Strategic outsourcing decisions for manufacturers competing on product quality

Abstract

This article examines strategic outsourcing decisions for two competing manufacturers whose key components have quality improvement (QI) opportunities. We consider the effects of vertical and horizontal product differentiation on demand. In deriving the Subgame Perfect Nash Equilibria (SPNE), it is shown that either a symmetric outsourcing strategy (i.e., both manufacturers outsource) or an asymmetric sourcing strategy profile (i.e., manufacturers use different sourcing strategies) can be an SPNE. Insights are provided into how sourcing strategies are affected by the factors such as fixed setup cost, unit production cost, QI efficiency, and horizontal and vertical differentiations. It is found that larger horizontal differentiation expands the range over which symmetric outsourcing is an equilibrium. In addition, the outsourcing manufacturer may provide a higher QI level, produce a higher quantity, and offer a lower retail price than the insourcing one in the asymmetric sourcing setting. On the other hand, the insourcing manufacturer should pay more attention to the effect of the rival's sourcing strategy on the QI level than the outsourcing one. Finally, it is shown that all players have an incentive to determine sourcing partner relationships before the wholesale price contract is offered.

Keywords:

• Channel structure
• game theory
• horizontal and vertical differentiation
• quality improvement
• outsourcing

Acknowledgements

We would like to thank the anonymous referees and Associate Editor for their many helpful suggestions and insightful comments, which have significantly improved the content and presentation of the article.

Funding

This research was supported in part by the National Natural Science Foundation of China under grants 71371093, 70971060 and 71071073 and by the National Planning Office of Philosophy and Social Science under grant 11&ZD169.