Manufacturing and procurement outsourcing strategies of competing original equipment manufacturers

Abstract

To cope with market competition and focus on core competence, many Original Equipment Manufacturers (OEMs) choose to outsource their product manufacturing and/or component procurement functions to Contract Manufactures (CMs). In this paper, we aim to investigate the strategic interplay between manufacturing outsourcing and procurement outsourcing in a three-tier supply chain consisting of one component supplier, one common CM, and two competing OEMs. Each OEM has four outsourcing strategies: no outsourcing, “manufacturing-only” outsourcing, “procurement-only” outsourcing, and “manufacturing + procurement” outsourcing. We build a two-stage game model, where two OEMs simultaneously choose their outsourcing strategies in the first stage; in the second stage, the CM and two OEMs make wholesale prices and quantity decisions based on the outsourcing structure formed in the first stage. We find that OEMs’ equilibrium outsourcing strategies depend on the discount rate of component price and the fixed investment cost of manufacturing. Our analysis also reveals the strategic relationship between manufacturing outsourcing and procurement outsourcing: OEMs would not outsource procurement until the product manufacturing is outsourced. Moreover, there may exist Prisoners’ Dilemma, where both OEMs earn higher profits when they choose “manufacturing + procurement” outsourcing, but neither OEM is willing to outsource procurement. Interestingly, we show that OEMs’ and CM’s profits may decrease with the discount rate and market potential, but increase in the fixed investment cost.