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Competitive outsourcing: choosing between value-added services and key component supplying capability

We examine outsourcing strategies of two competing firms. Each of the firms outsources product manufacturing to one of the two manufacturers. In addition to product manufacturing, the first manufacturer also produces a key component that is required by every product. On the other hand, the second manufacturer provides additional services that enhance product value. We characterise the firms’ equilibrium choice of outsourced manufacturers. We demonstrate that difference in the manufacturers’ operational advantages can result in asymmetric outsourcing decisions for ex-ante symmetric firms. Firm profitability can be Pareto improved when the manufacturer who produces the key component gains first-mover advantage. Moreover, that manufacturer can benefit from the entrance of a competitor in the key component market. Finally, even though the firms select their outsourced manufacturers based on self-interest, the resulting equilibrium outsourcing scenario can be the one that also maximises profitability of the manufacturers and the entire supply chain.