Should purchasing activities be outsourced along with production?

Abstract

When outsourcing its production to a contract manufacturer, a brand name company may also let the manufacturer take over the procurement of raw materials so as to focus on core competencies. However, by outsourcing the purchasing function, the brand name company may lose control over the quality of purchased materials, which may in turn damage its brand name and market share. In this paper, we study ways by which a brand name company can control the input material quality when outsourcing its procurement activities. Specifically, we consider a supply chain consisting of one brand name company, one contract manufacturer and a pool of material suppliers, each associated with a distinct quality level. The prices that the brand name company and the contract manufacturer are able to obtain from the suppliers depend on their bargaining power which may be private information. We show that a well designed procurement outsourcing contract can motivate the contract manufacturer to select higher quality materials. We also propose a material inspection strategy for fraud prevention and quality assurance in procurement outsourcing. Finally, we discuss the possibility of the brand name company ceding contracting rights to the contract manufacturer.