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Strategic Analysis of Dual Sourcing and Dual Channel with an Unreliable

Alternative Supplier
Article in Production and Operations Management · August 2018

DOI: 10.1111/poms.12938
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Vol. 28, No. 3, March 2019, pp. 570–587 DOI 10.1111/poms.12938
ISSN 1059-1478|EISSN 1937-5956|19|2803|0570 © 2018 Production and Operations Management Society
Strategic Analysis of Dual Sourcing and Dual Channel

with an Unreliable Alternative Supplier
Baozhuang Niu
School of Business Administration, South China University of Technology, No. 381, Wushan Road, Tianhe 510640, Guangzhou,
Guangdong, China, bmniubz@scut.edu.cn
Jiawei Li
Ross School of Business, University of Michigan, 1780 Broadway Street, Apt. 309, Ann Arbor, Michigan 48105, USA, jiawli@umich.edu
Jie Zhang*
School of Business Administration, Guangdong University of Finance and Economics, No. 21 Luntou Road, Haizhu District, 510320
Guangzhou, Guangdong, China, jiezh@gdufe.edu.cn
Hsing Kenneth Cheng

Warrington College of Business, University of Florida, P.O. Box 117169, Gainesville, Florida 32611-7169, USA,
kenny.cheng@warrington.ufl.edu
Yinliang (Ricky) Tan

A.B. Freeman School of Business, Tulane University, 7 McAlister DR, New Orleans, Louisiana 70118, USA, ytan2@tulane.edu
n today’s increasingly interconnected world, co-opetition has emerged as a new business practice among many high-
I tech firms. The boundaries between cooperation and competition becomes vague, and rivals engage in collaborative
activities. This study develops an analytical model to investigate the dual sourcing decision of the original equipment
manufacturer (OEM) in the presence of a competitive supplier (i.e., frenemy) as well as a non-competitive supplier who
nevertheless suffers from unreliable production yield. We study the competitive supplier’s dual channel decision if it pre-
fers operating both component-selling business and self-branded business, and find that the OEM always prefers supplier
diversification even though the additional non-competitive supplier is unreliable. Interestingly, our results reveal that the
non-competitive supplier’s expected profit is unimodal in its production technology level, which suggests the non-compe-
titive supplier may not have incentive to improve its production technology once it reaches a threshold. Furthermore, we
analyze the credibility of the competitive supplier’s threat to terminate the supply of the components to OEM as a
response of OEM’s engagement of a new supplier. We show that this termination of component-selling business by com-
petitive supplier is a non-credible threat to prevent OEM from seeking the alternative supplier.
Key words: co-opetitive supply chain; production technology; yield uncertainty; dual sourcing; dual channel
History: Received: August 2017; Accepted: July 2018 by Subodha Kumar, after 2 revisions.
This “frenemy” business relationship between

