Direct Sourcing or Agent Sourcing? Contract Negotiation in Procurement Outsourcing
Posted: 14 Apr 2015 Last revised: 18 Apr 2019
Date Written: November 20, 2017
Problem definition: In a supply network consisting of a buyer, a purchasing agent and a supplier, the buyer can procure the component from the supplier directly and rely on the purchasing agent for complementary services (named direct sourcing (DS)), or authorize the purchasing agent to conduct both procurement and complementary services (named agent sourcing (AS)). When parties bargain pairwisely, how do their bargaining powers influence the equilibrium procurement outsourcing structure?
Academic/Practical Relevance: Both outsourcing structures DS and AS are commonly observed in practice, whereas the literature has rarely answered the questions that we ask.
Methodology: We adopt the generalized Nash bargaining framework to model the negotiations among the parties, and derive the corresponding equilibrium outcomes under both outsourcing structures by taking into consideration the existence of a component spot market.
Results: When two parties negotiate directly, we define their direct negotiation coefficient as the ratio of their exogenous bilateral relative bargaining powers. If they negotiate indirectly through a third party, we define their indirect negotiation coefficient as the quotient of their respective direct negotiation coefficients with respect to the third party. We show that when parties negotiate over both wholesale prices and quantities, the buyer's preference over DS and AS solely depends on the comparison result of its direct negotiation coefficient versus the indirect one with respect to the supplier. When the quantity is determined by the buyer while parties negotiate over wholesale prices, the equilibrium outsourcing structure hinges critically upon the magnitude of the purchasing agent's relative bargaining power over the supplier. Interestingly, their preference over DS and AS may be aligned with each other. We also show that it is in the best interest of the buyer to negotiate over prices only.
Managerial Implications: Our research identifies endogenous bargaining powers between the parties that dictate the equilibrium outsourcing structure. It indicates that the buyer needs to adjust its procurement outsourcing decision accordingly when the bargaining powers of its upstream partners are altered, especially when the buyer's bargaining power is sufficiently large: we analytically show that the buyer's preference is very sensitive to the relative bargaining powers of the purchasing agent and the supplier. This might help explain why Walmart switches from AS with Li & Fung to DS within just three years.
Keywords: Procurement Outsourcing; Purchasing Agent; Direct Sourcing; Negotiation
JEL Classification: M11
Suggested Citation: Suggested Citation