Skip to main content

Product design outsourcing in a supply chain: impact of the design and conformance quality trade-off

Abstract

In many industries, original equipment manufacturers (OEMs) have been practicing production outsourcing to specialized manufacturing firms called contract manufacturers (CMs). Recently, with the growing research and development capabilities of CMs, OEMs have begun to delegate both product design and manufacturing to CMs. However, due to the design and conformance quality trade-off, it may be challenging for OEMs to achieve competitive levels of product quality by sending the total design and manufacturing to CMs. An increase in the level of product design quality with new technologies can decrease the level of product conformance quality with increased defects. Thus motivated, this study investigates the impact of the quality trade-off on the outsourcing decisions of OEMs. We consider a supply chain with an OEM and a CM facing the quality trade-off and analyze when the OEM benefits from product design outsourcing to the CM. Interestingly, we find that the interaction between the two quality types fosters the merit of OEM’s design outsourcing. This result suggests that CMs under design outsourcing actually can strike a good balance between the two quality levels. To promote CMs’ investment in design quality more widely, we propose an incentive-based contract and show that it can effectively enhance the benefit of design outsourcing for OEMs and CMs.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2
Fig. 3
Fig. 4

Notes

  1. 1.

    This type of CM is also commonly called an “original design manufacturer” or “ODM.” However, to avoid confusion with “OEM,” we refrain from using this term to refer to CMs involved in the product design for OEMs.

References

  1. Apple Newsroom (2013, September 16) iPhone 5s & iPhone 5c arrive on Friday [press release]. Retrieved from: https://www.apple.com/newsroom/2013/09/16iPhone-5s-iPhone-5c-Arrive-on-Friday-September-20/. Accessed 20 Oct 2019

  2. Arruñada B, Vázquez XH (2006) When your contract manufacturer becomes your competitor. Harvard Bus Rev 84:135–144

    Google Scholar 

  3. Baiman S, Fischer PE, Rajan MV (2000) Information, contracting, and quality costs. Manag Sci 46:776–789. https://doi.org/10.1287/mnsc.46.6.776.11939

    Article  Google Scholar 

  4. Balachandran KR, Radhakrishnan S (2005) Quality implications of warranties in a supply chain. Manag Sci 51:1266–1277. https://doi.org/10.1287/mnsc.1050.0408

    Article  Google Scholar 

  5. Banker RD, Khosla I, Sinha KK (1998) Quality and competition. Manag Sci 44:1179–1192. https://doi.org/10.1287/mnsc.44.9.1179

    Article  Google Scholar 

  6. Ben-Ammar O, Bettayeb B, Dolgui A (2019) Integrated production planning and quality control for linear production systems under uncertainties of cycle time and finished product quality. Int J Prod Res 58:1144–1160. https://doi.org/10.1080/00207543.2019.1613580

    Article  Google Scholar 

  7. Bolandifar E, Kouvelis P, Zhang F (2016) Delegation vs. control in supply chain procurement under competition. Prod Oper Manag 25:1528–1541. https://doi.org/10.1111/poms.12566

    Article  Google Scholar 

  8. Bray RL, Serpa JC, Colak A (2019) Supply chain proximity and product quality. Manag Sci 65:4079–4099. https://doi.org/10.1287/mnsc.2018.3161

    Article  Google Scholar 

  9. Brown S, Lamming R, Bessant J, Jones P (2005) Strategic operations management, 2nd edn. Butterworth-Heinemann, Oxford

    Google Scholar 

  10. Cao H, Guan X, Fan T, Zhou L (2020) The acquisition of quality information in a supply chain with voluntary vs. mandatory disclosure. Prod Oper Manag 29:595–616. https://doi.org/10.1111/poms.13130

    Article  Google Scholar 

  11. Cao Q, Zhang J (2020) Gray market’s product quality in the circular economy era. Int J Prod Res 58:308–331. https://doi.org/10.1080/00207543.2019.1638980

    Article  Google Scholar 

  12. Carbone J, (2000, January 13) Web: Key to electronics contract manufacturing. Purchasing Magazine Online

  13. Chase RB, Aquilano NJ (1992) Production and operations management: a life cycle approach, Subsequent. Irwin Professional Publishing, Homewood, Ill

    Google Scholar 

  14. Chen Y-J, Shum S, Xiao W (2012) Should an OEM retain component procurement when the CM produces competing products? Prod Oper Manag 21:907–922. https://doi.org/10.1111/j.1937-5956.2012.01325.x

