Strategic Sourcing under Supplier Development Investments

In this paper, we consider the capacity requirements allocation problem of a buyer between an incumbent supplier and a new supplier over a two-period horizon. The buyer allocates some of its capacity requirements to the incumbent supplier in the first period. This enables the incumbent supplier to reduce its cost in the second period due to the phenomenon of production learning. The buyer also makes supplier development investments in the new supplier in the first period. In addition, both the incumbent and the new entrant make process improvement efforts in the first period, which enhance the effective capacity available in the second period. Finally, the buyer allocates the rest of its capacity requirements between the two suppliers in the second period. We find that the buyer has various sourcing strategies to maintain a competitive supply base. We also find that the optimal supplier development investments and sourcing strategies depend on the collaboration relationship between the buyer and the new supplier.