Switching to profitable outside options under supplier encroachment

Abstract In practice, manufacturers may encroach on retail markets through a variety of methods, one being through the use of an online channel direct to the consumers, called encroachment. Current research typically assumes that downstream retailers retain procurement from the encroaching supplier. In reality, however, retailers may have the option of switching suppliers after encroachment. By considering a supply chain consisting of one manufacturer and one retailer with outside options, this paper analyzes the effects of the option of switching suppliers on the supply chain players' strategic interactions under the threat of supplier encroachment. We consider that the manufacturer makes encroachment decision preceding the retailer's switch decision. We capture various outcomes of the encroachment and switch decisions by using a classic encroachment model with quantity decisions (Cournot model). Specifically, we identify two effects of the outside option on the strategic encroachment decision. The first, the deterrence effect, means that the manufacturer's encroachment is deterred by the threat of switching supplies altogether; while the second, the permissive effect, indicates that the retailer intends to switch to the alternative source after the encroachment. Interestingly, we show that the encroachment could improve the total profit of the incumbent manufacturer and the retailer even when the retailer's switch has occurred. In this case, however, the manufacturer profits while the retailer is hurt by the encroachment and the switch. Finally, we also investigate several extended cases to demonstrate the robustness of our findings.