    Article  Google Scholar 

  15. Choi S (2016) Cosmetics makers advance to global markets on ‘K-Beauty’ boom. The Korea Times [online document]. https://www.koreatimes.co.kr/www/news/biz/2016/10/123_216150.html. Accessed 18 Oct 2016

  16. Debo L, Rajan U, Veeraraghavan SK (2019) Signaling quality via long lines and uninformative prices. Manuf Serv Oper Manag. https://doi.org/10.1287/msom.2018.0753

    Article  Google Scholar 

  17. Doig SJ, Ritter RC, Speckhals K, Woolson D (2001) Has outsourcing gone too far? McKinsey Quart. https://link.galegroup.com/apps/doc/A80118054/AONE?sid=lms. Accessed 20 Oct 2019

  18. El Ouardighi F, Kogan K (2013) Dynamic conformance and design quality in a supply chain: an assessment of contracts’ coordinating power. Ann Oper Res 211:137–166. https://doi.org/10.1007/s10479-013-1414-4

    Article  Google Scholar 

  19. Fang F, Natarajan HP (2020) Sourcing and procurement cost allocation in multi-division firms. Prod Oper Manag 29:767–787. https://doi.org/10.1111/poms.13139

    Article  Google Scholar 

  20. Feng Q, Lu LX (2013) The role of contract negotiation and industry structure in production outsourcing. Prod Oper Manag 22:1299–1319. https://doi.org/10.1111/poms.12026

    Article  Google Scholar 

  21. Fine CH (1986) Quality improvement and learning in productive systems. Manag Sci 32:1301–1315. https://doi.org/10.1287/mnsc.32.10.1301

    Article  Google Scholar 

  22. Grandoni D (2012) iPhone 5 price, release date announced: New iPhone starts at $199, arrives in U.S. on September 21. The Huffington Post [online document]. https://www.huffpost.com/entry/iphone-5-price-release-date-announced_n_1878231.Accessed on December 22, 2020

  23. Hayes R, Pisano G, Upton D, Wheelwright S (2005) Operations, strategy, and technology: pursuing the competitive edge. Wiley, Hoboken, NJ

    Google Scholar 

  24. He Y, Huang H, Li D (2018) Inventory and pricing decisions for a dual-channel supply chain with deteriorating products. Oper Res Int J 20:1461–1503. https://doi.org/10.1007/s12351-018-0393-2

    Article  Google Scholar 

  25. Hsieh C-C, Liu Y-T (2010) Quality investment and inspection policy in a supplier–manufacturer supply chain. Eur J Oper Res 202:717–729. https://doi.org/10.1016/j.ejor.2009.06.013

    Article  Google Scholar 

  26. Jacobs FR, Chase RB, Aquilano NJ (2009) Operations and supply management, 12th edn. McGraw-Hill, New York, NY

    Google Scholar 

  27. Juran JM, De Feo JA (2010) Juran’s quality handbook, 6th edn. McGraw-Hill, Columbus, OH

    Google Scholar 

  28. Karmarkar US, Pitbladdo RC (1997) Quality, class, and competition. Manag Sci 43:27–39. https://doi.org/10.1287/mnsc.43.1.27

    Article  Google Scholar 

  29. Kaya M, Özer Ö (2009) Quality risk in outsourcing: noncontractible product quality and private quality cost information. Nav Res Logist 56:669–685. https://doi.org/10.1002/nav.20372

    Article  Google Scholar 

  30. Kim K, Chhajed D (2002) Product design with multiple quality-type attributes. Manag Sci 48:1502–1511

    Article  Google Scholar 

  31. Koulamas C (2006) A newsvendor problem with revenue sharing and channel coordination. Decis Sci 37:91–100. https://doi.org/10.1111/j.1540-5414.2006.00111.x

    Article  Google Scholar 

  32. Lai G, Liu Y, Xiao W (2021) International taxation and production outsourcing. Prod Oper Manag 30:402–418. https://doi.org/10.1111/poms.13271

    Article  Google Scholar 

  33. Lederer PJ, Rhee SK (1995) Economics of total quality management. J Oper Manag 12:353–367. https://doi.org/10.1016/0272-6963(95)00007-F

    Article  Google Scholar 

  34. Lee WJ, Kim D, Cabot AV (1996) Optimal demand rate, lot sizing, and process reliability improvement decisions. IIE Trans 28:941–952. https://doi.org/10.1080/15458830.1996.11770747

