Benefits of Sourcing Alternative Inputs of Manufacturers for Suppliers

A downstream manufacturer can purchase high-quality inputs from its upstream raw-material supplier to produce high-quality products. The manufacturer may also have the option to source alternative cheaper low-quality inputs to partially replace the inputs from the original supplier to produce products with lower quality. Intuitively, this option could hurt the supplier in two ways: It sells fewer inputs, and it needs to set a lower wholesale price due to the competitive pressure. Interestingly, our study reveals an opposing finding: When the downstream manufacturer has the option of sourcing alternative inputs, the upstream supplier can benefit not only by selling more inputs but also by setting a higher wholesale price. Additionally, despite this higher wholesale price, it turns out that product price falls and the manufacturer can still earn more profits. Moreover, this paper shows that the wholesale price of the supplier's inputs can be higher than the price of the manufacturer's products. Finally, we also demonstrate the robustness of our findings under several alternative model settings