Managing Investments Under Bargaining in a Coopetitive Supply Chain

We study competition between an original equipment manufacturer (OEM) and its contract manufacturer (CM). The CM manufactures a product for the OEM and sells it to the OEM. Contract terms are determined through Nash bargaining. The CM also manufactures its own product and both products are sold to consumers in the final product market. The OEM and the CM make costly investments to enhance their own product's prominence. We show that due to the parties' asymmetric bargaining positions, the investments have opposite effects on the surplus that is shared between them. The OEM's investment always increases the trade surplus as the OEM can only profit when the bargaining process reaches an agreement. In contrast, the CM's investment reduces the trade surplus as the CM can still offer its product as a monopolist if bargaining fails. As a result, we find that (1) an increase in the consumers' common willingness to pay for both firms' products, (2) a decrease in the consumers' dislike of the CM's product, and (3) an increase in both firms' investment efficiency, can in fact reduce both parties' profits and hence harm the supply chain. This occurs since the CM's incentive to choose a higher destructive investment increases but the OEM's incentive to make a surplus-enhancing investment decreases. Finally, we find that an increase in the CM's bargaining power can actually reduce the CM's profit and increase the OEM's profit, but hurt the supply chain performance