Sourcing for Supplier Effort and Competition: Design of the Supply Base and Pricing Mechanism

Management Science, Forthcoming

35 Pages Posted: 14 Oct 2009 Last revised: 20 Dec 2012

See all articles by Cuihong Li

Cuihong Li

University of Connecticut - Department of Operations & Information Management

Date Written: July 1, 2012

Abstract

We study a buyer's sourcing strategy along two dimensions: the supply base design and the pricing mechanism, considering supplier competition and cost-reduction e ffort. The supply base design concerns the number of suppliers (one or two) included in the supply base, and the capacity to be invested in each supplier. The pricing mechanism determines the timing of the price decisions, with the buyer making price commitments before suppliers exert cost-reduction eff orts that may be renegotiated afterwards. We fi nd that symmetric capacity investment in suppliers and low price commitments (more likely to be renegotiated) are eff ective at fostering supplier competition, while asymmetric investment and high price commitments (less likely to be renegotiated) are better at motivating supplier e ffort. A complementary relationship exists between the supply base design and pricing mechanism: A more symmetric supply base should be combined with lower price commitments leading to more renegotiation opportunities. This results in three possible sourcing structures: sole sourcing (investing capacity in a single supplier and forming price with ex ante commitments), symmetric dual sourcing (investing equal capacity in both suppliers and forming price with ex post negotiations), and asymmetric dual sourcing (investing positive but unequal capacities in two (ex ante identical) suppliers and forming price using both ex ante commitments and ex post (re)negotiations). We characterize the conditions for each structure, and identify a strategic role of capacity investment.

Keywords: sourcing, supply base, supplier competition, supplier effort, commitment, renegotiation

Suggested Citation

Li, Cuihong, Sourcing for Supplier Effort and Competition: Design of the Supply Base and Pricing Mechanism (July 1, 2012). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1489101 or http://dx.doi.org/10.2139/ssrn.1489101

Cuihong Li (Contact Author)

University of Connecticut - Department of Operations & Information Management ( email )

368 Fairfield Road
Storrs, CT 06269-2041
United States

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