Supplier development or supplier switching?

Abstract

We study a firm's cost-based sourcing decision of whether to invest in an incumbent supplier or switch to an alternative supplier in order to realise lower purchasing costs. In isolation, it can be shown that the development of an incumbent supplier (i.e., a cooperative investment) becomes more attractive, the higher the uncertainty about the price the buying firm can realise on the market and the incumbent supplier's cost. Likewise, switching to an alternative supplier becomes more attractive, the higher the expected value of and the uncertainty about the buying firm's market price. For comparing these two sourcing strategies simultaneously we provide a profit-maximising framework for the buying firm that shows that switching is less recommendable the higher the variance of the incumbent's cost and if the uncertain maximum demand is negatively correlated with the uncertain incumbent supplier's cost. Overall, our study substantially expands the frequently followed approach of basing supplier development versus supplier switching decisions merely on strategic and qualitative considerations.

Keywords:

• purchasing
• cooperative investment
• decision analysis
• sourcing strategy
• supplier development
• supplier switching