1. Introduction Apple and Samsung becomes particularly evident in
Apple and Samsung, two of the largest smartphone many high-tech related industries. For example,
vendors in the world, have combined shipping over Sharp who is the leading supplier of the Apple’s iPad
533 million units in 2017, which is equivalent to 36.3% and iPhone’s LCD screens, also competes with Apple
of worldwide smartphone market (IDC 2018). in the smartphone and tablet market. Another classi-
Although they compete fiercely in the end-user market, cal example is between IBM and Cisco, where IBM
where consumers take them as the substitutable choices buys Cisco’s network equipment and Cisco also com-
(Chowdhry 2014), they also in many ways cooperate petes with IBM directly in the server market (Swartz
with each other. Samsung has supplied processors for 2009). The above illustrations epitomize the concept
Apple’s smartphone for many years (Reisinger 2015). of “co-opetition” (Brandenburger and Nalebuff
According to a recent report on Bloomberg (Lee and 1996), where two firms cooperate in some activities,
King 2015), Samsung will continue manufacturing the and at the same time compete with each other in
main chips for Apple’s next generation iPhone. other activities.
570
Niu, Li, Zhang, Cheng, and Tan: Dual Sourcing with Unreliable Supplier
Production and Operations Management 28(3), pp. 570–587, © 2018 Production and Operations Management Society 571
One of the most critical challenges in the co-opeti- engagement of a new supplier might also irritate the
tive supply chain is the concern about the sourcing competitive supplier who has enjoyed its exclusivity
strategy. From Apple and many other original equip- with the OEM, and thus it is possible that the compet-
ment manufacturers’ (OEMs, that is, purchase compo- itive supplier terminates its component-selling busi-
nents and then produce a new product with its brand ness as a threat. In practice, we observe that Samsung
name) perspective, it is generally risky to rely solely has considered terminating its LCD supply contract
on their competitors to provide the key components. with Apple when the Apple squeezes the component
One noteworthy problem is the wholesale price deter- wholesale price through supplier diversification from
mination, where the sole supplier maintains a strong LG and Sharp (Tibken 2012). Thus, the above example
pricing power. According to Forbes (Worstall 2013), occurring in reality raises some intriguing issues that
Samsung raised the price of a key component sup- have not been well understood in the literature. How
plied to Apple by 20% where Apple first disapproved will the competitive supplier respond to the OEM’s seeking
it, but finding no replacement supplier. It seems natu- an alternative supplier? Will the competitive supplier ter-
ral for the OEM to seek an alternative supplier who minate his component-selling business as a response?
will not compete directly with the OEM in the end In this study, we consider a supply chain associated
market by engaging the dual sourcing strategy. How- with the high-tech industry consisting of an OEM, a
ever, due to the sophisticated and unstable technol- competitive supplier and a non-competitive supplier.
ogy process, many new entering non-competitive We investigate the aforementioned research questions
suppliers suffers the yield loss from manufacturing by considering the following three scenarios: (i) The
defects. Bohn and Terwiesch (1999) have documented base scenario where the competitive supplier acts as
that high-tech manufacturers such as Seagate experi- the sole supplier of the OEM, (ii) The dual sourcing
enced production yields as low as 50%. Recent media scenario, in which the OEM sources from both the
reports reveal that the yield rates for TSMC1 who pro- competitive supplier and the non-competitive sup-
vide the fingerprint sensor for Apple is only around plier, although the non-competitive supplier’s compo-
70%–80% (Bora 2014). Similar to the previous litera- nents have uncertain yield, (iii) The termination
ture, we capture the notion of unreliable supplier in scenario, in which the OEM sources components
the technology industry by proportional random solely from the non-competitive supplier, and the
yield (Tang and Kouvelis 2011, Yano and Lee 1995). competitive supplier generates profits from self-
Essentially, the OEM can only expect to receive a por- branded business solely. We develop a stylized model
tion of what it orders from the alternative supplier. to investigate the incentives of the strategic decision
This yield uncertainty not only hurts the quality of of each player. The main insights of our research are
the products but also upsets the availability of the summarized as below.
products. OEM is facing a critical decision on whether First, OEM always prefers the supplier diversifica-
or not to engage an alternative supplier (i.e., non-com- tion although the non-competitive supplier suffers
petitive supplier for the remainder of the study) by from inferior technology and uncertain yield. Essen-
adopting the dual sourcing strategy. On the one hand, tially, by shifting component orders to the non-com-
sourcing from an additional supplier may reduce the petitive supplier, OEM’s dual sourcing strategy
component price through upstream competition. On benefits itself by inducing a price war in the upstream
the other hand, the non-competitive supplier suffers component supply market. The price war drives
from the yield uncertainty which may cause the qual- down the component price, which helps the OEM to
ity and supply problems for the OEM. The above dis- procure more components at a lower cost. This gives
cussion leads to our first research question: Is it the OEM an advantage competing with the competi-
beneficial for the OEM to seek a non-competitive supplier tive supplier in the end product market. Although the
who suffers from inferior production technology? And if benefits of supplier diversification have been well
so, how does the OEM optimally allocate its component established in other settings (Chen and Guo 2014,
orders between the competitive supplier and non-competi- Tang and Kouvelis 2011), we have extended this
tive one? result to a co-opetitive supply chain where the bene-
Securing an additional supplier may give the OEM fits of supplier diversification come from both
more leverage when it comes to component procure- upstream and downstream markets.
ment with its suppliers in the future. Previous litera- Second, the non-competitive supplier’s expected
ture have also established several benefits of the dual profit is unimodal in its production technology level in
sourcing, such as mitigating the supply risk through the dual sourcing scenario. That is, the non-competi-
supplier diversification (Cachon et al. 2008), fostering tive supplier has a most preferred technology level,
the upstream competition (Chen and Guo 2014), and and it has no incentive to further improve the produc-
reducing the inefficiency caused by random yield tion technology (even it’s costless). The intuition driv-
(Tang and Kouvelis 2011). However, this new ing this result is as follows: As the non-competitive
572 Production and Operations Management 28(3), pp. 570–587, © 2018 Production and Operations Management Society
supplier improves its production technology, initially the earlier literature. Later, there are more studies that
the OEM tends to purchase more components from it. focus on the mitigation of supply disruption risk by
However this allocation will intensify the upstream supplier diversification and dual sourcing. Tomlin
competition between the non-competitive supplier (2006) studies the strategies to manage the supply dis-
and competitive supplier, where the latter will cut his ruption risk when there are two suppliers–one is reli-
wholesale price as a response. As a result, OEM will able but expensive while the other is cheaper but with
gradually reduce her component orders to the non- yield uncertainty. Tang and Kouvelis (2011) assume
competitive supplier and shift orders back to the suppliers’ products have proportional random yield
competitive supplier. Therefore, we observe that the and show that two competing buyers’ dual sourcing
non-competitive supplier’s profit is unimodal in its strategies may be beneficial by mitigating the channel
technology level. inefficiency caused by yield uncertainty. They con-
Third, the termination of component-selling busi- sider exogenously given component prices and focus
ness by competitive supplier is a non-credible threat on the value of supplier diversification. Li et al. (2013)
to stop the OEM from seeking an alternative supplier. investigate a buyer’s supply diversification decision
As we have discussed, the OEM always prefers the by assuming the suppliers’ random capacities are cor-
dual sourcing strategy; however, one of the concerns related and the buyer adopts a responsive pricing
that may hinder the OEM seeking the alternative sup- strategy. They find that the insight “cost is the order
plier lies in the fact that the competitive supplier may qualifier and reliability is the order winner” holds
terminate its component-selling business. We show with two suppliers but fails to hold with more suppli-
that termination is never a credible threat by the com- ers. Chen and Guo (2014) study an asymmetric
petitive supplier. When the non-competitive sup- two-retailer-one-supplier model where one retailer
plier’s production technology is relatively low, the (referred to as the focal firm) can source from both the
competitive supplier is willing to maintain its collabo- unreliable supplier and the spot market, while its
ration with the OEM, because the competition in the rival (referred to as the rival firm) can only source
component market is not severe. As the non-competi- from the unreliable supplier. They show that the focal
tive supplier continues to improve its technology firm’s dual sourcing creates a win–win situation for
level, the OEM can ignore the termination threat by both firms. Even if the spot market price is low, strate-
the competitive supplier as the production quality of gically sourcing from the unreliable supplier can be
the non-competitive supplier is high enough such that beneficial for the focal firm. Tang et al. (2014) charac-
the OEM can be better by relying solely on the compo- terize the buyers’ trade off between sourcing from
nents from the non-competitive supplier. multiple suppliers and encouraging their preferred
The remainder of our study is organized as follows. supplier to reduce the degree of yield uncertainty.
In the next section, we first review the most relevant They identify the conditions under which dual sour-
literature and position our paper with respect to the cing or sole sourcing strategy can be preferred by the
literature to highlight our contributions. This is fol- buyers. More recently, Li et al. (2015) consider a set-
lowed by the introduction of our model setting and ting where there exists information asymmetry
the base scenario in section 3. Sections 4 and 5 investi- between the two heterogeneous suppliers and a com-
gate the dual sourcing scenario and termination mon retailer. They find that the equilibrium contract
scenario respectively, and we also compare the com- menus depend on how much information rent the
panies’ performances to understand their strategic supplier may need to pay.
decisions. Section 6 presents several extensions of our Compared to the aforementioned works, especially
model where we consider other factors that may the two most related papers—Tang and Kouvelis
impact the strategic decisions, which includes capac- (2011) and Chen and Guo (2014), we investigate a co-
ity constraint, alternative demand models and opetitive supply chain in which the competitive sup-
positive production cost. This study ends with plier serves as both the buyer’s upstream business
conclusions and avenues for future research. All the partner and downstream competitor. The buyer can
proofs are placed in the Appendix S1. source from a unreliable alternative supplier, whose
wholesale price is endogenously determined. We
focus on the channel members’ strategic decisions
2. Literature Review with respect to the buyer’s adoption of dual sourcing
Our work is closely related to the studies on unreli- strategy, the competitive supplier’s incentives of mar-
able supply and yield uncertainty problems. Early ket withdrawal, and the non-competitive supplier’s
researches are mostly concerned with optimal pro- preference of the degree of yield uncertainty. We note
duction, procurement and inventory replenishment that Tang and Kouvelis (2011) study a chain-to-chain
in the presence of yield uncertainty. Yano and Lee competition model without the consideration of co-
(1995) provide an excellent comprehensive review for opetition issues, and Chen and Guo (2014) study a
Hotelling model where the product wholesale prices and the competitive CM tends to generate profits
are exogenously given. With endogenized wholesale from both contract manufacturing and self-branded
prices, we show that dual sourcing does not necessar- businesses. Recently, Adner et al. (2015) develop a
ily sustain as the channel members’ win–win strategy. game-theoretic model to explain the incentives for
Our work is also closely related to the studies on two platforms to become frenemies when the differ-
co-opetition in supply chain. This stream is originated ence in their profit foci is sufficiently large.
from the literature of dual channel management in Similar to Dumrongsiri et al. (2008) and Cai (2010),
economics (Spiegel 1993) and the early OM/IS inter- we derive the outcomes in each scenario and then
face (Tsay and Agrawal 2004). While early literature compare them to analyze the supply chain parties’
focuses mostly on the impact of a direct channel to incentives toward alternative channel structures.
the related firms and the supply chain, more recent However, different from the existing works, we con-
studies investigate the supplier’s incentives to estab- tribute by considering the OEM’s dual sourcing strat-
lish a direct channel and the strategic interaction egy when it faces a competitive supplier and has the
between the supply chain members, and then option of sourcing from an unreliable alternative sup-
the stream of literature on co-opetition gradually plier, and analyzing the strategic interactions between
emerges. Kumar and Ruan (2006) assume customers the OEM and the competitive supplier.
are either brand-loyal or retailer-loyal, and show that
the supplier has incentives to open a direct channel
and hence, operates a dual channel business model.
3. Model Settings and Benchmark
Dumrongsiri et al. (2008) assume consumers are both 3.1. Notations and Assumptions
price and service quality sensitive, and examine the We consider a three-player game comprising a com-
manufacturer’s incentives regarding direct and retail petitive supplier (CS), a non-competitive supplier
channels. They show that, the channel cost difference, (NS) and an OEM where the NS does not compete
the demand variability, and the channel centralization directly with the OEM in the end market. Both com-
degree greatly influence the manufacturer’s decisions petitive supplier and non-competitive supplier are
of opening a direct channel. Cai (2010) identifies a capable of producing a key component, which is then
channel-adding Pareto zone and a contract-imple- used to produce the end products for the consumers.
menting Pareto zone in two single-channel and two Similar to Amaral et al. (2006), Chen et al. (2012), and
dual-channel supply chains. In the former zone, both Wang et al. (2013), we define OEM as a company that
the retailer and supplier have profit improvements purchases components and then finalizes a new pro-
when the supplier opens a direct channel. In the latter duct with its brand name. For the remainder of the
zone, the value of contract coordination is derived. study, we use the pronoun “he” to represent the com-
Wang et al. (2013) investigate the timing issue of two petitive supplier (cs), “she” to represent the OEM (o)
frenemies’ quantity decisions by solving an endoge- and “it” to represent the non-competitive supplier
nous timing game. They find that the OEM tends to (ns). Based on the motivations discussed in introduc-
source solely from a competitive contract manufac- tion, we analyze the following three scenarios, which
turer (CM) regardless the downstream competition, are illustrated in Figure 1.
Figure 1 Illustration of Three Different Scenarios

