Sourcing Competition under Cost Uncertainty and Information Asymmetry

35 Pages Posted: 4 Mar 2016 Last revised: 27 Jan 2019

See all articles by Lusheng Shao

Lusheng Shao

The University of Melbourne

Xiaole Wu

Fudan University - School of Management

Fuqiang Zhang

Washington University in St. Louis - John M. Olin Business School

Date Written: January 10, 2019

Abstract

Driven by increasing costs in the traditionally-regarded low-cost manufacturing bases (e.g., China), many firms have started to outsource their production to the regions of even lower costs (e.g., Southeast Asia). However, a new environment may involve higher cost uncertainty and severer information asymmetry. Motivated by these observations, we consider a sourcing game where competing firms choose between a supplier with transparent certain cost (type-C supplier) and a supplier with potentially lower but less transparent, uncertain cost (type-U supplier). We characterize the equilibrium of the sourcing game and study how different parameters affect the firms' sourcing strategy and profit performance. First, we find that due to information asymmetry, a large market size can make firms prefer the C-supplier to the U-supplier even if the latter has a lower average cost. Second, reducing the cost uncertainty or improving the signal accuracy of the U-supplier does not necessarily make it more attractive to sourcing firms, which cautions the suppliers when making efforts to mitigate cost uncertainty or better cost estimation. Third, higher competition intensity leads the diversified sourcing strategy to be more likely adopted under certain conditions. Interestingly, increasing the cost of the C-supplier (e.g., a cost hike in China) may make both sourcing firms better off because it can lead to a new sourcing equilibrium. Finally, this paper contributes to the mechanism design literature by showing that the direction of quantity distortion under the optimal competitive mechanism differs from that under the traditional monopolistic setting.

Keywords: strategic sourcing; mechanism design; Cournot competition; information asymmetry; cost uncertainty

Suggested Citation

Shao, Lusheng and Wu, Xiaole and Zhang, Fuqiang, Sourcing Competition under Cost Uncertainty and Information Asymmetry (January 10, 2019). Available at SSRN: https://ssrn.com/abstract=2741504 or http://dx.doi.org/10.2139/ssrn.2741504

Lusheng Shao

The University of Melbourne ( email )

198 Berkeley Street
Carlton, 3031
Australia

Xiaole Wu (Contact Author)

Fudan University - School of Management ( email )

No.670, Guoshun Road
Shanghai, 200433
China

Fuqiang Zhang

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

HOME PAGE: http://www.olin.wustl.edu/faculty/zhang/

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