Co-opetition or decentralization? A study of manufacturers’ sourcing and distribution strategies

Highlights

• Manufacturers’ sourcing and distribution strategies are examined.

• Strategic interaction between co-opetition and decentralization is analyzed.

• Decentralization helps the manufacturer purchasing the component efficiently mitigate price competition.

• Co-opetition helps the manufacturer selling the component efficiently mitigate price competition.

Abstract

This study aims to explore the impacts of manufacturers’ downstream distribution channels on upstream sourcing strategy and of the business relationship between manufacturers resulting from upstream sourcing transactions on downstream distribution strategy, through investigating the interplay of co-opetition and decentralization. We consider a framework with two manufacturers producing substitutable products. In the upstream component market, one manufacturer needs to source a key component from either a third-party supplier or its competing manufacturer. In the downstream consumer market, each manufacturer sells the end product through either an integrated or a decentralized distribution channel. The two channels engage in a price competition. For a given downstream distribution strategy, we find that even at a higher component price, the manufacturer who purchases the component may have incentive to source from its competitor that has an integrated channel, while having no incentive to choose a decentralized competitor. A key driver behind this contrast is that co-opetition can be substituted by a decentralized channel used by the competitor, which enables the manufacturer who purchases the component to mitigate price competition more efficiently. For a given upstream sourcing strategy, in contrast to the literature which shows that manufacturers generally prefer downstream decentralization at high competition intensity, we find that integration is always preferred by manufacturers who engage in supplier–buyer cooperation. A key underlying driver is that co-opetition helps the manufacturer who sells the component mitigate price competition more efficiently than decentralization. We also extend our analysis by investigating manufacturers’ decisions on both sourcing and distribution strategies.

Introduction

In recent years, many automakers have chosen to source components or raw materials from other manufacturers who also produce and sell self-branded cars. Daimler, for example, has contracted with Tesla to supply battery packs for Daimler electric smart cars and Mercedes-Benz electric cars. According to Dieter Zetsche, Chairman of the Board of Management of Daimler AG and Head of Mercedes-Benz Cars, Daimler's partnership with Tesla is very successful and will be continued (Tjan et al., 2014; Huddleston Jr., 2019). For Tesla, in addition to supplying the component to Daimler, it also sells self-branded cars to consumers through the direct (integrated) sales channel. Tesla uses the direct sales channel as it seeks better control over pricing and incentives (Schmidt et al., 2020). Tesla has created an international network of company-owned stores and operated 438 physical stores throughout the world by 2019, and it has also made use of direct internet sales where consumers could purchase a Tesla online (Gupta & Maurya, 2017; Fruhlinger, 2019). Since Tesla's business model integrates aspects of being an automaker and a component supplier, it also competes with its partners (such as Daimler) in the end consumer market, and thus acting as both an upstream partner and a downstream competitor to Daimler.

While this co-opetition business relationship between Daimler and Tesla has become particularly evident in the industry, there are also many automakers who rely on third-party component suppliers that do not have their own branded cars, and thus maintain a pure competition relationship with other car manufacturers. One classic example is between two Japanese automakers, Nissan and Toyota, which compete in almost every segment. Nissan made notable efforts to concentrate on its core operations by outsourcing component manufacturing to third-party suppliers, whereas Toyota hanged on to in-house component making, including batteries for its electric vehicles, for better control over its end-to-end supply chain (Chappell, 2005; Greimel, 2019; Jin et al., 2019). In such a case, Nissan and Toyota maintain a pure competition relationship. In addition, in the downstream consumer market, different from Tesla who uses the direct sales channel, both Toyota and Nissan sell their cars through independent dealers (decentralized channels).

Another observation from the automobile industry is that competing automakers who have engaged in a supplier–buyer cooperation in the upstream component market may pursue different downstream product distribution strategies from those who have maintained a pure competition relationship. For example, Ford and Volkswagen maintain a co-opetition relationship, in which Volkswagen has signed on to supply the electric vehicle architecture for Ford since 2019, even though they compete directly in the end consumer market (Brandenburger & Nalebuff, 2021; Rosevear, 2022). Unlike Nissan and Toyota who maintain a pure competition relationship and sell their cars through decentralized channels, Ford and Volkswagen launch direct internet sales, and plan to transition the sale of their electric vehicles to be fully online with non-haggle prices (Miller & Campbell, 2020; Jajoo, 2022; Stenquist, 2022).

