Strategic Commitment Under Complementary Sourcing

Complementary sourcing, where an end product depends on both a supplier's and a manufacturer's engineering and production efforts, is ubiquitous in modern supply chains. A unique feature of complementary sourcing is that efforts by one party enhance the marginal value of the other party's efforts. The complementary sourcing relationship thus has a positive spillover effect that improves product attributes and market demand. While this positive spillover effect can benefit both parties, it paradoxically induces a first-mover disadvantage (Gal-Or 1985) such that neither party is willing to exert efforts ex ante. We show, however, that a powerful manufacturer can be better off as a first mover when compared with an alternative setting where both parties exert efforts simultaneously. The reason is that, although their efforts are complementary, the purchase price is not. The latter factor creates a hold up problem where it is not effective for the manufacturer to act as a second mover. In such cases, a manufacturer can motivate a supplier to exert efforts more effectively by jointly committing to a certain effort level and purchase price in advance. When a manufacturer adopts such advanced commitment strategy, the committed price is always higher than what would have been committed if the manufacturer commits to purchase price only. As such, a supplier can also be better off, creating a win-win sourcing outcome. Market risk and resource constraints, however, can reverse and reduce the benefits to manufacturers and suppliers, respectively.