Horizontal Subcontracting From Competitors: When and What?

Abstract

We investigate horizontal subcontracting between two firms that compete in selling to uncertain markets. Each firm manages resources to make a key component indispensable for final assembly by both firms. A horizontal subcontract stipulates that one of them prepares key component or even produces final product for the other. The subcontract can be signed before or after resource preparation, which we refer to as forward and spot subcontracting, respectively. With the presence of demand uncertainty, the subcontract is signed before (after, resp.) demand realization in forward (spot, resp.) subcontracting, while resources are always prepared in advance. Forward subcontracting enables the firms to achieve the maximum overall cost saving by concentrating all production activities in the more cost‐efficient firm. Spot subcontracting draws the firms to unilateral undertaking to prepare resources and cooperative resource allocation. This gives rise to an efficiency effect by balancing production and market selling between the firms, and a pooling effect that enables them to profit from synergies between markets. The subcontracting subject is crucial to the contribution of total cost saving relative to total revenue gain to the efficiency effect, but is inconsequential on the scale of the pooling effect. We conduct a comparative investigation into forward and spot subcontracting, with the subject playing a differentiating role, and explore the impacts of the means and variances of demand intercepts and the firms’ costs on system performance under various horizontal subcontracting modes differentiated by timing and subject.