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In the global supply chain, retailers commonly source manufacturers through “middlemen.” Unfortunately, these intermediaries often collude with unethical manufacturers to collect rebates that are “hidden” from retailers. Due to the covert operations involved, this problem has received very little attention. In instrumental new work, Ying-Ju Chen from HKUST and colleagues present a first attempt to help retailers avoid hidden rebates and quote deception.

More and more Western retailers are sourcing their products from developing countries such as China, Cambodia, and Vietnam. Their lack of knowledge of manufacturers in these countries means that they frequently turn to procurement service providers (PSPs) to facilitate retailer–manufacturer transactions. While such intermediaries save retailers both time and money, their unique position in the supply chain is often abused.

A major problem concerns “hidden rebates” collected by PSPs from unethical manufacturers as referral fees. Such collusion can be costly for retailers, which remain unaware of the surreptitious arrangements involved. To receive such rebates, for example, PSPs “may manipulate the price quotes to help unethical manufacturers win contracts from the retailers,” explain the authors. This leads to the biased selection of unethical manufacturers and inflated price quotations, pushing up costs along the supply chain.

Retailers could insist on doing business only with ethical manufacturers, which are not willing to supply hidden rebates. However, this is unlikely to be a solution. “This sourcing strategy does not make use of the intermediary’s search capability at all,” the researchers tell us, “and may end up with a high procurement cost due to limited alternatives.” Furthermore, retailers can rarely be certain which manufacturers are ethical. This leads to an important question. “Can the retailer develop a more cost-effective procurement mechanism than just insisting on sourcing from ethical manufacturers?” the researchers asked.

As a first attempt at answering this question and tackling the problem of hidden rebates in the global supply chain, the team developed an elegant series of theoretical models that considered the behaviors of retailers, intermediaries, and ethical/unethical manufacturers. The researchers examined multiple variables that may feed into hidden rebates and inflated price quotations, such as import duties, cost–savings trade-offs, and penalties. This helped them to identify the best conditions for retailers when selecting a manufacturer.

The results revealed that the optimal mechanism is one that deters intermediaries from inflating ethical manufacturers’ quotations, reduces the incidence of hidden rebates, and decreases the retailer’s procurement cost. When the hidden rebate level falls below a certain threshold, the optimal mechanism is one in which the retailer benefits but no other party loses out. The influence of other conditions was also tested, such as whether a retailer is unsure about whether an intermediary-recommended manufacturer is ethical, and the optimal mechanism was found to be essentially the same.

“This paper represents an initial attempt to control quote deception and hidden rebates,” say the researchers. This is especially important, they add, “when law enforcement is inconsistent in developing countries.” Building on this pioneering study, future work could scrutinise the intermediary–manufacturer interaction in more detail, such as whether manufacturers are more tempted to offer hidden rebates when the intermediary shares information about other manufacturers’ bids.