Product Line Design and Outsourcing Strategies in Dyadic Supply Chains

Abstract

Motivated by the practices of product design and production outsourcing, we develop a game-theoretic model of a dyadic supply chain to study the joint decisions on product line design and outsourcing. We derive equilibrium decisions on product quality levels and identify the conditions under which the manufacturer outsources production. We first study the case of symmetric outsourcing where the manufacturer outsources both high-end and low-end products, and obtain the following managerial insights. Symmetric outsourcing tends to enlarge product differentiation within a product line, quality levels under symmetric outsourcing are lower than those under symmetric insourcing when the manufacturer's marginal quality cost is medium, and the size of the product line decreases with both the subcontractor's production cost under outsourcing and the manufacturer's production cost under insourcing. When allowing asymmetric sourcing where the manufacturer outsources one product and insources another product, we find that the sourcing strategy reverses the effect of the manufacturer's nonquality cost on quality levels where nonquality cost represents marginal production cost independent of quality level, and asymmetric sourcing may be taken when the manufacturer's nonquality cost is low and symmetric outsourcing should be taken when the manufacturer's nonquality cost is high.