(1) The base scenario, in which the competitive When the OEM sources from a non-competitive
supplier serves as the sole supplier of the supplier, she has to be concerned about its yield
OEM. uncertainty problem. That is, for an order of size q,
(2) The dual sourcing scenario, in which the the realized delivered quantity is eq, where e is a ran-
OEM sources from both competitive supplier dom variable with mean l and variance r2 (Yano and
and non-competitive supplier, although the Lee 1995). We restrict the support of e to be [0, 1] and
non-competitive supplier suffers from yield r < 1/2.3 It’s worth noting that the increase of the
uncertainty. expected yield l and/or the decrease of the yield vari-
(3) The termination scenario, where the OEM ance r2 can be interpreted as “quality improvement.”
sources components solely from the non-com- In practice, these improvements can be achieved
petitive supplier. This may either result from through better process management and investment
the OEM’s choice when it shifts all the orders in new technology. In the presence of the yield uncer-
to the non-competitive supplier, or the com- tainty problem, firms can only form an expectation of
petitive supplier’s choice when it refuses to their own and the rival’s profits. We assume that all
sell components to the OEM. supply chain members are risk-neutral profit maxi-
mizers. We also assume that the OEM pays for what
Without loss of generality, we assume that both the
she actually receives rather than what she orders. This
competitive supplier and OEM employ one unit of
is consistent with the industrial practice and previous
component to assemble one unit of end product. We
literature.4 Nevertheless, we show that these two
focus on those industries where the retail prices are
assumptions lead to almost identical results.
mainly determined by the supply quantities. Typical
For the remainder of this study, we incorporate
examples include influenza industry (Deo and Cor-
superscripts on the optimums: B, D, T to denote the
bett 2009), microchip industry (Tang and Kouvelis
base scenario, the dual sourcing scenario, and the
2011), and smartphone industry in which Samsung
termination scenario, respectively. For example, PBcs
and Apple compete (Autrey et al. 2014, Karp and
stands for the competitive supplier’s optimal profit
Perloff 2012). Thus, we assume that the competitive
in the base scenario. We denote qo (qb) as the OEM’s
supplier and the OEM engage in a Cournot-typed
(the competitive supplier’s) production quantity in
competition in the end-user market.
the end market, qcs as the component order quantity
In particular, similar to Tang and Kouvelis (2011),
allocated to the competitive supplier, and qns as the
the consumer demand for the competitive supplier’s
order quantity to the non-competitive supplier. In
product is represented by a linear, downward slop-
addition, Wcs represents the wholesale price
ing, (inverse) demand function Pcs = a bQ, where
between the competitive supplier and OEM, and
Pcs is the retail price, a is the market potential, b repre-
Wns represents that between the non-competitive
sents the quantity sensitivity and Q denotes the total
supplier and the OEM.
quantities available on the market. Without loss of
generality, we assume that the market potential a is
3.2. The Benchmark: Base Scenario
large enough such that the market demand is always
In this scenario, the OEM sources solely from the
positive (Wu and Zhang 2014). To capture the brand
competitive supplier. The event sequence is described
distinction between the products from the OEM and
as follows: First, the competitive supplier determines
the competitive supplier, we assume that the demand
the unit wholesale price Wcs. Second, the OEM places
for OEM’s product is Po = a bQ + m (m ≥ 0 and
an order to the competitive supplier, who also deter-
a ≥ m). Essentially, the OEM’s products enjoy a pre-
mines the production quantity for his self-branded
mium perception from the consumers (Arru~ nada and
products. Third, the OEM receives the components
Vazquez 2006). For instance, consumers are willing to
and both firms assemble the components to the end
pay a higher price for ThinkPad laptop (i.e., OEM)
products. Finally, products are sold to consumers at
than Asus laptop (i.e., CS) although the configuration
market clearing price. Note that, the OEM’s produc-
of the two computers are almost identical. This model
tion quantity in the end market, qo, exactly equals her
is originated from the Cournot competition model for
order quantity placed to the competitive supplier, that
differentiated goods (Singh and Vives 1984). Without
is, qo = qcs, because the competitive supplier does not
loss of generality, we also normalize the production
have the yield uncertainty problem.
costs of the competitive supplier, the non-competitive
Thus, the competitive supplier and the OEM’s
supplier, as well as the OEM’s assembly cost to be
profit functions are given as:
zero.2 In section 6.4, we analyze the situation in which
there is a positive cost for the production in both the Pcs ¼ ða bqb bqcs Þqb þ Wcs qcs ;
competitive and the non-competitive supplier, and
Po ¼ ða bqb bqcs þ mÞqcs Wcs qcs :
we find that our main findings are robust.
The competitive supplier’s profit comes from the competitive supplier suffers the yield uncertainty
following two sources: (i) component-selling busi- problem. Third, the OEM and the competitive sup-
ness; (ii) self-branded business. If he competes with plier finalize the components into end products and
the OEM intensively in the downstream market, it deliver them at the market-clearing price po and ps.
will not only squeeze the OEM’s selling quantity but The profit functions of the competitive supplier, the
also reduces the competitive supplier’s own revenue OEM and the non-competitive supplier are then:
from component-selling business. Hence, the OEM
and the competitive supplier have a co-opetitive rela- Pcs ¼ ½a bqb bðqcs þ eqns Þqb þ Wcs qcs ;
tionship, under which the competitive supplier has to Po ¼ ½a þ m bqb bðqcs þ eqns Þðqcs þ eqns Þ
balance his revenue from these two sources. The Wcs qcs Wns eqns ;
results are summarized in Lemma 1.
Pns ¼ Wns eqns :
LEMMA 1. In the base scenario, where the OEM sources
In the quantity-decision stage, both the competitive
solely from a competitive supplier, the equilibrium whole-
supplier and OEM evaluate their expected profits in
sale price is WcsB ¼ 5a þ104m, the production quantities are
2m
anticipation of the non-competitive supplier’s yield
qBb ¼ 5a10b , qBo ¼ qBcs ¼ 2m
5b , and the supply chain par- uncertainty. We summarize the optimums in the fol-
5a2 þ 4m2 4m2
ties’ profits are PBcs ¼ 20b , PBo ¼ 25b . lowing Lemma 2.
Clearly, the competitive supplier’s production LEMMA 2. In the dual sourcing scenario, where the
quantity is decreasing in m, while the OEM’s is OEM allocates her component orders to competitive and
increasing in m. This result is in line with intuition, non-competitive suppliers, the equilibrium wholesale
because the OEM’s brand image helps her products 4ð5a þ 4mÞr2 þ 4mÞr2
prices are WcsD ¼ 40r2 þ 27l2
, Wns D
¼ 2ð5a40r2 þ 27l2
; the
differentiate from the competitive supplier’s. We also 4ð5a 2mÞr2 þ 9ða mÞl2
find that the equilibrium wholesale price is increasing order quantities are qb ¼D
bð40r2 þ 2 7l2 Þ
, qD cs ¼
in m, but the selling quantity qBo still increases in m 16mr2 þ 4al2 þ 14ml2 ð5a þ 4mÞl
bð40r2 þ 27l2 Þ
, and qD ns ¼ bð40r2 þ 27l2 Þ. Correspond-
because the OEM’s profit margin increases. That is,
ingly, the equilibrium expected profits of the supply chain
the positive effect (i.e., larger selling quantity) due to
members are,
the increase of m outweighs the negative effect (i.e.,
higher wholesale price) in this scenario. Meanwhile,
2ð5a þ 4mÞ2 r2 l2
the competitive supplier’s overall profit is also ns ¼
EPD ;
increasing in m, indicating that his profit loss from bð40r2 þ 27l2 Þ2
self-branded business is compensated by its profit m2 ð320r4 þ 368r2 l2 þ 81l4 Þ 2aml2
gains from component-selling business. When m
increases, the competitive supplier gains from a ð80r2 þ 81l2 Þ þ a2 ð400r4 þ 440r2 l2 þ 81l4 Þ
cs ¼
EPD and
higher WcsB and sells more components qBcs . On the con- bð40r2 þ 27l2 Þ2
trary, if m approaches to 0, that is, the OEM’s product a2 l2 ð25r2 þ 81l2 Þ þ 4aml2 ð82r2 þ 81l2 Þ
has little brand advantage toward its competitor, then
the OEM only gains very limited profits and can þ 4m2 ð64r4 þ 148r2 l2 þ 81l4 Þ
o ¼
EPD ;
hardly survive in the market. bð40r2 þ 27l2 Þ2
4. The Dual Sourcing Scenario respectively.

