts a lnear trang strategy o = B + Bs + Bp; M ω ) The equlbrum market prce p = A + A s + L ; = where A, A, B, B, B, an L are constants. Therefore, the nex prce p can be vewe as a nose sgnal of the aggregate precton M = s. The exstence an unqueness of the lnear REE guarantee a one-to-one mappng from the sperse market sgnals to the aggregate market prce. L, whch often represents market lquty n the REE lterature, reflects the precson of the nformaton transformaton. The larger the value of L, an/or the less the nfluence of ω, the more precse p s as an aggregate ncator of the useful sgnals. M s It s also worth notng that the nex market prce reflects the average sgnal M rather than = each nvual sgnal. By law of large numbers, such a sgnal s manpulaton free when the number of nforme market partcpants s large. In other wors, suppose one retaler submts an orer o = B + B ( s + κ ) + B p ntenng to mslea the market usng a sturbe sgnal s + κ rather than the true sgnal s. By Proposton, the effect of ths orer on the fnal market prce accuracy s scounte by a factor A / M. We can easly show that, when M s large enough, one sngle traer s effort to mslea the market prce wll be n van. Gven that the equlbrum market prce s nsenstve to one traer s sgnal storton, the traer wll n fact be worse off f she evates from the equlbrum trang strategy that maxmzes her expecte payoff. Hence, no one agent has an ncentve to manpulate the market. Agents best strategy s to follow the one escrbe n Proposton. Ths shows that the market-base nformaton revelaton s ncentve compatble. The aggregate forecasts reveale by the market prce can be extremely accurate when the number of nforme traers approaches nfnty. To quantfy ths effect, we efne prce nformatveness as PI. That s to say, the less varaton of X s contonal on p, the more nformatve the nex var ( xp ) prce p s. We use the recprocal to capture ths relatonshp n the efnton. Proposton 3: The market prce becomes more nformatve when the number of nforme traers n the market ncreases,.e., PI ncreases n M. Moreover, when the number of nforme traers n the market approaches nfnty, the nex market prce converges to the true value of the retal nex,.e., lm PI = an lm p = X. M M Snce prce precson ncreases n the number of nforme traers, nformatonal effcency rses as Conecturng an provng the exstence an unqueness of a lnear REE s a stanar technque n the fnancal economcs lterature. However, ue to slghtly fferent nformatonal assumptons n the moel setup, no avalable results can be rectly apple. A complete proof of Propostons an 3 can be foun n Guo et al. (6). 7 Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

11 Fang et al./collectve Outsourcng more useful nformaton s mpoune n the market prce Value of the Inex Market on Forecastng In ths secton, we show that the eman forecast generate by a specally esgne nex market s more accurate than the nvual retaler s own forecast (the ecentralze supply chan scenaro where no forecast nformaton s share). In aton, we show that the collectve eman forecast can be as precse as that of an aggregate forecast (the aggregate supply chan scenaro where all supply chan partners truthfully share ther own eman forecasts). Fnally, we show that t s possble that the overall precton power of the supply chan partners mproves because the precton market has the ablty to ncorporate outse nformaton sources. For example, f the useful nformaton possesse by nforme outse traers omnates the nosy nformaton possesse by those unnforme traers, then the open market s precton power wll be greater than that of a close supply chan forecast sharng moel. Usng the Bayesan rule of upate, we can erve the respectve means X an varances of Γ retaler 's forecaste eman strbuton, for =,,,, uner the three supply chan moels (.e., = am,, ). a X = τ s + τδ s τ δ+ τ τδ+ τ, X = = τ s + τδ s τ δ+ τ τδ+ τ, m τ τδ ( M ) τv ω X = s + s + s + τ ( M ) v ( M ) v ( M ) L δ+ τ + τ τδ+ τ + τ τδ+ τ + τv M s s s =, τv ( + τ L ), an b δ τω a τ + τ δ τ ε b m = +. Γ τ + τ ( M ) δ+ τv τε where ( ) = +, = b + Γ Γ τ + τδ τ, ε Snce the pror eman strbuton (before observng any sgnal s ) s a normal strbuton wth mean b X = a + bs an varance = +, by smple comparson we obtan the followng result. Γ τ τ ε Proposton 4: The nex market-base forecastng yels the same mean but hgher precson than m m the pror eman strbuton,.e., E( X ) = X, Γ Γ. Furthermore, there are contons uner whch the nex market-base forecastng outperforms the aggregate forecastng,.e., m a Γ Γ. 3 Proposton 4 emonstrates the eman forecastng accuracy uner the COM framework. The nex market-base forecastng not only mproves upon the pror knowlege about the eman strbuton, but may be more accurate than the aggregate forecast. Ths s because the market not only ncorporates all the prvate sgnals from the retalers, but also ntegrates other nformaton sources from