Technological Upgrading Investment and Encroachment Strategies in an Outsourcing Supply Chain with Licensing

This paper deals with technological upgrading investment, encroachment and technology licensing in a supply chain comprised of an original equipment manufacturer (OEM) and a contract manufacturer (CM), in which the OEM is a quality and quantity leader. We characterize the equilibrium strategies of the OEM and the CM in five scenarios. By comparing the equilibrium outcomes in different scenarios, we examine the interactions between the OEM’s technological upgrading investment and the CM’s encroachment strategies considering royalty-based technology licensing between them. Our analysis demonstrates that neither the OEM’s technological upgrading investment nor royalty charges can effectively prevent the CM from encroaching downstream market. Conversely, the CM’s encroachment increases the OEM’s incentive to make technological upgrading investment for the CM. We further prove that win–win situation can be achieved in situations involving investment and encroachment. This paper breaks the traditional notion that low substitution degree is always preferable for the OEM or the CM and demonstrates that win–win situation is only available when market advantage is not weak. We also show that there always exist suboptimal strategies for the CM and the OEM when win–win situation is not available and analyze the effects of substitution degree, market advantage and brand advantage on the shift of win–win situation or suboptimal strategies. Furthermore, we consider two extended models: a sequential game where the CM acts as a first-mover, and a simultaneous quantity competition game. We characterize the conditions to achieve win–win situation in different models.