Analyzing financing and encroachment strategies for a capital-constrained contract manufacturer

Abstract

This paper investigates a two-echelon supply chain, in which an original equipment manufacturer (OEM) outsources the production to a capital-constrained contract manufacturer (CM) who may choose to create independent brand to encroach on the market. To ease the financial burden, the CM has two sources of financing, bank loans (i.e., borrowing money from financial institutions) and OEM equity financing (i.e., raising capital through selling shares to the OEM). Considering the interrelationship between the two supply chain members, we comparatively examine the financing strategy and encroachment decision of CM. Our analytical results show that the OEM always offers equity financing when no encroachment is involved; but with the presence of encroachment, this type of financing only occurs when the OEM’s shareholding ratio and the CM’s initial capital are fairly large. From the CM’s perspective, the OEM equity financing is always chosen if the capital gap is relatively large, independent of encroachment. Thus, the two parties can achieve a win-win situation at a moderate initial capital level. For the entire supply chain, the OEM equity financing is optimal with encroachment only when the OEM’s shareholding ratio or bank loan interest rate is relatively large Moreover, the capital-sufficient CM benefits from encroachment at low market-entry costs, while the encroachment strategy of the capital-constrained CM is akin to the financing cost. The numerical examination of portfolio financing shows that the OEM benefits from encroachment at high shareholding and equity financing ratios, whereas the CM favors portfolio financing at a medium OEM’s shareholding ratio.