Value Allocation to Maintain Suppliers in Development-Intensive Supply Chains

Abstract

Market-dominating buyers in research and development (R&D)-intensive industries who deal with only a few suppliers must balance their short-term goal of minimizing cost with their long-term interest in maintaining financially healthy relationships with a limited number of qualified suppliers. In this paper, we analyze how a prominent buyer's interest in preserving a healthy supply base impacts his procurement decisions. To do so, we formulate a mathematical model in which a focal and a partner supplier, where the focal supplier has greater resources available to commit to her relationship with the buyer, sequentially choose their cost reducing efforts to compete for a divisible supply of known buyer value. We then examine the buyer's supplier selection problem as well as the suppliers' equilibrium financial health using non-cooperative game theory, analytically in a single-period setting and numerically in multiple-period settings. The buyer's long-term financial health concerns on this supplier structure reveals insights that have been overlooked in the previous literature on supplier selection. In particular, we demonstrate that the buyer may allow the partner supplier some profit in the absence of any information asymmetry. More interestingly, the forward-looking buyer may provide the partner supplier higher profits when the focal supplier has the technological lead. We also observe that, unless both suppliers are financially weak, the profit-maximizing buyer endows the suppliers with equally strong financial resources in the long run.

Keywords: sourcing relationships and strategy, financial health, R&D competition

JEL Classification: C44, D40, G30, D81