the outse traers. The more useful nformaton that comes from outse traers, the better the COM framework s compare to the full-nformaton benchmark where all the retalers truthfully share ther prvate nformaton Value of Informaton Sharng on the Bullwhp Effect The bullwhp effect s a well-known nformatonal problem n the supply chan represente by the observe ncreasng orer varances from ownstream partners n the supply chan (Lee et al., 997). We show that mprove eman forecastng reuces the retalers orer varaton an thus allevates 3 Please refer to Guo et al. (6) for a scusson of the specfc contons. Those contons state when an how the useful nformaton from outse the supply chan can contrbute to mprove the nternal supply chan forecast accuracy. Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8 8

12 Fang et al./collectve Outsourcng the nformaton storton (e.g., the bullwhp effect) n the supply chan. It s easy to show that, n our newsvenor-base moel, retaler s optmal orer quantty s etermne by ω Q = a + b X + Φ, for = am,,. ( ) Γ r We see that varaton of the retaler s orer quantty s proportonal to ts forecastng stanar evaton. Comparng the orer quanttes, we obtan the followng result. Proposton 5: Wth the nformaton reveale from the nex market, the manufacturer can estmate m each retaler s orer wth more accuracy,.e., var ( Q p) < var( Q ). Moreover, when the nex m market s more lqu, the orer varance ecreases,.e., var ( Q p ) ecreases as M ncreases. When the nex market s extremely effcent, the orer varance approaches,.e., m a lm var Q p = var Q ( s ) = =. M ( ) ( ) Snce the nex market prce s precse enough to forecast the macro uncertanty, retalers can more accurately forecast the macro economy an ther own eman when makng ther orer ecsons. The nex market-base forecast sharng helps reuce orer varance from the retalers. The manufacturer can also beneft by makng more accurate nferences about the expecte aggregate orers from her contracte retalers Value of COM on Supply Chan Effcency The outsource supply chan generates greater total system effcency than the non-outsource (ecentralze) supply chan. Uner certan contons, COM coul prouce more accurate forecasts an greater economc gan than the aggregate supply chan soluton (the full nformaton benchmark). The total expecte supply chan proft s etermne by the sum of all supply chan partners expecte profts. After smple algebrac manpulaton, t can be expresse as: EΠ = E ( ), ( ) r c E Q Π = re Q = Ψ = =, t ω where Ψ, ( Q ) = Φ( t) t an t ( r ) Γ =Φ, for = am,,. Proposton 6: Uner ml regularty contons, the expecte supply chan proft s hgher uner the m nex market coornaton than that n the ecentralze scenaro,.e., EΠ > EΠ. Moreover, the expecte supply chan proft uner the nex market coornaton approaches the full nformaton m a benchmark when the number of retalers approaches nfnty,.e., lm EΠ = lm EΠ. M The tratonal supply chan lterature consers the ncentve an coornaton ssues by vewng the supply chan as a close system. Our propose framework emonstrates the value of useful nformaton from outse sources to ncrease overall supply chan effcency. Ths framework s extremely sutable n stuatons where the number of supply chan partners s large. 3.4 A Bettng Market When Precson s Heterogeneous In some supply chan practces, the number of chan partners may not be large. In aton, they may have heterogeneous abltes to prect future uncertanty. That s, the relablty of each retaler s prvate sgnal can be fferent ue to retalers access to potentally fferent nformaton sources. In ths secton, we revse the assumpton on the nformaton structure n the prevous moel to aress ths ssue. Specfcally, we assume that each retaler obtans a prvate sgnal s = x + δ, where 9 Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

13 ( ) Fang et al./collectve Outsourcng δ ~, are nepenent forecastng errors. τ τ s the precson of each prvate sgnal, whch s fferent for each retaler. The larger the τ, the less the varance of δ an the more precse s the prvate forecast of retaler. If all the retalers share ther sgnals { s },,, honestly, an the precsons of those sgnals = { τ } =,,, are publc nformaton, we shall have that { } τs X s, τ ~ =, =, τ τ = = followng ormal Learnng Theorem (DeGroot, 97). It s obvous that an effcent aggregaton of all the retalers prvate forecasts s a weghte average of all the retalers sgnals { s },,, an that = the weghts are proportonal to the precson of ther sgnals { τ },,,. Therefore, n orer to get = the best aggregaton of the sgnals, not only shall each retaler share her prvate forecast s, she shall also reveal her relablty τ. However, the market mechansm scusse n Secton 3. has a rewar structure that s base only on s an s generally unable to stngush the precson τ. After all, the sgnal s ust a guess about the future uncertanty. Two retalers may get two sgnals of the same value, whle