Direct Sourcing or Agent Sourcing? Contract Negotiation in Procurement Outsourcing

Posted: 14 Apr 2015 Last revised: 18 Apr 2019

See all articles by Yulan Wang

Yulan Wang

Hong Kong Polytechnic University

Baozhuang Niu

School of Business Administration, South China University of Technology

Pengfei Guo

Hong Kong Polytechnic University - Faculty of Business

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business

Date Written: November 20, 2017

Abstract

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

Wang, Yulan and Niu, Baozhuang and Guo, Pengfei and Song, Jing-Sheng Jeannette, Direct Sourcing or Agent Sourcing? Contract Negotiation in Procurement Outsourcing (November 20, 2017). Available at SSRN: https://ssrn.com/abstract=2591229

Yulan Wang

Hong Kong Polytechnic University ( email )

Hung Hom, Kowloon
Hong Kong

Baozhuang Niu (Contact Author)

School of Business Administration, South China University of Technology ( email )

Wushan
Guangzhou, AR Guangdong 510640
China

Pengfei Guo

Hong Kong Polytechnic University - Faculty of Business ( email )

Hong Kong

Jing-Sheng Jeannette Song

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States

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