Outsourcing with Quality Competition: Insights from a Three Stage Game Theoretic Model

Abstract

Outsourcing decisions by organizations have strategic and operational implications. Strategically, understanding the market and competition is necessary to make effective outsourcing decisions. In this paper we recognize this concern and model the situation where an organization with quality and cost pressures and operational strategies may arrive at different outsourcing solutions based on competitor quality strategy traits. We develop a three-stage game-theoretic oligopolistic model based on differentiated product strategy and integrating quality expectations of the market. The model is solved for equilibrium points on price, outsourcing activity, and investments in quality. The results show that these decision factors are sensitive to market expectations and quality performance of competitors. Performance measures based on profitability and market share results are also presented within this model. Observations and insights are also presented.

Keywords: Outsourcing, Quality, Operations Strategy, Price, Game Theory

JEL Classification: C7, C71, D21, D43, D58, L11, M11, R32