Supplier Competition and Cost Improvement

Abstract

Buyers have two levers to enhance their supply base performance: fostering supplier competition and inducing suppliers to improve. The competition–improvement relation between the two levers has important implications for supply base design. We study a buyer facing two potential suppliers that can exert cost-reduction efforts, examining the interplay of supplier competition and supplier cost improvement under various information structures (i.e., the supplier effort is observable or unobservable) and commitment capabilities (i.e., the buyer may not commit, or may commit to a full or partial procurement mechanism, before suppliers exert efforts). We find that the two identical suppliers may choose unequal efforts, resulting in an asymmetric equilibrium outcome that enhances the performance of dual sourcing. Moreover, the competition–improvement relation depends on the effort observability. Whereas supplier competition always leads to lower improvement effort when the effort is unobservable, it may induce h...