one s extremely confent but the other s not so sure about t. A mechansm nees to be specfcally esgne to elct both s an τ from a retaler. Recall that n our nex market esgn there s a one-to-one mappng between the trang volume an a traer s sgnal. If the task of nformaton aggregaton s two mensonal (both the sgnal an the precson), then theoretcally we nee two market parameters. To fulfll ths task, we aopt the market mechansm propose by Fang et al. (7). The mechansm was esgne base on the popular sayng, puttng your money where your mouth s. Specfcally, the nformaton thr party can run a bettng market to allow each partcpant to submt a report r on the possble future value of X an place a certan amount of money as a bet on hs or her report, B. The task of the thr party s to esgn a rewar functon f( r, B, X ) pa to each of the partcpants, whch s contngent on the corresponng report an bet, ( r, B ). To effectvely aggregate the nformaton, the rewar functon shoul:. nuce each partcpant to report truthfully her prvate forecast of the future value of X, that s, r = E[ X s ];. elct the precson of each bettor s prvate sgnal s, that s, B = g( τ ) where g ( ) s monotonc. One of the canate rewar functons satsfyng the above requrement s a quaratc loss functon f( r, B, X) = B ( τ ( r X) ), where the partcpant maxmzes the payoff when the report conces wth the future value of X. For each rsk-neutral retaler, the overall maxmzaton problem s to ece the report, bet, an future orer quantty so as to maxmze her aggregate expecte payoff from both the bettng market an local commoty markets. Snce all the retalers are rsk neutral, the two ecsons are nepenent. Proposton 7 shows the best strategy of each bettor. τ s + τ s τ + τ * Proposton 7: The bettor s optmal bettng strategy s r = E[ X s ] = an * B = τ wth a postve expecte payoff τ τ ( τ + τ ) ( τ + τ ) A ratonal bettor wll bet a postve amount of money as long as her precson s postve ( τ > ). In. Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

14 Fang et al./collectve Outsourcng aton, the bet ncreases when the sgnal s more precse (.e., as τ ncreases). A bettor wth no relevant nformaton ( τ =) wll not place a bet. Therefore, the market can effectvely aggregate all the relevant nformaton wthout generatng nosy traers. Proposton 8: Base on bettor 's report an bet ( r, B ), the market maker can stll the bettor s prvate nformaton an precson usng the followng formulae s τ B + r s τ B τ τ B = an τ = τ. Ths shows that the bettng mechansm wll reveal both the bettor s sgnal an ts precson. The nformaton can then aggregate all { s, τ } =, achevng the obectve of the two mensonal nformaton aggregaton. 4. Dscusson an Implementaton The propose COM framework avances supply chan nformaton coornaton through ts ablty to aggregate sperse nformaton uner fferent nformatonal assumptons an from a varety of sources. A market mechansm s mportant, as ts rewar structure proves an ncentve for retalers to reveal ther prvate forecasts. In the followng, we frst compare the two market mechansms that we scusse above. Then we emonstrate the role of the nformaton thr party an scuss the benefts an costs of mplementaton. 4. Comparson of Market Mechansms The nex market s an open system. Its ablty to extract an aggregate valuable nformaton from outse of the supply chan s ts maor avantage. Accorngly, ths market mechansm s sutable n a forecastng envronment where the subect s not senstve, an the subect tself attracts partcpaton from outse experts. Some macroeconomc varables ten to be nsenstve subects. For example, economc ncators such as the U.S. gross omestc prouct an retal sales fall n ths category. Moreover, these macro level factors generate publc attenton easly, so traers outse of the supply chan can contrbute to the nformaton aggregaton an mprove the market s precton power. Therefore, ths market mechansm has the potental to generate forecasts that are more accurate than those of any nvual retaler or what can be obtane through a close supply chan system. Compare to the nex market mechansm, a bettng mechansm has an avantage over aggregate nformaton when the sources of sperse nformaton are not evenly strbute. In aton, the nformaton thr party can control all the bets an reports that are not observable to other bettors. Ths proves a secure way to ncorporate outse nformaton wthout revewng the aggregate precton. The bettng market mechansm s especally useful when the forecastng subect s senstve an the ssemnaton of nformaton shoul be restrcte wthn the supply chan. Very often, such a senstve forecastng subect oes not attract attenton from the publc, an thus t s mpractcal to trae n an open market envronment. Therefore, the bettng mechansm s sutable for restrcte partcpaton when the supply chan partners have heterogeneous forecastng capabltes an some retalers have better nformaton than others. 