Strategically decentralize when encroaching on a dominant supplier

A manufacturer may encroach on his suppliers by developing substitutable components. In the presence of encroachment, the manufacturer could assemble products using (high-end) components purchased from the supplier, and assemble products using (low-end) components produced in-house. Thus, the manufacturer must deliberate on how to manage the expanded organization consisting of competing product divisions. In this paper, we examine the quintessential organizational structure decision – the centralization versus decentralization choice – from the perspective of the manufacturer. Our model assumes that the supplier is a dominant player in the supply chain, moving first by pricing the high-end component, and consumers have a higher willingness-to-pay of the product containing the high-end component. In such a context, we find that the manufacturer may encroach on the supplier even if producing one unit low-end component costs more than producing one unit high-end component. The supplier should strategically price to deter or accommodate downstream encroachment contingent on the manufacturer’s organizational structure decision. If the unit cost of low-end components is high enough, product-based decentralization is preferred to centralization due to the supplier’s lower wholesale price. Furthermore, we find that the manufacturer’s strategic decentralization always hurts the supplier, always benefits the customers, and could benefit or hurt the entire supply chain under certain conditions.