Make or Buy in the Presence of Strategic Competition on Substitutable Products

Abstract

In this paper, we study make-or-buy decisions with the consideration of retail-level competition, in which a supplier provides substitutable products to two retailers. One incumbent retailer is capable of producing the product in-house and makes the make-or-buy decision, while the rival retailer can only outsource from the supplier. Intuitively, the incumbent will not outsource if the wholesale price is higher than its production cost. However, we illustrate this may not be true when the supplier also supplies the retail rival. In this case, the incumbent may accept a high wholesale price to limit the suppliers incentive to serve the retail rival on particularly favorable terms. Moreover, under certain circumstances, the supplier may charge a wholesale price lower than its production cost to attract orders from the incumbent, which can generate for the supplier and the incumbent a higher total profit than the situation in which the incumbent makes the product in-house.