Sourcing for Supplier Effort and Competition

As suppliers provide more value in today’s supply chains, eliciting supplier cost-reduction efforts and inducing supplier competition are two important levers for a buyer to reduce sourcing costs. In this paper, we study a buyer’s sourcing strategy considering supplier effort and competition. The buyer has two instruments in her strategy: the composition of the supply base and the contracting mechanism. In our model, two suppliers are available to be included in the supply base. The buyer invests in the suppliers’ capacity, facing uncertain market demand. The suppliers invest cost-reduction efforts, the realized production cost to be uncertain and private information. In the supply base design, the buyer determines the number of suppliers (one or two) in the supply base, and the capacity to be invested in each supplier. In the contracting mechanism design, the buyer chooses the time of price and capacity decisions, either before or after suppliers’ effort investment. We find that a supply base with symmetric capacity is effective at inducing supplier competition, while a supply base with asymmetric capacity is better at motivating supplier effort, when the capacity is invested before supplier effort. As a result, the buyer may invest in capacity for only one supplier (sole sourcing), equal capacities for both suppliers (symmetric dual sourcing), or positive but unequal capacities for both suppliers (asymmetric dual sourcing), even though the suppliers are ex ante identical. We characterize the conditions for each structure, and show that asymmetric dual sourcing should be considered only with uncertain demand. As the buyer’s investment influences supplier competition, we find that increasing demand uncertainty may cause the supply base structure to shift away from dual sourcing towards sole sourcing, while reducing the total capacity. Finally, we investigate the buyer’s joint decisions concerning the supply base and contracting mechanism. We find that, as supplier cost uncertainty or the cost of supplier effort increases, the buyer prefers greater supplier competition in the supply base and favors more decision delays in the contracting mechanism. In the result, sole sourcing combined with capacity and price commitments, and dual sourcing combined with ex post capacity and price decisions, often emerge as two optimal sourcing strategies.