Process improvement plays a significant role in reducing production costs over the life cycle of a product. We consider the role of process improvement in a decentralized assembly system in which a buyer purchases components from several first-tier suppliers. These components are assembled into a finished product, which is sold to the downstream market. The assembler faces a deterministic demand/production rate and the suppliers incur variable inventory costs and fixed setup production costs. In the first stage of the game, which is modeled as a non-cooperative game among suppliers, suppliers make investments in process improvement activities to reduce the fixed production costs. Upon establishing a relationship with the suppliers, the assembler establishes a knowledge sharing network – this network is implemented as a series of meetings among suppliers and also mutual visits to their factories. These meetings facilitate the exchange of best practices among suppliers with the expectation that suppliers will achieve reductions in their production costs from the experiences learned through knowledge sharing. We model this knowledge exchange as a cooperative game among suppliers in which, as a result of cooperation, all suppliers achieve reductions in their fixed costs. In the non-cooperative game, the suppliers anticipate the cost allocation that results from the cooperative game in the second stage by incorporating the effect of knowledge sharing in their cost functions. Based on this model, we investigate the benefits and challenges associated with establishing a knowledge sharing network. We identify and compare various cost allocation mechanisms that are feasible in the cooperative game and show that the system optimal investment levels can be achieved only when the most efficient supplier receives the incremental benefits of the cost reduction achieved by other suppliers due to the knowledge transfer. 
Cooperation in assembly systems: The role of knowledge sharing networks