Combating product label misconduct: The role of traceability and market inspection

Traceability has become an important feature in supply chain management. It can be adopted to identify the sources of many quality problems. In this paper, we develop a game theoretical model to study the role of traceability in combating product label misconduct. Specifically, we consider an industrial organization that assigns product labels to its members to certify their products in an output market. However, a member of the organization may choose to sell its product label to an unregulated party that makes unqualified units. The organization can choose between a traceable product label system and an untraceable one. The former has the advantage of identifying the responsible member when the inspection detects an unqualified unit. We derive the optimal inspection polices of the two product label systems and demonstrate that the organization may incur a higher cost by adopting the traceable rather than untraceable label system. This non-intuitive result indicates that without a proper management mechanism in place, the adoption of a traceable product label system may backfire. We extend our base model and show that our main insights are robust in various settings.