Strategic production and responsible sourcing decisions under an emissions trading scheme

Increased environmental awareness has resulted in consumers’ willingness to pay more for products with a smaller environmental footprint. Additionally, emissions trading schemes reward manufacturing firms who produce products with lower-than-average emissions rates. We examine how a manufacturer makes effective sourcing decisions, even if a supplier holds a responsibility certificate that only discloses partial information about a specific product. We also examine how a strategic production strategy (green versus traditional production) can be chosen so that the entire supply chain is motivated to become more sustainable. A game-theoretic model is developed to study the impact of an emissions trading scheme on the screening mechanism with asymmetric information and the production strategies of competing manufacturers. We first show that the performance-based contract plays an active role in driving sustainable improvements, which is consistent with practical activities occurring in the industry. We then show that a general supplier cannot receive patronage, even if the sourcing and production costs are less expensive for the manufacturer. Sourcing materials with a lower emissions rate are not a strictly dominant strategy. These findings further indicate that the equilibrium production strategy in chain-to-chain competition depends on the threshold of trading prices, the supplier’s effort, and the additional production cost per allowance saved. Moreover, even if the manufacturer has sufficient emission allowances, it still prefers to adopt the green production strategy rather than choose a cost-effective strategy to cut production and sourcing costs. The outcomes provide useful guidance for manufacturing industry practices in sustainable development.