Supplier selection under production learning and process improvements

Abstract

We study a buyer's sourcing strategy when suppliers can reduce their unit costs through production learning coupled with investments in process improvements. The buyer sources her requirement from these suppliers over two periods. In the first period, guaranteed allocations by the buyer to the suppliers decrease their unit cost due to production learning. In the second period, she procures a certain amount through a competitive bidding process. In order to win this bid amount, suppliers also invest in process improvements. We find that if the supply base is learning efficient, then the buyer should follow dual sourcing-single sourcing strategy (sourcing from both the suppliers in the first period and the balance from the winner of the bidding competition in the second period). However, if the supply base is learning inefficient, then the buyer procures the entire capacity through one-shot single sourcing strategy (sourcing entire capacity from a single supplier through a bidding competition). We link our model insights to examples from business practice.