In this scenario, the OEM adopts dual sourcing strat-
egy and allocates her component orders to both the For the remainder of this study, we denote
competitive supplier and the non-competitive sup- x = (l/r)2 as the technology level of the non-
plier. The event sequence is as follows: First, both the competitive supplier, which is an indicator of the
competitive supplier and the non-competitive sup- quality in its production process, and almost all the
plier determine their component wholesale prices. decisions/outcomes can be represented as functions
Second, after observing both wholesale prices, the of x. It’s straightforward to see that the increase of l
OEM and the competitive supplier determine their and/or the decrease of r leads to a higher level of x.
production quantities simultaneously. Note that the Essentially, the higher the technology level x is, the
OEM’s orders are allocated between the competitive more reliable the non-competitive supplier’s produc-
and the non-competitive suppliers, which are labeled tion process are. Suppliers can improve their produc-
as qcs and qns respectively, and her total received com- tion process not only through costly R&D innovations
ponent quantity is qo = qcs + eqns, where the non- but also by inexpensive administrative efforts. For
Figure 2 Illustration of Impact of x on Profits of Each Supply Chain Party [Color figure can be viewed at wileyonlinelibrary.com]
0.8 0.06
0.7
OEM 0.05
0.6
0.04 Non−competitive Supplier

0.5
Profit
Profit
0.4 0.03
Competitive Supplier
0.3
0.02
0.2
0.01
0.1 Non−competitive Supplier
0 0
0 1 2 3 4 5 0 1 2 3 4 5
example, Snow et al. (2006) have documented that the competitive supplier as the non-competitive supplier
bio-technology firm Genentech worked very hard to has a relative price advantage (Wns D
\ WcsD ). Its
improve its yield through “monitoring the raw mate- improvement on production quality increases the
rials, limiting human involvement in production, test- competitive supplier’s pressure significantly and
D
ing frequently and ensuring that all connections hence, Wcs and Wns both decrease. That is, the com-
between pieces of equipment were tightly sealed.” petitive supplier’s component price has to be low-
Next we use x to rearrange the supply chain parties’ ered along with the non-competitive supplier’s. As a
profits shown in Lemma 2, which leads to the follow- result, from Proposition 1, we conclude that a price
ing two interesting results through sensitivity analy- war between the suppliers can be successfully
sis. The results are also illustrated in Figure 2. induced by the OEM’s dual sourcing strategy. When
the competitive supplier lowers WcsD , to respond, we
PROPOSITION 1. When the OEM adopts the dual sourcing observe the increase of qD cs . That is, the OEM shifts
strategy, the competitive supplier’s expected profit decreases some component orders back due to the competitive
in x while the OEM’s expected profit increases in x. supplier’s price undercutting behavior.
Regarding the OEM, when x increases, the lowered
Our findings toward the profits of the competitive average component wholesale price provides her a lar-
supplier and the OEM are in line with expectation: ger cost advantage in the downstream market, because
The higher the technology level of the non-competitive she can procure more components from the competi-
supplier is, the more intense the competition between tive supplier at a lower cost. Eventually, the competi-
the suppliers will be. This reduces the competitive sup- tive supplier’s self-branded business is hurt, and
plier’s profit from component-selling business. For the therefore qD
b decreases in x. That is, the OEM benefits
OEM, it always benefits from the non-competitive sup- from both the suppliers’ price war and the resolved
plier’s production quality improvement, and the main yield uncertainty at the non-competitive supplier, and
reason is the component price war induced between thus she prefers a higher value of x. However, the com-
the suppliers. Taking a closer look at the wholesale petitive supplier’s loss from downstream self-branded
prices and quantities of the competitive supplier, we business prevails his gains due to component order
have the following comparative statics: increase in the component-selling market, and thus he
suffers from the non-competitive supplier’s improve-
@WcsD @qD @qD
\0; cs
[ 0; b
\0: ment of it technology level, x. Then, we reach the fol-
@x @x @x lowing result: the OEM is strictly better off while the
When the technology level x increases, the non- competitive supplier is strictly worse off in the dual
competitive supplier becomes a threat to the sourcing scenario, because the base scenario can be
regarded as a special case when x = 0 and the non- fiercer competition in the component selling market,
competitive supplier is completely incapable. This and its optimal response is to reduce WcsD . As a result,
D
finding is consistent with the existing literature of dual the non-competitive supplier will reduce Wns corre-
sourcing and dual channel. spondingly, but the price war becomes less intense
because the difference between the prices becomes
smaller. In anticipation of the competitive supplier’s
PROPOSITION 2.
response, the OEM may be willing to shift some of
1. The non-competitive supplier’s expected profit EPD ns her order back to the competitive supplier when x is
is unimodal in x; at a high level. That is, we observe an increasing qD cs
D
2. Wns is decreasing in x; qD
ns is unimodal in x for all and a decreasing qD ns . The intuition is as follows: When
given feasible r. the non-competitive supplier’s quality is approaching
D
to the competitive supplier’s, although Wns keeps
We then study the non-competitive supplier’s pref- decreasing, the price advantage of the non-competi-
erence of x. Conventional wisdom suggests that the tive supplier is not very significant. Therefore, the
non-competitive supplier should improve its technol- OEM’s gains from component price war become lim-
ogy level as much as possible in order to attract more ited, and is more concerned about her gains from the
orders from the OEM. However, our findings toward downstream market, where the competitive supplier
the non-competitive supplier’s preference of x is is her major competitor. It has been illustrated by pre-
rather surprising: Its profit is unimodal in its technol- vious literature that, placing more orders to a rival
ogy level x. In other words, the non-competitive sup- can limit the rival’s incentives to develop the self-
plier has a most preferred technology level, and it has branded business (Spiegel 1993, Wang et al. 2013),
no incentives to further improve the production tech- and hence, reduce downstream competition. There-
nology, if it still can. fore, to generate more profits from the downstream
To understand this finding, we further investigate market, we observe an increasing qD cs and a decreasing
how the quantities and the wholesale prices change in qDns , even if W D
ns is further decreasing and x is increas-
the technology level x. Interestingly, we find that qD ns ing. Being aware of this, to snatch more component
is non-monotone in x in the support of a given r. This orders, the non-competitive supplier has no other
D
is the key reason to explain why the profit of the non- choices but to further lower its wholesale price Wns ,
competitive supplier is unimodal in x. When the tech- though its production quality is already high. We
nology level x improves, the OEM tends to shift her illustrate the above results in Figure 3.
order to the non-competitive supplier, that is, qD ns If we think the competitive supplier’s products as
increases. Then, the competitive supplier faces a “luxury goods” with high price elasticity for its high
Figure 3 Illustration of Impact of x on Wholesale Prices and Quantities [Color figure can be viewed at wileyonlinelibrary.com]
0.8 2.5
0.7
2
0.6
0.5
Wholesale Price
1.5
Quantity
0.4
0.3
1
0.2
0.1 0.5
0
0 1 2 3 4 5 0 1 2 3 4 5
quality, and the non-competitive supplier’s products

