Technology spillovers and contract manufacturer’s encroachment in outsourcing supply chains

Within global production and logistics networks, outsourcing links original equipment manufacturers (OEMs) and contract manufacturers (CMs) in ways that can unintentionally generate technology spillovers, lowering CMs’ costs in both contract manufacturing and own-branded production. This paper investigates how such outsourcing-induced technology spillovers impact CMs’ encroachment strategies and the stability of OEM–CM outsourcing relationships. We develop a game-theoretic model of a two-tier supply chain in which an OEM can outsource the production of intermediate components to a CM, and the CM may encroach on the downstream market with own-branded final products. Our findings reveal several key insights. First, strong spillovers paired with high product value induce CM encroachment, whereas moderate levels favor focusing on contract manufacturing while building encroachment capability. Second, increases in spillover intensity can generate a wide spectrum of outcomes for both firms, including “win-win,” “lose-win,” “win-lose,” or even “lose-lose” results. Third, when in-house production is an option for the OEM, a decline in spillovers from moderate to low can be as risky for the CM as sufficiently high spillovers, because either can prompt the OEM to end outsourcing. The paper provides implementable guidance on sourcing structure, capability allocation, and spillover control in production and logistics networks with extensive manufacturing outsourcing.