Sourcing Decision in the Presence of a Complementary Component

The studies on the make-or-buy decision traditionally focus on the sourcing decision of one component. Yet, most products consist of multiple components that influence product quality simultaneously and these components are often provided by different suppliers. Accordingly, strategic interactions may arise because of the interdependence, however, little is known how this would influence the sourcing decision. Using a game theoretical model, we study sourcing decision of a manufacturer in the presence of a complementary component. Different from typical sourcing options (make or buy), the presence of the complementary component classifies the manufacturer’s sourcing options as follows: (1) produce in-house, (2) outsource to an incumbent supplier that provides the complementary component and (3) outsource to an entrant supplier that provides the specific component only. We demonstrate that each sourcing strategy can be optimal depending on the relative capability in quality improvement between firms. Interestingly, we show that the manufacturer may prefer outsourcing even if the supplier has a lower capability in quality improvement than the manufacturer. Such behavior is not observed in the benchmark case without a complementary component, indicating that the presence of the complementary component is the driving force. We reveal that two strategic effects, i.e., interception effect and spillover effect, result in this counter-intuitive behavior.