Sourcing Strategies in the Presence of Social Comparison, Random Yields and Supplier Competition with Limited Capacity

Abstract

Dual sourcing is a strategy commonly adopted by original equipment manufacturers (OEMs) to diversify their supply base, secure capacity supply, and induce competition between suppliers. However, because the sourced components are produced by different suppliers, the final products might differ in quality. Consumers may become dissatisfied if they receive a lower quality product and conduct social comparison with others. In this paper, we examine how such consumer aversion to disadvantageous inequality affects an OEM’s sourcing decision and suppliers’ whole- sale price decision. We show that consumer aversion to disadvantageous inequality reduces the OEM’s incentive to dual source and intensifies competition between suppliers, thereby hurting suppliers but benefiting the OEM. Consumers, however, can be either hurt or benefited by their inequality aversion. We further show that when the suppliers have insufficient capacity, a pure strategy Nash equilibrium may not exist for the supplier’s wholesale pricing game. Nonetheless, we can characterize a mixed strategy wholesale price equilibrium and show that limited capacity levels can alter the role of consumer inequality aversion. This is the first work to fully characterize the equilibrium of supplier competition under limited capacity, random yields, and consumer inequality aversion in a supply chain setting.

Keywords: supplier diversification, quality uncertainty, correlated random yields, social comparison, game theory