Pcs ¼ ða bqb beqns Þqb ;
as “economy substitutes” with low price elasticity for
its inferior quality, then it’s easy to understand that Po ¼ ða þ m bqb beqns Þeqns Wns eqns ;
the marginal order increase due to price reduction of Pns ¼ Wns eqns :
“luxury goods” will be more obvious. This also helps
explain the finding that qD D The equilibrium decisions and outcomes are sum-
ns decreases while qcs
increases when the suppliers’ wholesale prices are marized in Lemma 3.
both decreasing. In summary, we find that when x is
small, the OEM shifts orders to the non-competitive LEMMA 3. In the termination scenario, where the OEM
supplier as x increases, and then it has incentive of can only source from the non-competitive supplier, the
improving technology. When x becomes large, the equilibrium component wholesale price is Wns T
¼ a þ42m;
OEM tends to shift orders back to the competitive the supply chain parties’ production quantities are qTb ¼
supplier. As a result, the non-competitive supplier 8ar2 þ ð5a 2mÞl2 ða þ 2mÞl
16br2 þ 12bl2
, and qTns ¼ 8br2 þ 6bl2
; and the supply chain
will lose some orders even if it has further reduced
þ ð5a 2mÞl2 Þ2
EPTcs ¼ ð8ar16bð4r
2
the wholesale price due to the intensive upstream parties’ profits are 2 þ 3l2 Þ2
, EPTo ¼
competition. Combining the foregoing forces, the ða þ 2mÞ2 l2 ðr2 þ l2 Þ ða þ 2mÞ2 l2
, EPTns ¼ 8bð4r2 þ 3l2 Þ
respectively.
non-competitive supplier has no incentive to further 4bð4r2 þ 3l2 Þ2
improve its production technology when its most pre-
ferred quality level has been already achieved. Again, we find that the OEM’s production quantity
We also conduct the sensitivity analysis with respect is increasing while the competitive supplier’s produc-
to the price premium m. Most insights are similar to tion is decreasing in the brand difference m. The
those in the base scenario: The wholesale prices is OEM’s profit as well as the non-competitive sup-
increasing in m. When m is increasing, the competitive plier’s profit both increase in m. Without the compo-
supplier’s production quantity of his own product will nent-selling business, there is no tradeoff and the
decrease, and the OEM’s ordering quantities from both competitive supplier’s profit will decrease in m.
suppliers as well as her profit will increase. With an Regarding the impact of the non-competitive sup-
alternative supplier, the OEM can always survive in plier’s production technology level, our findings are
T
the market, even if m = 0, because now its supply is as follows: (i) the wholesale price Wns is a constant.
T
not fully controlled by its competitor. A different result (ii) qb is deceasing in x, which indicates that the com-
is that, the competitive supplier’s profit is decreasing petitive supplier, acting as a pure competitor of the
in m when it is smaller than a threshold, but increasing OEM, will be hurt when OEM finds a high quality
in m when it is sufficiently large. The driving force alternative supplier. (iii) qTns is unimodal in x for all
comes from the price war induced by the OEM’s dual given r, which implies that the OEM’s order quantity
sourcing strategy, which weakens the positive impact might be decreasing in x when x is sufficiently high.
of an increasing WcsD and strengthens the negative (iv) EPTo is increasing in x, because when the non-com-
effect of a decreasing qD
b , when m is increasing. By con-
petitive supplier has a high quality level, although the
trast, the competitive supplier’s pricing power ensures ordering quantity at the non-competitive supplier qTns
him to gain more from an increasing m in the base is lower but the actual received component quantity
model, even if qBb is decreasing in m. lqTns is higher.
Performance comparison between the termination and
base scenarios. Shifting from the base scenario to the
5. The Termination Scenario termination scenario may benefit or hurt the OEM,
In this scenario, the OEM sources solely from the non- because the non-competitive supplier can provide the
competitive supplier. The event sequence is as fol- components to the OEM at a lower price but at the
lows. First, the non-competitive supplier determines same time it has yield uncertainty. As for the competi-
the component wholesale price Wns. Second, the com- tive supplier, he has an incentive to terminate his
petitive supplier and the OEM determine their pro- component supply business because he competes
duction quantities simultaneously. Third, both firms with the OEM directly in the end-user market. We are
assemble the components to end products. Finally, interested in the changes of performances of the OEM
products are sold at market clearing prices. Note that and the competitive supplier from the base scenario
the OEM’s production quantity of the end products to the termination scenario. The results are summa-
is qo = eqns, where the non-competitive supplier rized in the following proposition.
becomes the sole supplier for the OEM.
The profit functions of the competitive supplier, PROPOSITION 3. The competitive supplier is strictly
the OEM and the non-competitive supplier are, worse off in termination scenario than that in the base
respectively scenario; The OEM is better off under the termination
scenario when x exceeds a threshold value xO, otherwise PROPOSITION 4. Comparing the profits in the dual sour-
it prefers the base scenario. cing scenario and termination scenario,
1. the OEM is always better off in the dual sourcing
Note that the competitive supplier becomes the
scenario;
pure competitor of the OEM in the termination sce-
2. the competitive supplier is better off in the dual
nario. Compared with the base scenario, we find that
sourcing scenario when x is smaller than a
the competitive supplier’s strategy of terminating his
threshold value xC, otherwise the competitive
component-selling business will indeed hurt the OEM
supplier prefers the termination scenario.
when x < xO. This indicates that the competitive sup-
plier’s termination decision of the component-selling
business can induce a lose–lose situation in the down- We find that the incentives of the OEM and the
stream competition. This situation no longer holds competitive supplier can be aligned when the newly
when x ≥ xO, where we find that the OEM can be bet- entered non-competitive supplier’s technology level
ter off in the termination scenario even when the non- is lower than the threshold value, xC, such that both
competitive supplier’s production technology is not OEM and competitive supplier prefer the dual sour-
very stable. Essentially, this is because that in the ter- cing strategy to the termination scenario. For the OEM,
mination scenario, the wholesale price offered by the we can conclude that the dual sourcing is its most pre-
non-competitive supplier is always lower than the ferred strategy as it generates the largest profit among
price offered by the competitive supplier in the base the three scenarios. An immediate insight is that the
scenario, that is, Wns T
\ WcsB . When the technology OEM will always benefit from the newly entered alternative
level x is low, the cost advantage of the OEM in the supplier even it suffers from technology inefficiency.
termination scenario is not strong enough to offset the That is, the OEM has no incentive to place all compo-
drawback brought by the low production technology. nent orders to a sole supplier.
However, as x increases, the drawback in production For the competitive supplier, intuitively speaking,
quality becomes less significant, and eventually when it’s more profitable to engage both component-selling
x surpasses xO, the OEM becomes better off in the ter- business and self-branded business (Wang et al. 2013).
mination scenario. We find that this intuition only holds when the compe-
Proposition 3 establishes the fact that the competi- tition in the upstream component market is not very
tive supplier always benefits from engaging the intense. That is, when the non-competitive supplier’s
component-selling business with OEM and termi- production technology is relatively low, the reduction
nating the component supply will shrink OEM’s in component wholesale price is not very significant.
profit when x < xO. We have also shown that the Furthermore, engaging in self-branded business will
OEM has strong incentives to diversify her supply contribute to the competitive supplier’s profit through
sources. Thus, an intriguing and important question revenue diversification. In practice, many technologi-
arise naturally, if the OEM wants to adopt the dual- cal firms have realized this and producing and selling
sourcing strategy by purchasing from an additional self-branded products, such as Samsung and Intel.
unreliable supplier, can the competitive supplier However, we find that this intuition breaks when the
prevent that by the threat of terminating his supply alternative non-competitive supplier’s production
of components? Next, we will investigate this ques- technology is sufficiently high. The resulting fierce
tion by comparing the supply chain parties’ perfor- price war will hurt the competitive supplier while pas-
mances under the termination and dual sourcing sing the gains to OEM. On the one hand, the competi-
scenarios. tive supplier’s benefit from component-selling
Performance comparison between the termination and business diminishes due to the intense competition in
dual sourcing scenarios. This comparison can be the the component market. On the other hand, the OEM
most interesting one—as we have mentioned in the benefits from the component price war which strength-
introduction, emerging debates have recently taken ens her business of the end product and hurts the com-
place in the OM/marketing field (Epstein 2014, Kaiser petitive supplier’s self-branded business. Being aware
2013, Kim 2012, Worstall 2013, Humphries 2012). of this, it’s worthwhile for the competitive supplier to
Essentially, the OEM prefers the situation where the terminate his component-selling business so as to
competitive supplier does not terminate the compo- increase the component costs for OEM and squeeze
nent-selling business even if she shifts some compo- OEM’s margin. This also benefits the competitive sup-
nent orders to a new alternative supplier. Especially plier’s self-branded business. Our finding here helps
when x < xO, the supplier’s termination threat seems explain Samsung’s recent termination of LCD contract
credible and indeed hurts the OEM’s profitability. with Apple (Humphries 2012).
The results of our analysis are summarized in the fol- We now turn our attention to the critical but open
lowing proposition. question: Is the termination of component-selling
Figure 4 Illustration of Performance Comparison [Color figure can be viewed at wileyonlinelibrary.com]
business by the competitive supplier a credible threat for although the yield uncertainty is not yet completely
the OEM? In other words, when the OEM tries to solved.
adopt the dual sourcing strategy, is it possible that From the OEM’s perspective, dual sourcing is
the competitive supplier terminates his supply of always the preferred strategy. When x is relatively
components as a response such that the OEM earns low, the competitive supplier is willing to continue
even less than in the base scenario? If this is true, the the component-selling business with OEM, hence
OEM has to consider more carefully when soliciting their incentives are coordinated and the dual sourcing
the alternative supplier. In Proposition 3, we show strategy can be successfully adopted. As the technol-
that it is possible that the OEM becomes worse off in ogy level x gradually increases and finally surpasses
the termination scenario than in the base scenario, xC, the component business will be terminated by the
and there exists a threshold value xO. In order to competitive supplier due to the intense competition
determine whether this termination is a credible in the component market. However, the OEM still
threat, we compare the two critical threshold value: becomes better off compared to the base scenario.
xC and xO. The result is provided in the following With the foregoing analysis, we can now conclude
proposition. that: Termination is never a credible threat by the competi-
tive supplier. It’s always optimal for the OEM to seek
PROPOSITION 5. For any given parameters of a, m, l and an alternative supplier (even with lower production
r, xO < xC. technology) and adopt the dual sourcing strategy. No
matter the competitive supplier accepts it or not, the
We illustrate this proposition in Figure 4. A direct OEM will always be better off compared with the ori-
implication of Proposition 5 is that when the technology ginal (base) sourcing strategy. In summary, we have
level x is strong enough to convince the competitive sup- the general equilibrium of the supply chain structures
plier to terminate his component-selling business, it is also in the following Table 1.
strong enough to enable the OEM to be better off in the ter- From the above discussions, dual sourcing is
mination scenario than in the base scenario. We summar- always OEM’s dominating strategy and the competi-
ize the strategic interactions between the OEM and tive supplier’s best response depends on x: if x < xC,
the competitive supplier as follows. From the compe- he chooses to maintain the co-opetition relationship
titive supplier’s perspective, when the OEM conducts with the OEM; otherwise when x ≥ xC, he will choose
dual sourcing strategy and when x is relatively low, to terminate its component-selling business and
the competitive supplier is still willing to cooperate become a pure competitor of the OEM. Therefore,
with the OEM since the competition in the component “Dual Sourcing” and “Termination” can be the equili-
market is not very intense. As x gradually increases, brium structure in general, depending on the alterna-
the upstream competition in the component market tive supplier’s technology level.
becomes fiercer, and eventually when x surpasses xC,
it’s actually better for the competitive supplier to ter-
Table 1 General Equilibrium of Supply Chain Structures
minate his component-selling business. However,
Proposition 5 indicates that it’s already “too late” for Competitive supplier
the competitive supplier to do so. The production
quality of the non-competitive supplier is so high that Co-opetition Competition
the OEM can be better off by relying solely on the OEM Single Base N/A
components from the non-competitive supplier, Dual Dual sourcing (x < xC) Termination (x ≥ xC)
We also investigate the impact of the non-competi-

