Accepting defective products: Implications for supplier incentives

Abstract

The suppliers might sometimes develop a new product of the quality inferior to the buyer’s expectations. We model the possibility of conditional acceptance of such products by the buyer. Our goal is to track the effect of conditional acceptance on the supplier incentives to exert product development efforts. We construct a non-cooperative sequential game with risk-neutral players and analyze their equilibrium strategies. We find that implementing the conditional acceptance policy indeed affects the supplier incentives if the product is of relatively high value to the buyer. The effect direction depends on the cost of effort and project success probability.