Product Design Outsourcing in Competitive Markets

Abstract

Original design manufacturers (ODM) is a new form of global outsourcing. Traditional outsourcing only transfers the production of a product from brands to manufacturers. An ODM, in contrast, not only manufactures the product for a brand, but also designs the product. Using an analytical model, we investigate strategic design outsourcing decisions of firms. Two firms competing in a horizontally differentiated market decide whether to design the products by themselves or to outsource product design to an ODM. We consider two different channel structures – one in which each firm partners with an exclusive ODM and the other in which both firms partner with a common ODM. We find that both symmetric and asymmetric outsourcing outcomes can arise in the equilibrium, even though competing firms are assumed to be completely symmetric. Surprisingly, firms’ outsourcing incentive can be inversely related to the cost of designing a product, i.e., neither firm outsources product design when the cost is high, one firm outsources product design and the other insources when the cost is in an intermediate range, and both firms outsource product design when the cost is low. We also find that firms are more likely to outsource product design when there is a common ODM in the channel than when there are exclusive ODMs.