    Article  Google Scholar 

  35. Liao B, Yano CA (2020) Optimizing store-brand quality: Impact of choice of producer and channel price leadership. Prod Oper Manag 29:119–137. https://doi.org/10.1111/poms.13084

    Article  Google Scholar 

  36. Lien J, Shen S (2013) Apple reportedly having some IC yield problems with new iPhone manufacturing. DigiTimes [online document]. https://www.digitimes.com/news/a20130716PD206.html. Accessed on December 22, 2020

  37. Lien J, Hong M, Shen J (2014) TSMC to dramatically improve yield rates for Apple’s touch ID. DigiTimes [online document]. https://www.digitimes.com/news/a20140211PD207.html. Accessed on December 22, 2020

  38. Liu G, Zhang J, Tang W (2015) Strategic transfer pricing in a marketing–operations interface with quality level and advertising dependent goodwill. Omega 56:1–15. https://doi.org/10.1016/j.omega.2015.01.004

    Article  Google Scholar 

  39. Liu Z, Zheng X (2013) The analysis of Chinese enterprises’ upgrading from OEM to ODM: the opportunity windows and paths. Can Soc Sci 9:1–8

    Google Scholar 

  40. Niu B, Zeng F, Chen L (2021) “Production+ procurement” outsourcing with competitive contract manufacturer’s partial learning and supplier’s price discrimination. Int Trans Oper Res 29:1917–1951. https://doi.org/10.1111/itor.12904

    Article  Google Scholar 

  41. Meirovich G (2006) Quality of design and quality of conformance: contingency and synergistic approaches. Total Qual Manag Bus Excell 17:205–219. https://doi.org/10.1080/14783360500450640

    Article  Google Scholar 

  42. Mitropoulos P (2019) Production and quality performance of healthcare services in EU countries during the economic crisis. Oper Res Int J. https://doi.org/10.1007/s12351-019-00483-3

    Article  Google Scholar 

  43. Nichols BS, Stolze H, Kirchoff JF (2019) Spillover effects of supply chain news on consumers’ perceptions of product quality: an examination within the triple bottom line. J Oper Manag 65:536–559. https://doi.org/10.1002/joom.1033

    Article  Google Scholar 

  44. Pasternack BA (1985) Optimal pricing and return policies for perishable commodities. Mark Sci 4:166–176. https://doi.org/10.1287/mksc.1070.0336

    Article  Google Scholar 

  45. Plambeck EL, Taylor TA (2005) Sell the plant? The impact of contract manufacturing on innovation, capacity, and profitability. Manag Sci 51:133–150. https://doi.org/10.1287/mksc.4.2.166

    Article  Google Scholar 

  46. Porkar S, Mahdavi I, Vishkaei BM, Hematian M (2020) Green supply chain flow analysis with multi-attribute demand in a multi-period product development environment. Oper Res Int J. https://doi.org/10.1007/s12351-018-0382-5

    Article  Google Scholar 

  47. Qin F, Mai F, Fry MJ, Raturi AS (2016) Supply-chain performance anomalies: fairness concerns under private cost information. Eur J Oper Res 252:170–182. https://doi.org/10.1016/j.ejor.2016.01.033

    Article  Google Scholar 

  48. Reyniers DJ, Tapiero CS (1995) Contract design and the control of quality in a conflictual environment. Eur J Oper Res 82:373–382. https://doi.org/10.1016/0377-2217(94)00270-M

    Article  Google Scholar 

  49. Saouma R (2008) Optimal second-stage outsourcing. Manag Sci 54:1147–1159. https://doi.org/10.1287/mnsc.1070.0834

    Article  Google Scholar 

  50. Shen B, Li Q, Dong C, Quan V (2016) Design outsourcing in the fashion supply chain: OEM versus ODM. J Oper Res Soc 67:259–268. https://doi.org/10.1057/jors.2015.23

    Article  Google Scholar 

  51. Shi L, Ólafsson S, Chen Q (2001) An optimization framework for product design. Manag Sci 47:1681–1692. https://doi.org/10.1287/mnsc.47.12.1681.10243

    Article  Google Scholar 

  52. Stevenson WJ (2007) Operations management, 9th edn. McGraw-Hill/Irwin, New York

    Google Scholar 

  53. Ülkü S, Schmidt GM (2011) Matching product architecture and supply chain configuration. Prod Oper Manag 20:16–31. https://doi.org/10.1111/j.1937-5956.2010.01136.x