The above observations from the automobile industry motivate us to explore the impact of manufacturers’ downstream product distribution channel structures on the upstream component sourcing strategy, and the impact of the business relationship between manufacturers (i.e., whether or not they engage in supplier–buyer cooperation in the upstream component market) on the downstream product distribution strategy, through investigating the interaction between co-opetition and decentralization.

Co-opetition is a broad concept that refers to interdependence, where two or more firms simultaneously compete against and cooperate with each other (Brandenburger & Nalebuff, 1996, 2021). Nowadays, the practice of co-opetition can be observed not only in the automobile industry but also in many other high-tech industries, such as electronics and medical devices (Brandenburger & Nalebuff, 2021; Li & Zhao 2022; Niu et al., 2019). Many high-tech firms increasingly engage in supplier–buyer cooperation with their competitors due to short product life cycles, high expenses on research and development (R&D), and fierce market competition (Chen et al., 2019). Previous studies in the literature have identified several benefits of co-opetition, such as enhancing the component branding investment (Xu et al., 2010), reducing the component production cost (Chen et al., 2019; Li & Zhao, 2022), and mitigating competition between firms in the end product market (Jiang & Shi, 2018; Li et al., 2020; Niu et al., 2019; Wang et al., 2013). In this study, we focus on the benefit of co-opetition in softening competition, which results from the fact that a competing firm can earn revenue from both its self-branded business and component-selling/contact-manufacturing business, and thus it is less likely to engage in cutthroat competition with the buyer (manufacturer) in the end product market (Jiang & Shi, 2018; Li et al., 2020; Wang et al., 2013).

The connection between manufacturers’ sourcing and distribution strategies may arise due to the formation of co-opetition relationship through sourcing/outsourcing transactions. The studies in the literature on distribution channel structure have shown that the strategic value of downstream channel decentralization lies in the fact that the use of independent retailers can insulate manufacturers from direct price competition at the retail level (e.g., McGuire & Staelin, 1983; Moorthy, 1988; Moorthy et al., 2018; Zhao et al., 2009). However, when the manufacturers have maintained a co-opetition relationship by engaging in a supplier–buyer cooperation in the upstream component market, the value of downstream channel decentralization may be weakened, which affects manufacturers’ distribution decisions on whether to sell to the end consumer market directly through a company-owned store, or indirectly, through an independent retailer. On the other hand, the manufacturer's decision on whether to source from a competitor or a non-competing third-party supplier may also be affected by the competitor's downstream distribution channel structure that has already been established. This is because whether the competitor directly controls the retail price by owning the sales channel determines the effectiveness of coordinating its price competition with the manufacturer in the downstream consumer market.

Despite the potential link, the impacts of the manufacturers’ downstream distribution channel structures on the upstream sourcing strategy and of the business relationship between manufacturers resulting from the upstream sourcing transaction on the downstream distribution strategy are as yet understudied in the literature. Developing a framework that considers the manufacturers’ sourcing and distribution strategies allows us to fill this gap by exploring the interaction between co-opetition and decentralization, and by addressing the following research questions:

• What are the implications of distribution channel structure for the manufacturer's choice of component supplier, and vice versa?

• Will the manufacturer prefer to purchase from a competing manufacturer who uses the decentralized channel?

• Will the manufacturers who maintain a co-opetition relationship prefer to decentralize their distribution channels?

