Title: Ecology studies
1Breach Remedy, Renegotiation and Design of Supply
Contracts
Erica L. Plambeck Graduate School of
Business Stanford University
Terry A. Taylor Graduate School of
Business Columbia University
2Motivation Biopharmaceuticals
- 1990 BI builds capacity for tPA Activase, plans
1 B revenue - Mid-90s drug fails, BI sells plant to Immunex
at a loss - Late 90s unanticipated success of Enbrel,
Rituxan, etc. - Dosing 10-100 times greater than expected
- 3-4 year leadtime to build capacity, obtain FDA
approval - Lonza, BI reserve capacity 3 years in advance,
steep fees - some firms drop or postpone promising drug RD
projects
3Contract Manufacturing of Biologics
biotech firms invest in RD
realize demand
production
Lonza builds capacity
- efficient capacity utilization, pool uncertain
demands - - ?
4Contract Manufacturing of Biologics
biotech firms invest in RD
realize demand
production
Lonza builds capacity
- Watch Out for Hold Up Problem (Plambeck
Taylor, 2001) - Outsourcing ? profit if buyer is powerful,
e.g. - CM has excess capacity or competition
- or needs future business
- Otherwise, firms should own capacity
- Contract to pool capacity STRATEGIC and EARLY
5Contract Manufacturing of Biologics
biotech firms invest in RD
realize demand
production
Lonza builds capacity
CHALLENGE Design supply contracts that induce
first best innovation and capacity investment
(max. total expected profit)
- SURPRISE Often, simple reservation contracts are
optimal - depends on remedy for breach of contract,
bargaining power - assumes common information (Plambeck Taylor,
2003)
6Court Remedies for Breach of Contract
Specific Performance Expectation Damages
must perform contract (prohibitively large penalty) pay to put injured firm in same financial position as if contract were performed
manufacturer must deliver Q unless buyer agrees to less manufacturer can deliver lt Q , pay for lost revenue or substitute capacity
awarded on discretionary basis for unique items routine in procurement
7Literature Review
- Efficient breach theory ED remedy encourages
promisors breach where the resulting profits to
promisor exceed loss to promisee (Holmes, 1881) - Econ and supply chain lit implicitly assumes SP
- Scholars begin to advocate routine availability
of SP - efficient breach with SP through renegotiation
- ED is complex, undercompensatory(Varadarjan,2001)
- ED skews investment (EdlinReichelstein,1996)
- Firms use reputation/relational contract to
guarantee SP because courts do not (De
Alessi,1994)
8Conclusions
Specific Performance
Expectation Damages
first best with simple reservation contracts
excess capacity, too little RD
powerful manufacturer
too little capacity, excess RD
buyers have some bargaining power
first best with simple reservation
contracts Qi Eshare of optimal capacity
tradable options ? profit
requires separability condition
9Ongoing Research
- Contract EARLY to avoid Hold Up
- In designing supply contract, anticipate
renegotiation - Outcome of renegotiation depends on court remedy
for breach of contract (even if we never go to
court) - Specific performance remedy may become routine
10Ongoing Research on Outsourcing
- Information asymmetry
- Relational contracts (enforced by value of
future business, not the courts) - Scope of responsibility for CM design?
procurement? - Product recovery and recycling or remanufacturing
Suggestions ?