Factory encroachment and channel selection in an outsourced supply chain

Business practices have demonstrated that a contract manufacturer (CM) can introduce an own-label product and thus compete with its original equipment manufacturer (OEM), i.e., factory encroachment, which has not been obtained much attention in literature. Considering a three-level outsourced supply chain consisting of a CM, an OEM, and a retailer, this paper analyzes the impact of factory encroachment on players' gains. We show that factory encroachment could implement Pareto improvement, i.e., all supply-chain players' gains increase under encroachment. We also demonstrate that factory encroachment always offers more surplus to the entire supply chain and the consumer. In addition, the most preferred channel for the supply-chain players, the entire supply chain system, and the consumer are investigated. We find that an encroachment strategy could be simultaneously favored by all involved parties, provided there is no integration between the OEM and the retailer. However, if the OEM and the retailer act as a single entity, only the no-encroachment strategy could be favored by all parties simultaneously.