6. Extensions and Discussions tive supplier’s production technology level x on its
6.1. Capacity Constraint of the profit when its competitor does not have sufficient
Competitive Supplier capacity. It is not difficult to show that EPDK
ns is still
In practice, the capacity of technological firms is unimodal in x. However, we find that the threshold
typically limited and difficult to adjust once becomes even smaller than the previous one, that is,
determined in the short term. In this subsection, the non-competitive supplier is less willing to
we explore how the capacity constraint of the improve its technology if its competitor has limited
competitive supplier influences our results in the capacity. This is because when the competitive sup-
dual sourcing scenario. Let K denote the competi- plier has limited capacity, the OEM has to rely on the
tive supplier’s capacity. As long as K qD b þ qcs ,
D non-competitive supplier to a higher degree, which
it is obvious that the competitive supplier will reduces the latter’s incentive of improvement.
fully utilize its capacity and satisfy all the compo- Furthermore, in section 4, we have shown that the
nent orders by adjusting the wholesale price OEM is always better off while the competitive sup-
accordingly. That is, qDK b þ qDK
cs ¼ K, where the plier is always worse off in the dual sourcing scenario
superscript “K” is used to denote the equilibrium comparing with the base scenario. We now investi-
with limited capacity. Then, we obtain the equi- gate if this result changes when there is a capacity
librium and outcomes similar to Lemma 2, but constraint for the competitive supplier.
we omit the lengthy formulations here for exposi-
tion. We find that the competitive supplier has a PROPOSITION 7. When the competitive supplier’s produc-
most preferred level of K because his profit is tion quantity is constrained by a limited capacity K,
concave in K. Furthermore, this “most preferred”
1. There exists a threshold Ko ¼ 14a bð29
m þ 4ða mÞx
þ 12xÞ such
capacity level is smaller than qD b þ qcs , the equilib-
D
that, the OEM is better off in the dual sourcing
rium output of the competitive supplier without
scenario when K > Ko, and vice versa;
capacity constraint. That is, the competitive sup-
2. There exists a threshold Kc ¼ 12a þbð28
4m þ ð5a þ mÞx
þ 15xÞ such
plier actually benefits from insufficient capacity.
that, the competitive supplier is worse off in the
This finding is presented in the following
dual sourcing scenario when K > Kc, and vice
proposition.
versa;
36m
DK
PROPOSITION 6. Let Kcs denote the most preferred 3. Kc > Ko if and only if x [ 11a24m .
capacity level that maximize EPDKcs , then Kcs \
DK
qb þ qcs .
D D When the competitive supplier has limited capac-
ity, the performance comparison becomes more com-
From Proposition 6, we find that an insufficient plicated and depends on the relationship among a, m,
capacity may benefit the competitive supplier. The and x. We illustrate this proposition in Figure 5 and
key to understand this finding is the yield uncer- have the following observations: (i) when the compet-
tainty problem of the non-competitive supplier. If itive supplier has very limited capacity, the perfor-
the non-competitive supplier has 100% yield rate, all mance comparison is just the reverse of traditional
unmet demand will be immediately shifted to the wisdom: the OEM is worse off while the competitive
non-competitive supplier, and the component prices supplier is better off in the dual sourcing scenario.
will remain unchanged. However, due to yield This is because, the component price war will bring
uncertainty, the OEM can only shift a partial order. limited gains to the OEM, and protect the competitive
This enhances the competitive supplier’s negotiation supplier’s component-selling business. The OEM has
advantage, and enables him to raise the wholesale to procure more components from the low-quality
price. In other words, the capacity constraint actually alternative supplier at the average high purchasing
alleviates the price war in the component market. price, and thus its profitability is hurt. (ii) Interest-
Thus, a small K benefits the competitive supplier and ingly, when the competitive supplier has moderate
harms his rival, the OEM. This explains why but limited capacity, dual sourcing may result in
\ qD either a win–win situation or a lose–lose situation,
b þ qcs . As a result, with a tight capacity
DK D
Kcs
constraint the total component ordering quantity is depending on the OEM’s price premium m and the
reduced. One recent example supporting our finding non-competitive supplier’s quality x. If the non-com-
is that Samsung outsmarted Apple by raising chip petitive supplier has a high quality, and/or the
prices using limited production capacity. According OEM’s premium is small, both the competitive sup-
to a report from Financial Times, Samsung follows a plier and the OEM obtain more profits in the dual
similar strategy when it sold application processors sourcing scenario; otherwise, both companies prefer
to Apple (Song 2012). the base scenario.
Figure 5 Illustration of Performance Comparison with Capacity [Color figure can be viewed at wileyonlinelibrary.com]
(a)
(b)
3. EPDtcs decreases in l and increases in r; EPo

