Competition Under Diseconomies of Scale: The Role of Subcontracting and Single-Sourcing Commitment
Forthcoming in Decision Sciences
37 Pages Posted: 14 Jul 2017 Last revised: 16 Jul 2017
Date Written: January 20, 2017
This paper studies a supplier competition model in situations with flexible resources where suppliers face diseconomies of scale. Under such a situation, it is generally believed that a buyer may split an order across different suppliers; and even if the buyer chooses only one supplier, the winning supplier may subcontract part of the work to the others. Our results, however, show that the buyer always prefers to commit to single-sourcing prior to running a procurement auction. This is because such commitment eliminates the 'assurance' of getting a positive order from the buyer, thus intensifying supplier competition. We also find that subcontracting may be beneficial (detrimental) to the buyer if the subcontract is determined by the winning (losing) supplier of the bidding game. Finally, we show that, for the case with linear costs, the buyer is always better off when subcontracting is considered.
Keywords: Subcontracting, split contracts, diseconomies of scale, commitment, supplier competition
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