In this study, we develop and analyze a model where the two manufacturers produce and sell partially substitutable products. One unit of the key component is required to make each unit of the end product for both manufacturers. In the upstream market, one manufacturer can produce the component in house, whereas the other does not have the infrastructure required to make this component and may purchase it from either the competing manufacturer or a non-competing third-party supplier. In the downstream market, each manufacturer may sell the end product through either the company-owned physical/online store (i.e., an integrated channel) or an exclusive retailer (i.e., a decentralized channel). The two channels engage in a price competition. We consider asymmetry between market bases of the two manufacturers to capture the real-world scenarios. For example, Ford's consumer base is greater than Volkswagen's in the United States (Brandenburger & Nalebuff, 2021). For Nissan and Toyota, the former's consumer base is smaller than that of the latter (Statista, 2022). We investigate the aforementioned research questions by examining the manufacturer's decision on sourcing strategy when the downstream distribution channel structure has been established and the manufacturers’ decisions on distribution strategy when the upstream sourcing strategy has been determined, respectively. The main findings of our research are summarized below.

For the given product distribution channel structure, we find that although the third-party supplier offers a lower component price, the manufacturer prefers to strategically source from the competitor who uses the integrated channel in the end product market if this manufacturer has sufficient advantage over its competitor in market base. However, the manufacturer has no incentive to source from a competitor who uses the decentralized channel in the end product market, regardless of market base. This result contributes to the existing co-opetition literature (e.g., Chen et al., 2019; Li & Zhao, 2022; Li et al., 2020; Niu et al., 2019; Wang et al., 2013) by showing that the decentralized channel, used by the manufacturer who produces the component in house, removes co-opetition as an equilibrium of sourcing strategy. We therefore identify two key drivers for the emerging phenomenon of co-opetition: (1) the direct sales channel used by the manufacturer who has the component-selling business, and (2) the sufficiently strong market base owned by the manufacturer who needs to purchase the component. The intuition is that by sourcing from the competitor with the integrated channel, the manufacturer can reduce the competitor's incentive to compete aggressively on retail price and benefit from softened price competition in the downstream market. This benefit can offset the higher procurement cost if this manufacturer has sufficient advantage in market base. However, when the competitor uses a decentralized channel, co-opetition can be substituted by downstream decentralization as the decentralized channel used by the competitor can also soften price competition. Furthermore, choosing a third-party supplier helps the manufacturer to procure at a lower cost.

For the given component sourcing strategy, we find that when the manufacturer sources from a third-party supplier, depending on the degree of product competition and the ratio of market bases of the two manufacturers, the equilibrium product distribution strategy can be either pure integration or decentralization. However, when the manufacturer sources from its competitor, pure integration becomes the unique equilibrium outcome of product distribution strategy. This finding demonstrates how the emerging phenomenon of co-opetition overturns the celebrated result found in distribution channel structure literature (e.g., Gupta & Loulou, 1998; McGuire & Staelin, 1983; Moorthy, 1988), in which decentralization can be an equilibrium outcome. This result may also provide a theoretical support on the common assumption in the co-opetition literature that manufacturers operate in a vertically integrated fashion in the end consumer market (see, for example, Chen & Chen, 2014; Chen et al., 2019; Ghamat et al., 2018; Hu et al., 2020; Li et al., 2020; Heese et al., 2021; Jiang & Shi, 2018; Li & Zhao, 2022; Niu et al., 2019; Wang et al., 2013). As aforementioned, in addition to relying on downstream decentralization to mitigate price competition, the co-opetition relationship can achieve similar effects. The manufacturer with the component-selling business prefers staying integrated to better balance its two revenue streams, which pushes the other manufacturer toward integration as well.

The above discussion suggests that downstream decentralization enables the manufacturer who needs to purchase the component, whereas co-opetition enables the manufacturer who produces the component in house, to mitigate price competition efficiently. To further discuss the interplay of co-opetition and decentralization, we also extend our analysis to the scenario where the manufacturers can decide both sourcing and distribution strategies.

The remainder of this study is organized as follows. In Section 2, we briefly review the relevant literature. We formalize the model in Section 3. In Section 4, we analyze the impact of distribution strategy on the manufacturer's choice of sourcing strategy, and in Section 5, we analyze the impact of sourcing strategy on the manufacturers’ choices of distribution strategy. The analysis is further extended by examining manufacturers’ decisions on both sourcing and distribution strategies in Section 6. Section 7 concludes and provides practical implications. Equilibrium solutions are in Appendix A and all proofs are in Appendix B.