Navigating supplier encroachment: Game-theoretic insights for outsourcing strategies

It has become increasingly typical for the upstream suppliers to invest in direct sales channels and compete with the downstream manufacturer. The oft-called phenomenon of supplier encroachment allows the supplier to benefit from both the wholesale to the manufacturer and the sale to end customers. However, from the manufacturer’s perspective, encroachment may suggest the supplier’s lack of reliability, which can contribute to the breakdown of supplier–manufacturer collaboration. In response to the supplier’s encroachment, the manufacturer can change its supplier(s); while the encroaching supplier might face consequences (e.g., the manufacturer dropping the supplier to seek new partnerships). The existence of future outsourcing alternatives for the manufacturer and the future consequences for the supplier has not been studied in the extant literature. In this paper we propose a two-period game-theoretic approach to supplier encroachment; where the downstream manufacturer outsources the production to a group of suppliers that are characterized by a low-quality supplier without encroachment capabilities, and a high-quality supplier with encroachment capabilities, i.e., capable of launching its own independent product. We show that (a) an increase in the quality of the encroaching supplier’s independent product can convince the manufacturer to redirect its wholesale order from the non-encroaching supplier to the encroaching supplier and simultaneously boost the manufacturer’s profits, (b) as the quality of the non-encroaching supplier is improved, the manufacturer may opt to drop the non-encroaching supplier and redirect its wholesale order to the encroaching supplier instead, and (c) an improvement in the qualities of the encroaching and non-encroaching suppliers might decrease their corresponding profits. Accordingly, we offer actionable guidelines for practitioners; in particular, we help practitioners navigate the competitive outsourcing landscape under threat of encroachment and advise them on the counter-productive impacts of quality improvements.