Abstract:
Driven by increasing costs in the traditionally-regarded low-cost manufacturing bases (e.g., China), many firms have started to outsource their production to the regions of even lower costs (e.g., Southeast Asia). However, a new environment may involve higher cost uncertainty and severer information asymmetry. Motivated by these observations, we consider a sourcing game where competing firms choose between a supplier with transparent certain cost (type-C supplier) and a supplier with potentially lower but less transparent, uncertain cost (type-U supplier). We characterize the equilibrium of the sourcing game and study how different parameters affect the firms' sourcing strategy and profit performance. First, we find that due to information asymmetry, a large market size can make firms prefer the C-supplier to the U-supplier even if the latter has a lower average cost. Second, reducing the cost uncertainty of the U-supplier does not necessarily make it more attractive, which cautions the suppliers when making investments to mitigate cost uncertainty. An improvement of U-supplier's private signal accuracy can make U-suppliers more likely be chosen by manufacturers only when both signal accuracy and cost uncertainty are above a certain level. Third, higher competition intensity leads the diversified sourcing strategy to be more likely adopted if the cost uncertainty of U-supplier is sufficiently large; otherwise, intensified competition can favor either C-supplier or U-supplier. Interestingly, increasing the cost of the C-supplier (e.g., a cost hike in China) may make both sourcing firms better off because it can lead to a new sourcing equilibrium. Finally, this paper contributes to the mechanism design literature by showing that the direction of quantity distortion under the optimal competitive mechanism differs from that under the traditional monopolistic setting.