Green Supply Chain Formation Through By-Product Synergies

Many firms across the world are discovering and benefiting from the ability to identify, recover, and reuse industrial by-products from other firms in traditionally unrelated industries. We examine how the formation of a by-product synergy between two firms, in different industries, and its environmental impact, are influenced by factors such as the by-product trading price, the fixed costs of synergy formation (e.g., innovation cost), and the distinct characteristics of the two markets in which potential partners operate. We show that an incentive compatible region, which ensures a profit increase for both firms, can be characterized by an interior region of the by-product trading price, and the incentive compatible region may enlarge or shrink with the firms share of the fixed cost. Second, we find that when the firms are willing to share the synergy formation cost, higher volatility of either market could better incentivize the formation of the by-product synergy. Third, we find conditions when there exists a set of prices that are both incentive compatible and environmentally efficient.