Home or Overseas? An Analysis of Sourcing Strategies Under Competition

Motivated by the recent backshoring trend, this paper studies a sourcing game where competing firms may choose between efficient sourcing (e.g., sourcing from overseas) and responsive sourcing (e.g., sourcing from a home country). Efficient sourcing usually provides a cost advantage, whereas responsive sourcing allows a firm to obtain more accurate demand information when making procurement decisions. By characterizing the equilibrium outcome, we find some interesting results driven by the strategic interaction between the firms. First, a firm may still use efficient sourcing in equilibrium even when the cost advantage associated with efficient sourcing does not exist. This is because the firm can dampen competition by reducing the correlation between its own demand information and the competitor's. Second, a cost hike in efficient sourcing (e.g., the rising labor cost in Asia) may benefit all the firms in the industry. The reason is that the cost hike may alleviate competition by inducing a new equilibrium sourcing structure. This paper also sheds some light on the recent backshoring trend. First, our analysis indicates that more firms will shift from efficient sourcing to responsive sourcing in equilibrium (i.e., backshore) if the market size shrinks, the demand becomes more volatile, or the sourcing costs rise simultaneously. Second, a firm's backshoring behavior reduces the competition on the cost dimension, but it also has an ambiguous informational impact on the other firms in the market. In particular, some firms may benefit from increased correlation of their demand information under Cournot competition with substitutable products. Overall, the backshoring behavior can be beneficial to all the firms sticking to their original sourcing strategies under certain conditions. This paper was accepted by Martin Lariviere, operations management.