Cooperative quality investment in outsourcing

This paper highlights the importance of having a cooperative quality investment (CQI) strategy and proposes a simple proportional investment sharing schedule in the outsourcing of a supply chain, which consists of a contract manufacturer (CM, the supplier) and two competitive original equipment manufacturers (OEMs, the buyers), the demands of which are sensitive to both price and product quality. A three-stage dynamic game-theoretic framework is applied to describe decisions of every entity. Specifically, we analyze three possible decision structures for the quality choice: the CM optimally sets the product quality, and two OEMs cooperatively or noncooperatively set the product quality. By the backward induction approach, we obtain the analytical equilibrium solutions for each decision scenario. We determine that the CM׳s share of quality investment expenses is sufficiently large, and the CQI strategy will be beneficial to quality enhancement regardless of who sets the product quality level. With respect to the equilibrium payoffs (profits), this study shows that the CM always prefers to have complete control of the quality choice when there is implementation of the CQI strategy, while the OEMs are always hurt by this strategy, except when they cooperate on the quality decision with a rather large CM share. In addition, the whole supply chain׳s profit can be improved by practicing the CQI strategy. Furthermore, we explicitly propose the conditions for realizing this improvement.