Optimal supplier switching with volume-dependent switching costs

Abstract

To reduce costs, a buyer would seek a more affordable price for products from alternative suppliers. For the buyer, there is asymmetric information about the alternative supplier׳s cost. A supplier switching model is constructed based on principal-agent theory to minimize the buyer׳s cost which includes the transfer payment to the entrant supplier, the payment to the incumbent supplier and the switching cost that is dependent on the switching volume. The analytical solutions of the optimal supplier switching strategies are obtained. It is shown that for a concave switching cost function the optimal switching takes the form of all-or-nothing switching strategy, and for a convex switching cost function the optimal switching may take the form of nonlinear partial switching strategy. Additionally, the optimal switching strategies under symmetric information are also presented to illustrate the effect of information premium on the switching decision-making. Furthermore, we propose a quantity–price contract to demonstrate the advantage of the contract designed on basis of the principle-agent theory.