Service outsourcing: The dilemma of third-party service providers

Consumer-facing firms often seek outsourcing services from third-party providers to reduce costs and focus on their core competencies. We consider a scenario where a single service provider offers outsourcing services to two firms through different service modes: the dedicated mode and the shared mode. With the dedicated mode, the service provider delivers customized services to one firm exclusively. With the shared mode, the two firms share the service capacity of the provider. We develop game-theoretical models in two contract structures. Under the monetary service contract (Contract M), only a service fee is specified. Under the performance-based service contract (Contract P), both the service fee and the service level are predetermined. We find that the service provider should specify the service level in advance and adopt the shared mode when attracting consumers through services is costly. When service cost and service sensitivity are moderate, the provider should select Contract M to serve two firms simultaneously while only gaining profit from one of them. When it is easy to induce demand through service, the provider should opt for the dedicated mode to serve the firm whose consumers are less price-sensitive, as the choice of contract structure (M or P) makes no difference in this case. Furthermore, we analyze (i) the provider’s optimal service mode under each contract, (ii) the conditions under which supply chain performance is maximized, (iii) when a triple-win outcome is achieved, and (iv) consumer surplus. Overall, we derive valuable and interesting insights that can guide both service providers and firms in their decision-making.