Strategic interaction of original equipment manufacturers between outsourcing and purchasing in a quality-differentiated market

Abstract

Economic globalization has swept the whole world. To focus on their main business, enterprises that are referred to as original equipment manufacturers (OEMs) outsource non-core production activities to contract manufacturers (CMs). By constructing a two-level supply chain consisting of two competing OEMs and one upstream CM, the strategic interaction of the OEMs between outsourcing and purchasing is studied. Specifically, the CM can offer custom- and predefined modes of original equipment manufacturing (namely, CO mode and PO mode, respectively). The former mode enables OEMs to determine product quality, while the latter only allows them to purchase from several quality configurations. The results show that, first, since the CO mode allows the adopter to lead the product design, whether to choose this mode depends on the required R&D cost. Interestingly, however, a lower R&D cost does not necessarily result in the adoption of the CO mode if the product quality difference is small under the PO mode. Second, the optimal purchasing strategy of an OEM is indifferent to the outsourcing mode (CO and PO) of its rival but significantly affected by the quality cost. However, compared to the PO mode, choosing the CO mode would cause the competitor to suffer more profit losses. Third, differing from the prior literature, this paper finds that when the downstream OEM can make quality decisions, although this may lead to profit loss of the contract manufacturer in some channels, it could benefit the CM overall.