Dt
6.2. Capacity Constraint of the Non-competitive
Supplier increases in l and decreases in r;
We now explore how the capacity constraint of the 4. EPDtns is unimodal in l and/or r.
non-competitive supplier influences our results. The
existence of this constraint means that the OEM can-
Although the comparative statics become more com-
not mitigate the yield uncertainty problem by simply
plicated, they share the similar qualitative insights into
increasing its order quantity qns. Let s denote the non-
our previous results. The two decisions made by the
competitive supplier’s capacity. Similarly, it is obvi-
competitive supplier, WcsDt and qDt are negatively
ous that this constraint is binding when s qD ns . With
b
related to its competitor’s technology levels. When the
this constraint, l and r are not homogeneous in the
competitive supplier’s wholesale price decreases, it is
formulations and thus they cannot be rearranged as
intuitive that the OEM should place a larger order to
functions of the technology level x. As a result, we
him, but now the effects of l and r become diverse.
examine the comparative statics for l and r respec-
The intuition holds when r decreases, but is not neces-
tively. Let the superscript “t” denote the correspond-
sarily true when l increases, unless the technology
ing equilibrium and outcomes. We have the following
level is not very high. When the non-competitive sup-
proposition:
plier is constrained by the capacity, the effective
expected quantity that the OEM can obtain is exactly
PROPOSITION 8. When the non-competitive supplier’s
ls. Therefore, the qualified component quantity from
total output is constrained by s,
the non-competitive supplier that the OEM can obtain
b both decrease in l and increase in r;
1. WcsDt and qDt is increasing in l, but she does not necessarily increase
2. qDt
cs decreases in r, and increases in l if x < 40/9; her order size to the competitive supplier.
Regarding the non-competitive supplier’s decisions The first one is an extension to the original model
and outcomes, we find that similar insight holds: It with a variable price premium of the OEM, m = bQ
may not have incentives to improve the technology and b > 0, that is, the OEM’s price premium is a linear
levels, that is, increase l or decrease r. We show that, increasing function of the total output quantity. In this
its profit is quasi-concave in both l and r, that is, (i) case, the OEM has a greater advantage toward its
the non-competitive supplier is not willing to increase competitor as the total market becomes larger due to
l when it is large enough; (ii) the non-competitive the OEM’s branding effect. The OEM’s inverse
supplier will decrease r only when it is large enough. demand function can also be rewritten as
These insights are highly consistent with Proposition Po = a bQ + m = a (b b)m, that is, the OEM’s
2. Furthermore, we show that the OEM still benefits product has a smaller price elasticity than its competi-
from diversifying its component orders to both sup- tor’s. It is worth noting that b cannot be too large
pffiffiffiffi
pliers, which hurts the competitive supplier. (b \ 193 2 b 0:786b). Otherwise the competitive
We also consider a different scenario in which the supplier will charge a sufficiently high wholesale
non-competitive supplier has sufficient capacity. We price leading to a boundary solution.
show that it will produce at its full capacity and sells The second one is the Cournot competition model
the excess components to an outside spot market at a with substitutable products Pi = a qi cqj, i,
constant market price W. Then, the non-competitive j 2 {cs, o}, where c (0 < c < 1) measures the degree of
supplier’s profit function becomes product substitutability. The larger the c is, the less
Pns ¼ Wns eqns þ Weðs qns Þ: distinction between the end products of the competi-
tive supplier and the OEM. Correspondingly, the
We further investigate the non-competitive sup- downstream competition will become more intense.
plier’s incentives to cooperate with the OEM, and The price premium m is thus absent in this model.
use “ ” on the top of the equilibrium and out- To verify the robustness of our findings, we con-
comes in this scenario. duct the same analysis in the previous sections for
these alternative demand models. We first derive the
PROPOSITION 9. If W \ 10a þ 8m ~ Dt ~ Dt
20 þ 9x , then W cs [ W ns [ W equilibrium of the three scenarios: Base, Dual Sour-
and ~qns [ 0; otherwise, ~qns ¼ 0.
Dt Dt
cing and Termination, under the two alternative mod-
els, and compare the profits among the three
This proposition shows that, when the market price scenarios. We find that, under either alternative
of the spot market is sufficiently high, the non-compe- model, the OEM still benefits from dual sourcing, but
titive supplier is more likely to sell its components to the competitive supplier suffers from this strategy.
the spot market than to cooperate with the OEM, We also find that, similar to that in section 4, we can
because the equilibrium wholesale price is lower than rearrange the non-competitive supplier’s profit func-
W. We also note that, this threshold is a decreasing tion with the notation x = (l/r)2, and the non-compe-
function of the technology level x. That is, a firm of a titive supplier’s expected profit is unimodal in x. It
lower technology level is more willing to cooperate affirms that our findings and explanations are robust
with the OEM. Furthermore, we re-examine the non- under these alternative demand models.
competitive supplier’s profit function with respect to We next consider the strategic interaction between
its technology level, the competitive supplier and the OEM. Similarly, we
2 study how the competitive supplier responds to the
~ Dt ¼ sWl þ xð10a þ 8m 20W 9WxÞ :
EP OEM’s order-shifting behavior, and whether termina-
ns
2bð40 þ 27xÞ2 tion is a credible threat to the competitive supplier.
Unfortunately, it is too complicated to derive analyti-
It can be shown that the second part is unimodal in cal results. We thus conduct extensive numerical
x. However, the first part is a linear increasing func- studies to see how b (in the first model), c (in the sec-
tion of l, representing the potential profit that the ond model) and x affect the outcomes. Parameters
non-competitive supplier can obtain from the spot that we used are provided in Table 2. We have varied
market. Therefore, it has a strong incentive to thousands of different feasible combinations and find
improve its technology level, especially the average that the results are robust to the changes of
yield rate l, when it has such an outside option.
This incentive is even stronger when the non-com- Table 2 Summary of Parameters
petitive supplier has more excess capacity.
Market potential a = 2, b = 1
6.3. Alternative Demand Models Brand effect b 2 [0, 0.75], step length = 0.025
In this subsection, we examine whether our findings Substitutability c 2 [0, 1], step length = 0.025
Technology level x 2 [0, 5], step length = 0.025
are robust under two alternative demand models.
Figure 6 Illustration of Strategic Interaction with Alternative Demand Models [Color figure can be viewed at wileyonlinelibrary.com]
(a) (b)
parameters. We illustrate one of the typical curves in non-competitive supplier’s profit is unimodal in x.
Figure 6. The competitive supplier will terminate his compo-
The bottom-right corner in Figure 6a and top-right nent-selling business when the non-competitive sup-
corner in Figure 6b represents the cases when the com- plier’s production technology level is higher than a
petitive supplier decides to terminate his component- threshold value and the competitive supplier’s termi-
selling business, but the OEM also performs better nation of component-selling business is not a credible
than the base scenario (i.e., Competitive supplier’s ter- threat to prevent the OEM engaging an additional
mination is not threatening). The top-left corner in Fig- alternative supplier.
ure 6a and bottom-left corner in Figure 6b represents
the cases when both the competitive supplier and the 6.4. Suppliers’ Positive Production Costs
OEM are happy with continuing their component-sell- In this subsection, we relax the zero production cost
ing business. The area in the middle represents the assumption by assuming a positive unit production
cases where termination could make the OEM perform cost c for both suppliers. Although all equilibriums
worse than the base scenario, but the competitive sup- can be obtained in closed-form, additional analysis
plier tends to continue the component-selling business becomes intractable. Therefore, we resort to the
(i.e. Competitive supplier has no incentive of termina- numerical analysis to derive the findings here.
tion). xC and xO are two curves to divide the three We first re-investigate the impact of x on the order-
areas. For either model, we observe xC > xO, so there ing quantity qcs and qns. When there is a positive pro-
does not exist an area where the competitive supplier’s duction cost, the non-competitive supplier may not be
termination threatens the OEM effectively to stop the able to gain profits, if its quality x is too low. We
order-shifting behavior as well as benefits himself. observe qns ≤ 0, in either the dual sourcing scenario or
Regarding the sensitivity analysis, we have the fol- the termination scenario. Then, the base scenario is
lowing observations. For the first alternative model, the OEM’s sole choice. The reason is that, when the
we observe that the large the b is, the less likely that non-competitive supplier has a positive production
the competitive supplier will terminate his compo- cost, if x is too low, the received payment from the
nent-selling business. For the second alternative OEM may not cover the production cost. In other
model, we observe that the smaller the c is, the less words, when the OEM considers the dual sourcing
likely that the competitive supplier will terminate. scenario, she should seek a relatively reliable alterna-
These observations consistently imply that the com- tive supplier, so that the dual sourcing strategy is fea-
petitive supplier will be more tolerant toward the sible. It is also obvious that the threshold of x
competition in the up-stream component market if his increases in c. That is, the higher the production cost
end product in the downstream market is highly dif- is, the larger x the non-competitive supplier should
ferentiated from the OEM’s. have for surviving.
In short, under the alternative demand models, we Our second observation is that, Proposition 2 may
find that our main qualitative insights hold. The not hold when c is sufficiently high. When c becomes
very high, qns is no longer unimodal but increasing in

