Abstract: This paper addresses the strategic pricingdecisions of the a decentralized assemble-to-order system, and the effects ofsourcing structure on system performance. We consider an assemble-to-ordersystem consisting of two substitute products and three components manufacturedby different suppliers. Demand for the products is price-sensitive. The sellingprices for the products are jointly determined by firms in the system. We studythe system under both centralized and decentralized decision making situations.For the centralized system, we demonstrate that there exists a unique optimalpricing solution. For the decentralized system, we show that there exists aunique Nash equilibrium in the players’ pricing game. We further analyze theeffects of different sourcing structures on the system performance and theassembler’s performance. We find that reduction of suppliers in the system doesnot guarantee improvement of system performance. Different sourcing structureshave different impacts on performance. When the two dedicated components aresourced from a single supplier and the common component is sourced from anotherindependent supplier, the system and the assembler’s performance become worse.We show that the decentralized system can be effectively coordinated and thesystem performance can be improved with a simple profit-sharing contract.Finally, we provide comprehensive numerical examples to demonstrate someimportant managerial insights.
Key words:sourcing structure, substitutioneffect, pricing, assembler-to-order
1. Introduction
In this paper, we study the pricingdecisions of a decentralized assemble-to-order system with an assembler andmultiple suppliers, who produce substitute products. In many industries,manufacturers produce a series of substitute products with different options orqualities. For example, Dell provides a series of desktops and notebooks withdifferent options and prices. And General Motors manufactures both luxury carsand compact cars. In this setting the demand for a certain product depends bothon its own price and on the prices of other substitute products. A priceincrease (decrease) in a product positively (negatively) influences sales ofother related products. This substitution effect is common in practice. Some customersare willing to substitute their favorite quality and style product for acheaper one they can afford, or to upgrade if the price of a high-qualityproduct is attractive.
In practice, many firms focus on their corecompetencies and source components from independent suppliers. The rapid growthin outsourcing and subcontracting of manufacturing and other activities haschallenged decentralized supply chains. In a decentralized supply chain,closely interrelated business activities are carried out by independent firmswith conflicting objectives. When the decisions of these firms areuncoordinated, the supply chain as a whole encounters a significant loss inefficiency (Zhao and Wang, 2002). In an uncoordinated decentralized assemble-to-ordersystem where each player is independent, and demand for the substitute productsand the system profit are influenced by the pricing decisions of all players inthe system. Hence, coordination of pricing decisions is of great importance toassembler and suppliers.