A Bayesian Incentive Compatible Mechanism for Decentralized Supply Chain Formation

In this paper, we consider a decentralized supply chain formation problem for linear, multi-echelon supply chains when the managers of the individual echelons are autonomous, rational, and intelligent. At each echelon, there is a choice of service providers and the specific problem we solve is that of determining a cost-optimal mix of service providers so as to achieve a desired level of end-to-end delivery performance. The problem can be broken up into two sub-problems following a mechanism design approach: (1) Design of an incentive compatible mechanism to elicit the true cost functions from the echelon managers; (2) Formulation and solution of an appropriate optimization problem using the true cost information. In this paper, we propose a novel Bayesian incentive compatible mechanism for eliciting the true cost functions. This improves upon existing solutions in the literature which are all based on the classical Vickrey-Clarke-Groves mechanisms, requiring significant incentives to be paid to the echelon managers for achieving dominant strategy incentive compatibility. The proposed solution, which we call SCF-BIC (supply chain formation with Bayesian incentive compatibility), significantly reduces the cost of supply chain formation. We illustrate the efficacy of the proposed methodology using the example of a three echelon manufacturing supply chain.