Competition or Compensation: Supplier Incentives under the American and Japanese Subcontracting Systems

Abstract

Two fundamentally different subcontracting systems arise as distinct solutions to the quality control problem facing an input buyer. The "American" system involves competitive bidding on each contract, large orders, and inspections. The "Japanese" system involves repeat purchases from a supplier who earns a premium, small orders, and no inspections. Both systems may coexist as local solutions, but the global optimum is determined by the ratio of set-up to inspection costs. This suggests that the adoption of flexible manufacturing equipment and rising product complexity may be responsible for the shift from the American to the Japanese system observed in many industries. (JEL L14, L15, and L22).