Outsourcing Under Price and Quality Competition: Single Firm Case

Abstract

In this chapter, we add another set of decision-makers to a supply chain network – that of the contractors. We present a supply chain network equilibrium model with outsourcing under price and quality competition. We consider a firm that is engaged in determining the optimal product flows associated with its supply chain network activities in the form of manufacturing and distribution. In addition to multimarket demand satisfaction, the firm seeks to minimize its cost, with the associated function also capturing the firm’s weighted disrepute cost caused by possible quality issues associated with the contractors. Simultaneously, the contractors, who compete with one another in a noncooperative manner in prices a la Bertrand, and in quality, seek to secure manufacturing and distribution of the product from the firm. This game theory model allows for the determination of the optimal product flows associated with the supply chain in-house and outsourcing network activities and provides the firm with its optimal make-or-buy decisions and the optimal contractor-selections. We state the governing equilibrium conditions and derive the equivalent variational inequality formulation. We propose an algorithm and apply it to compute solutions to numerical examples to illustrate the generality and applicability of the framework.