Sourcing strategies in a price and quality competition

In a price competition between two original equipment manufacturers (OEMs), we investigate under which conditions each OEM chooses to outsource its production to a contract manufacturer (CM) under the assumption that outsourcing improves product quality but may come with a higher cost. A characterization of subgame perfect Nash equilibrium also reveals the two OEMs’ optimal pricing strategies in each case of insourcing versus outsourcing decisions. Later, in an extension of our model, we assume that there are two competing CMs that aim to attract outsourcing OEMs by setting a sufficiently low price level, and we further analyze how equilibrium sourcing and pricing strategies change compared to those in the main model.