x. An explanation is, when there is a large production
7. Conclusion
cost related to both suppliers, their component prices The co-opetitive relationship between Apple and
will be raised correspondingly, because they still need Samsung motivates their strategic decisions such as
a reasonable profit margin. This induces the OEM to the component sourcing quantity allocation and self-
keep increasing the order size to the non-competitive branded business development. In this study, we
supplier with the hope of further lowing the average characterize the main properties of such a co-opetitive
component purchasing cost. This also affects the non- supply chain and find that the dual sourcing strategy
competitive supplier’s profit and changes the result in is always in the OEM’s best interest. It induces a price
Proposition 2. Since the increasing order quantity war between component suppliers, which reduces the
may have larger impact than the decreasing whole- OEM’s total procurement cost. Such a cost reduction
sale price on its profit, the non-competitive supplier’s further strengthens the OEM’s competition advantage
profit is increasing in x. in the downstream market of end products. However,
We find the remaining results are consistent with the OEM’s component order-shifting seriously harms
the results derived from the base model when there is the competitive supplier, resulting in two possible
a positive production c > 0 both suppliers: strategic choices: stop its self-branded business, or ter-
minate the component-selling business and become a
1. The blue lines in Figure 7 represent the OEM’s
pure competitor of the OEM. We show that the latter
profits in the three scenarios. We observe that
is never a credit threat for the competitive supplier to
EPD o is the highest one and dominates the prevent the OEM from engaging an additional alter-
other two, and the OEM is better off in the ter-
native supplier.
mination scenario than in the base scenario
Contrary to conventional wisdom, we also find
when x > xO.
that the non-competitive supplier may not have
2. The red lines represent the competitive sup-
incentive to improve its technology and raise its yield
plier’s profits in the three scenarios. We
rate. When its quality indicator has surpassed a most
observe that EPBcs is the largest one and domi-
preferred level, the upstream price competition
nates the other two, and he is better off in the
becomes so intense that the price advantage of the
dual sourcing scenario than in the termination
non-competitive supplier almost vanishes. Thus, the
scenario when x < xC.
OEM tends to shift back most component orders to
3. We note that xC > xO, that is, the competitive
the competitive supplier who has 100% yield rate.
supplier’s threat on termination is non-
This indicates that that the OEM may fail to find a
credible.
non-competitive supplier that has sufficiently good
4. In the dual sourcing scenario, the competitive
quality of components. Interestingly, we find that the
supplier’s expected profit EPD cs decreases while non-competitive supplier’s wholesale prices are
the OEM’s expected profit EPD o increases in x. decreasing and production quantities are unimodal
in its quality level, which helps explain the non-com-
Figure 7 Illustration of Impact of x on the Competitive Supplier’s and petitive supplier’s incentive to manage its yield
the OEM’s Profits with a Positive Cost [Color figure can be uncertainty problem. We also consider the impacts of
viewed at wileyonlinelibrary.com] the two suppliers’ capacity constraints respectively
1 and find that the upstream component price war will
be alleviated and the downstream market supply will
0.9
be reduced when the competitive supplier has lim-
0.8 ited capacity.
We note a few limitations of this study and provide
0.7
promising avenues for future research. First, we
0.6
adopt a Stackelberg game framework to facilitate our
analysis. For the future research, it will be interesting
Profit
0.5 to study the wholesale price negotiation problems

0.4
among the three players, rather than the take-it-or-
leave-it pricing scheme that we assumed here. Sec-
0.3 ond, in this study, we consider the scenario that OEM
does not have the capability to influence the non-com-
0.2
petitive supplier’s production technology. It is possi-
0.1 ble that the OEM can co-invest in the non-competitive
supplier’s quality improvement so as to give
0
0.88 5 10 15 20 25 more pressure to the competitive supplier. The
0
corresponding cost-sharing mechanisms and contract non-competitive supplier’s wholesale price Wns T
¼ lWns
T
types may influence the supply chain parties’ strate- which becomes lower, because it does not bear the yield
gic decisions. cost in that case. We realize that these two payment
We find that termination is always better for the schemes (i.e., pay for what is ordered, and, pay for what
is received) are mostly equivalent. Similar results and
non-competitive supplier because in this scenario it
explanations can be found in Tang and Kouvelis (2011).
becomes the sole supplier of the OEM and the
upstream price war no longer exists. Then, the non-
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Appendix S1: Proofs.
10, 2017).
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Strategic Analysis of Dual Sourcing and Dual Channel with an Unreliable

Article in Production and Operations Management · August 2018

Baozhuang Niu Jiawei Li

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Jie Zhang Hsing Kenneth Cheng

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Strategic Analysis of Dual Sourcing and Dual Channel

Hsing Kenneth Cheng

Yinliang (Ricky) Tan

This “frenemy” business relationship between

Figure 1 Illustration of Three Different Scenarios

4. The Dual Sourcing Scenario respectively.

0.04 Non−competitive Supplier

quality, and the non-competitive supplier’s products

Figure 4 Illustration of Performance Comparison [Color figure can be viewed at wileyonlinelibrary.com]

We also investigate the impact of the non-competi-

3. EPDtcs decreases in l and increases in r; EPo

very high, qns is no longer unimodal but increasing in

0.5 to study the wholesale price negotiation problems

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