4. Benefts of Market Implementaton In aton to the varous benefts scusse n Secton 3.., another aspect of the market-base ncentve algnment s ts mmunty to the moral hazar problem n tratonal contract esgn an coornaton (Grossman an Hart, 983). For example, as a rsk sharng mechansm, a buy-back contract allows retalers to sell back unsol proucts at a pre-specfe salvage value to the manufacturer. The retaler may not put much effort nto sellng proucts f the promoton cost s hgher than the guarantee salvage value. The market-contngent contract can solve ths moral hazar problem, snce t s wrtten on the retal nex, whch s hghly correlate wth the retalers eman, but retalers stll have to bear the resual rsk of ther own uncertan market eman. Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8

15 Fang et al./collectve Outsourcng Unerstanng the traeoff between rsk an ncentve has been a complex task (Trole, 998). The market-base framework extens the range of nformaton sharng beyon the tratonal supply chan bounares. It also opens the oor for other market nnovatons nclung the ntroucton of securtes an ervatves for the purpose of managng corporate rsk. By separatng the nformaton flow from the physcal prouct flow, retalers may hege ther own operatonal rsk effectvely usng fnancal nstruments avalable n the nformaton market. Retalers self-selecte rsk management may be more effectve than relyng on the constructon of overly complex an har-to-mplement contracts to acheve the coornaton. 4.3 Costs of Market Implementaton The nformaton thr party plays a crucal role n successfully managng the nformaton supply chan. The thr party shoul be truste by all the chan members to share nformaton truthfully va the esgne rewar mechansm. In constructng an open market, the nformaton thr party shoul also be capable of unerstanng the supply chan nformaton structure, nvestgatng the correlatons of the retalers emans, an entfyng the macro factor to forecast. In choosng an effectve market mechansm, the thr party also nees to estmate how the prvate nformaton s strbute among all the chan partners an whether outse nformaton sources are neee. The nformaton thr party s then able to esgn the approprate type of precton market an to elver the aggregate precton wth the esre soluton qualty. However, there wll always be costs assocate wth the thr party, for example, the cost to hre such a thr party an the cost for each company to communcate wth the thr party. In orer to manage an electronc precton market, the supply chan partners woul have to prove the buget to nvest n the harware an software to evelop an support the market functon. However, wth the ecreasng cost of the IT nfrastructure an the ncreasng popularty an acceptance of precton markets, such costs are becomng more afforable. One possblty s that supply chan partners share the cost. Another possblty s that the manufacturer or whoever benefts the most from the fnal precton proves the subsy. The cost of runnng a precton market vares epenng on the choce of market mechansm. An nex market scusse n Secton 3. s essentally a zero-sum market, meanng that the market maker (generally the nformaton thr party) oes not prove explct compensaton an expects no proft (or loss). The traers purchase contracts expectng to make money from less-nforme traers (generally calle the nosy traers). The presence of nosy traers can therefore motvate nforme traers to partcpate n the market. However, ther ranom orers may reuce the overall precson of the equlbrum prce. If aoptng the bettng mechansm escrbe n Secton 3.3, the market maker esgns the bettng contract so that each partcpant can expect a postve payoff f she has qualty nformaton. The more precse the nformaton source, the hgher payoff the partcpant can expect to get. The rewar mechansm lures traers to research an mprove ther nformaton precson. The market maker, therefore, has to compensate for the cost of nformaton acquston n orer to get more precse nformaton. Fortunately, the compensaton costs can be controlle by the esgn of contract parameters. Fang et al. (7) has proven that the gan from gettng more accurate prectons can always excee the overall compensaton cost, f the contract parameters are chosen approprately. Beng aware of the potental cost assocate wth the collectve outsourcng, supply chan members must ontly ece whether the gan n effcency wll overcome the cost an how the cost shoul be share among the partners. The choce coul vary n fferent scenaros. Our scusson attempts to prove a general guelne for selectng who wll partcpate an how the collectve outsourcng actvtes work. 5. Concluson Parallel to the physcal supply chan, an funamentally ntegral to t, are the nformaton supply chans that help acheve busness obectves by enhancng crtcal busness processes. By separatng Journal of the Assocaton for Informaton Systems Vol. 9 Issue 3/4 pp Specal Issue 8