Horizontal Coordinating Contracts in the Semiconductor Industry

European Journal of Operational Research 237(3) 887–897

51 Pages Posted: 18 Feb 2014 Last revised: 5 Feb 2015

See all articles by Xiaole Wu

Xiaole Wu

Fudan University - School of Management

Panos Kouvelis

Washington University in St. Louis

Hirofumi Matsuo

Kobe University

Hiroki Sano

University of Texas at Austin

Date Written: February 15, 2014

Abstract

Integrated device manufacturers (IDMs) and foundries are two types of manufacturers in the semiconductor industry. IDMs integrate both design and manufacturing functions whereas foundries solely focus on manufacturing. Since foundries often have cost advantage over IDMs due to their specialization and economies of scale, IDMs have incentives to source from foundries for the purpose of avoiding excessive capacity investment risk. As the IDM is also a potential capacity source, the IDM and foundry are in a horizontal setting rather than a purely vertical setting. In the absence of sophisticated contracts, the benchmark contract for the IDM and foundry is a wholesale price contract. We define “coordinating'' contracts as those that improve both the IDM's and foundry's expected profits over the benchmark wholesale price contract and also lead to the maximum system profit. This paper examines if there exist coordinating capacity reservation contracts. It is found that wholesale price contracts in the horizontal setting cannot achieve the maximum system profit due to either double marginalization effect, or “misalignment of capacity-usage-priority''. In contrast, if the IDM's capacity investment risk is not too low, there always exist coordinating capacity reservation contracts. Furthermore, under coordinating contracts, the IDM's sourcing structure, either sole sourcing from the foundry or dual sourcing, is contingent on the firms' cost structures.

Keywords: supply chain management, horizontal capacity coordination, reservation contract, wholesale price contract in horizontal setting, sourcing structure

JEL Classification: L00

Suggested Citation

Wu, Xiaole and Kouvelis, Panos and Matsuo, Hirofumi and Sano, Hiroki, Horizontal Coordinating Contracts in the Semiconductor Industry (February 15, 2014). European Journal of Operational Research 237(3) 887–897, Available at SSRN: https://ssrn.com/abstract=2397077 or http://dx.doi.org/10.2139/ssrn.2397077

Xiaole Wu (Contact Author)

Fudan University - School of Management ( email )

No.670, Guoshun Road
Shanghai, 200433
China

Panos Kouvelis

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

HOME PAGE: http://www.panoskouvelis.info

Hirofumi Matsuo

Kobe University ( email )

2-1, Rokkodai-cho, Nada-ku
Kobe, 657-8501, 657-8501
Japan

Hiroki Sano

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

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