Strategic decentralization of self-branded and contract manufacturing businesses

This paper explores the incentive of a competitive contract manufacturer (CCM) to adopt a decentralized structure by segregating contract manufacturing from its self-branded business. We consider an original equipment manufacturer (OEM) with the option to outsource production either to a CCM producing its self-branded product, or to a non-competitive contract manufacturer (NCM) also serving another OEM. The CCM has the option to centralize or decentralize its two businesses and competes in quantity with both OEMs in the end-user market. Our analysis of the strategic interactions between the OEM's outsourcing decision and the CCM's organizational structure choice shows that the likelihood of the OEM outsourcing to the CCM increases when the CCM adopts a decentralized structure compared to a centralized one. Under decentralization, a sufficiently low wholesale price offered by the contract manufacturing division provides the OEM with a competitive advantage. Consequently, the CCM is motivated to strategically deploy a decentralized structure to attract contract manufacturing business from the OEM, even though decentralization yields a lower profit than centralization. However, the CCM must be cautious when implementing a decentralized structure to secure orders from the OEM. The resulting intensified market competition undermines its profit from self-branded business and potentially makes it worse off from producing for the OEM. In such case, the CCM should maintain a centralized structure and uphold a purely competitive relationship with the OEM. Moreover, we demonstrate how the profitability of another OEM supplied by the NCM is influenced by the interplay between the CCM and the OEM.