This paper explores production and outsourcing decisions for two Original Equipment Manufacturers (OEMs) who produce partially substitutable products and have opportunities to invest in reducing the manufacturing cost. In such an environment, competition drives both OEMs to set lower prices and invest more than would maximize their combined profits, particularly when product substitutability is high. However, outsourcing provides a mechanism by which the two OEMs can credibly signal that they will not overinvest in cost reduction, mitigating a mutually destructive cost competition. Our paper explores the role that an external supplier(s) can play in dampening competition between the OEMs when there are opportunities to invest in cost reduction. In particular, we characterize the conditions under which a supplier can profitably enter the market by inducing the OEMs to outsource production. We first examine a basic model of two identical OEMs in which there is a single common supplier and a single component that is a candidate for outsourcing. Later, we extend the basic model to allow for market asymmetry, two suppliers, and more than one component that might be outsourced.

Supply chain versus supply chain is an important aspect of business competition as the channel structure of each supply chain affects its own channel profit as well as the rival’s channel profit. Manufacturers have two distribution channel structure strategies: integrated channel and decentralized channel. The channel structure strategy can be influenced by price and service, two key competitive dimensions that affect both customer demand and firm profitability. The authors develop game-theoretic models to explore channel structure strategies for two manufacturers competing on price and service and examine how service provisions affect these strategies. Here, service can be provided by either producers (i.e., manufacturers) or sellers. When manufacturers provide service, this study reveals that symmetric decentralization (i.e., both manufacturers choosing a decentralized channel) is an equilibrium only when price elasticity, service cost, and service competition are low. When service is provided by sellers, symmetric decentralization is an equilibrium only when the retailer’s service cost is high and that of the manufacturer is low; otherwise, an asymmetric equilibrium may exist.