Sourcing Innovation: When to Own and When to Control Your Supplier

Abstract

Many firms rely on their suppliers as a major source of innovation, and they harness the innovation potential of their supplier base by organizing procurement (or innovation) contests. Extant research on contests has mostly assumed that suppliers compete on even grounds in a procurement contest. However, in practice, contests are frequently biased because suppliers can differ widely in one important aspect: whereas some suppliers are independent from the buying firm, others may be affiliated with or even controlled by the buyer. This paper seeks to understand how (varying degrees of) supplier ownership and supplier control affect the outcomes of a procurement contest in terms of a buying firm's profits as well as the level of product innovation. Using a game-theoretic model, we identify the mechanism by which supplier ownership and control effectuate results; we characterize when (and when not) supplier ownership and control are beneficial for a buying firm; and we study when the goals of increasing profits and fostering innovation are aligned with one another, and when they are at odds. Overall, our analysis yields important insights about the optimal configuration of a buyer's supplier base structure, and it sheds light on the rationale behind recent supplier base developments in many large industries.

Keywords: innovation contest, industrial procurement, supplier management, supply base, control rights