Strategic Sourcing Under Competition and Asymmetric Cost Information

Abstract

Driven by increasing costs in the traditionally-regarded low-cost manufacturing bases (e.g., China), many firms have started to outsource their production to the regions of even lower costs (e.g., Southeast Asia). However, a new environment may involve higher cost uncertainty and severer information asymmetry. Motivated by these observations, we study a sourcing game where competing firms choose between a supplier with certain cost (C-supplier) and a supplier with potentially lower but uncertain cost (U-supplier). We find that a larger market size will make firms favor C-supplier more despite its higher average cost. However, the effect of cost uncertainty is ambiguous: Reducing the cost uncertainty may either improve or reduce the attractiveness of U-supplier, depending on the current uncertainty level. The intensity of competition may also influence the firms' sourcing choice: More intense competition will make the diversified sourcing strategy more likely to be chosen if the cost uncertainty of U-supplier is sufficiently large; otherwise, intensified competition can favor either C-supplier or U-supplier. Interestingly, it has been found that increasing the cost of C-supplier (e.g., a cost hike in China) may make both sourcing firms better off because it can lead to a new sourcing equilibrium. Finally, this paper contributes to the mechanism design literature by showing that the direction of quantity distortion under the optimal competitive mechanism differs from that under the traditional monopolistic setting.