Sourcing Innovation: When to Own and When to Control Your Supplier

Problem definition: many firms rely on their suppliers as a source of innovation, and they harness the innovation potential of their supplier base by organizing procurement contests. Most research on contests has simply assumed that suppliers are independent from the buyer and thus compete “on even ground.” In practice, however, this assumption is not always valid because some suppliers may be affiliated with or even controlled by the buyer. This paper seeks to understand how (varying degrees of) supplier ownership and supplier control affect the outcomes of a procurement contest in terms of the buying firm’s profits and the extent of product innovation. Methodology/results: the authors use a game-theoretic model to identify the mechanism by which supplier ownership and control effectuate results. They characterize when supplier ownership and control are (or are not) beneficial for a buying firm, and they study cases in which the optimal supplier base structure promotes (or impedes) product innovation. Managerial implications: The authors analysis yields practicable insights regarding the optimal configuration of a buyer’s supplier base structure, and it helps explain the rationale behind recent supplier base developments in many large industries. They demonstrate in particular that the presence of an affiliated supplier may dampen all suppliers’ incentives to innovate and thereby undermine product innovation. Finally, the authors explain why a buyer does not always benefit from exerting control over its affiliated suppliers.