The Effect of Learning and Integration Investment on Manufacturing Outsourcing Decisions: A Game Theoretic Approach

41 Pages Posted: 22 Aug 2011

See all articles by Wenli Xiao

Wenli Xiao

Georgia Institute of Technology-Operations Management Area

Cheryl Gaimon

Georgia Institute of Technology - Operations Management Area; Georgia Institute of Technology - Scheller College of Business

Date Written: August 18, 2011

Abstract

We introduce a two-period Stackelberg game of a supplier and buyer. We recognize that learning based on manufacturing experience has many advantages. Consistent with much of the literature, we assume both the buyer and supplier realize reductions in their respective production costs in period 2 due to volume-based learning from period 1 production. Additionally, we introduce another learning concept, the future value, to capture the benefits of transferring current manufacturing experience for the design and development of future products and technologies. In contrast to the literature, we allow the supplier two mechanisms to impact the buyer’s outsourcing decision: price and the investment in integration process improvement that reduces the buyer’s unit cost of integration. Integration process improvement may include the investment in new materials, specialized technology, or the re-design of the integration process. Conditions are given whereby the buyer partially outsources component demand as opposed to fully outsourcing or fully producing in-house. We explore when the supplier’s price and investment in integration technology are substitute strategies versus complements. We analyze the effect on the buyer and supplier’s decisions due to: the buyer’s base integration cost, the supplier’s cost of integration process improvement, the rates of learning for both the buyer and supplier, and dynamic demand.

Keywords: Integration Process Improvement, Volume-Based Learning, Partial Outsourcing, Stackelberg Game

JEL Classification: C72

Suggested Citation

Xiao, Wenli and Gaimon, Cheryl, The Effect of Learning and Integration Investment on Manufacturing Outsourcing Decisions: A Game Theoretic Approach (August 18, 2011). Available at SSRN: https://ssrn.com/abstract=1914726 or http://dx.doi.org/10.2139/ssrn.1914726

Wenli Xiao (Contact Author)

Georgia Institute of Technology-Operations Management Area ( email )

Atlanta, GA 30332
United States

Cheryl Gaimon

Georgia Institute of Technology - Operations Management Area ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
404-894-4934 (Phone)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

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