Monday, August 1, 2011

Why SME’s have poor quality and MNC’s have poor services? Game theory analysis

The quality and service dilemmas of SME’s and MNC’s can be analyzed from the game theory.



The quality of finished product is dependent on quality of input components.

Both SME and MNC buy input component from a same vendor.

If the vendor has some defected lot, the vendor has three choices –

  • Choice 1: Discard defected lot
  • Choice 2: Supply the defected lot to SME
  • Choice 3: Supply the defected lot to MNC

Assume price of the component is 5 units and profit is 1 unit. If vendor discards than he will feel loss of 4 units. So present pay off for choices are:

  • Choice 1: (-4 Units)
  • Choice 2: (1 Unit)
  • Choice 3: (1 Unit)

But there are future consequences and payoffs also

For choice 1, if the vendor discard defected lot , he would not be able to fulfill his supply obligations and face additional penalty. In addition the vendor would face short term loss in his books, and face negative corporate or investor pressure. Quantifying additional supply penalty of 1 Units and corporate and investor pressure as loss of 2 Units, the total future loss is 3 units

For choice 2, SME will not give next 3 year business to the vendor; assume the loss is 6 Units

For choice 3, MNC will not give next 3 year business to vendor, MNC business is much larger value, so assume the loss is 12 Units

So future pay off for choices are:

  • Choice 1: (-3 Units)
  • Choice 2: (-6 Units)
  • Choice 3: (-12 Units)

Combining present and future pay off for choices:

  • Choice 1: (-4-3 = -7 Units)
  • Choice2: (1-6 = -5 Units)
  • Choice3: (1-12 = -11Units)

Out of above 3 choices, the choice 2 of sending defective input lot to SME’s will be the best rational choice for the vendor

This game can be modeled on different payoff choices and assumptions but more often than not ditching SME’s is rational choice for vendors and that explains why SME’s often have poor quality.


Similarly for service, when an organization has limited service resources, it has to look for best rational choice on how to deploy them.

Assume a small customer has both option either to buy from a MNC or from a SME.

While present value of the customer is same for both SME and MNC, the relative future value of the small customer will be less for a MNC compare to the relative value of same customer for a SME.

In case of any service resource constraint, the rational choice for SME’s and MNC’s will be to give importance according to customer’s relative future value. So MNC’s are more likely to give less importance to small customers in comparison to SME’s.


SME’s need to look for service edge to beat MNC’s

SME’s need to watch out for the quality of their inputs from the vendors. They can sort out this quality dilemma by uniting with other SME’s for procurement and other areas.

For consumers, where service is not of much importance (such as FMCG goods) MNC’s are best choice. Where service is important, SME’s are better option. However exceptions will always be there!!