Strategic alliance via co-opetition: Supply chain partnership with a competitor

Why do two competitors form an alliance yet still compete with each other in the marketplace? Consider Yahoo's recent alliance with Microsoft to use its Bing search engine, yet both companies will compete with each other to sell search ads. In this paper we study dynamic alliance formation among competing firms with a multi-period model. In each period, there is a two-stage game of co-opetition. In Stage 1, two competing firms decide on forming a partnership by negotiating a contractual agreement; and in Stage 2, all firms in the market engage in price competition. We formulate the economic incentives and costs of the cooperation, propose the optimal contract and discuss the reasons for a temporary co-opetition and a delayed co-opetition. The results of the paper shed light on firms' strategic decision on co-opetition and provide implications to public policy makers.