Are supply and plant inspections complements or substitutes? A strategic and operational assessment of inspection practices in biotechnology

This paper theoretically and empirically examines the conventional wisdom in procurement management that often portrays supply inspections and supplier plant inspections as substitutes. We develop a theoretical model that focuses on potential internal spillover costs of the buyer receiving low-quality inputs and external spillover costs should low-quality inputs go undetected. Key to our analysis is the condition of whether a buyer can commit to the intensity of supply inspection. If a buyer cannot commit, supply inspections and plant inspections are substitutes, as widely believed. The two types of inspections, however, may become complements when a buyer is able to commit to the intensity of supply inspection. Complementarity is especially likely when (a) external spillovers are smaller than expected internal spillovers, which depends on the level of buffer inventory, (b) when knowledge sharing between buyer and supplier becomes more effective as the supplier allocates more resources to learning for quality improvement, or (c) when hiding aspects of the production processes is easier for suppliers. We empirically evaluate our model with a new data set drawn from a large biotechnology manufacturer. Empirical results provide broad support for theory, which, we argue, might help to explain variation in inspection practices across industries. Our theory and empirical analysis contribute to the literatures on strategic management, organizational economics, and procurement management by highlighting the organizational and strategic use of inspection practices.