Supplier Development and Integration in Competitive Supply Chains

Abstract

Supplier development and supplier integration are two deeply interconnected strategic tools that manufacturers often employ to improve the efficiency and competitiveness of their supply chains. This paper studies the interaction of these two strategic decisions in a competitive environment. Specifically, we consider a duopoly model where two supply chains, each consisting of one manufacturer and one supplier, sell substitutable products in the market. Each manufacturer orders components from its supplier and decides whether to integrate with the supplier and how much to invest to help reduce its cost. We find that, in most cases, a manufacturer invests more on supplier development after it integrates with its supplier; and both manufacturers integrate with their suppliers at equilibrium. However, when the heterogeneity of the manufacturers’ supplier development capabilities is sufficiently high and the more capable manufacturer integrates, the less capable manufacturer would invest less on supplier development after integrating its supplier; and at equilibrium, the less capable manufacturer prefers not to integrate. Furthermore, when considering the suppliers’ incentives to be integrated, we find that the less capable manufacturer is more likely not to integrate with its supplier. We also extend our model to another commonly seen sourcing structure, that is, diversified sourcing, where each manufacturer sources from two common suppliers (but each only considers supplier integration and development for one distinct supplier). In contrast to the previous case (which we call dedicated sourcing), under diversified sourcing, supplier integration of a manufacturer always leads to its more supplier development investment and both manufacturers would integrate at equilibrium. Finally, when each manufacturer could choose whether to source from one or two suppliers, we show that dedicated sourcing is the equilibrium structure.