    Article  Google Scholar 

  54. Wang Y, Niu B, Guo P (2013) On the advantage of quantity leadership when outsourcing production to a competitive contract manufacturer. Prod Oper Manag 22:104–119. https://doi.org/10.1111/j.1937-5956.2012.01336.x

    Article  Google Scholar 

  55. Xie G, Wang S, Lai KK (2011) Quality improvement in competing supply chains. Int J Prod Econ 134:262–270. https://doi.org/10.1016/j.ijpe.2011.07.007

    Article  Google Scholar 

  56. Xu W, Song DP (2020) Integrated optimisation for production capacity, raw material ordering and production planning under time and quantity uncertainties based on two case studies. Oper Res Int J. https://doi.org/10.1007/s12351-020-00609-y

    Article  Google Scholar 

  57. Yoo SH, Cheong T (2018) Quality improvement incentive strategies in a supply chain. Transp Res E Logist 114:331–342. https://doi.org/10.1016/j.tre.2018.01.005

    Article  Google Scholar 

  58. Yoo SH, Choi TY, Kim D (2020) Multitier incentive strategies for quality improvement: Case of three-tier supply chain. Decis Sci. https://doi.org/10.1111/deci.12447

    Article  Google Scholar 

  59. Yoo SH, Shin H, Park MS (2015) New product development and the effect of supplier involvement. Omega 51:107–120. https://doi.org/10.1016/j.omega.2014.09.005

    Article  Google Scholar 

  60. Zhu K, Zhang RQ, Tsung F (2007) Pushing quality improvement along supply chains. Manag Sci 53:421–436. https://doi.org/10.1287/mnsc.1060.0634

    Article  Google Scholar 

  61. Zhu X (2016) Managing the risks of outsourcing: time, quality and correlated costs. Transp Res E Logist 90:121–133. https://doi.org/10.1016/j.tre.2015.06.005

    Article  Google Scholar 

  62. Zirpoli F, Becker MC (2011) The limits of design and engineering outsourcing: performance integration and the unfulfilled promises of modularity. R D Manag 41:21–43. https://doi.org/10.1111/j.1467-9310.2010.00629.x

    Article  Google Scholar 

Download references

Acknowledgements

This work was supported by the research fund of Hanyang University (HY-201800000000634).

Author information

Affiliations

Authors

Corresponding author

Correspondence to Kun Soo Park.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix: Proofs

Appendix: Proofs

Proof of Theorem 1

Comparing \({\Pi }_{O}^{OD}\) and \({\Pi }_{O}^{CD}\) yields \({\Pi }_{O}^{CD}-{\Pi }_{O}^{OD}\) = πO(2γη − δθ)2(8πCλη − πO(4λη − θ2))/(16λη2(4λη − θ2)). Therefore, the sign (\({\Pi }_{O}^{CD}-{\Pi }_{O}^{OD}\)) depends on the sign (8πCλη − πO(4λη − θ2)) since 4λη − θ2 > 0 from Condition 3. This establishes the condition of πO in Theorem 1(1) that determines the relationship between \({\Pi }_{O}^{CD}\) and \({\Pi }_{O}^{OD}\).

Similarly, if we directly compare xOD and xCD, DOD and DCD, and ΠOD and ΠCD, sign[xCD − xOD] = sign[DCD − DOD] = sign[ΠCD − ΠOD] = sign[4πCλη − πO(4λη − θ2)]. The comparison between 1/σCD and 1/σOD induces sign[1/σCD − 1/σOD] = sign[πO(4λη − θ2) − 4πCλη]. From these comparisons, we can obtain the results of Theorems 1(2) and 1(3). □

Proof of Theorem 2

Comparing \({\Pi }_{O}^{OD}\) and \({\Pi }_{O}^{CDI}\) yields \({\Pi }_{O}^{OD}-{\Pi }_{O}^{CDI}\) = (2γη − δθ)2(πO2(2λη − θ2) − 4ληπOπC − 2ληπC2)/(16λη2(4λη − θ2)). Hence, sign[\({\Pi }_{O}^{OD}-{\Pi }_{O}^{CDI}\)] = sign[πO2(2λη − θ2) − 4ληπOπC − 2ληπC2]. From this, \({\Pi }_{O}^{OD}>{\Pi }_{O}^{CDI}\) holds if πO > [(2λη + \(\sqrt{2\lambda \eta (4\lambda \eta -{\theta }^{2})}\))/(2λη − θ2)]πC or πO < [(2λη − \(\sqrt{2\lambda \eta (4\lambda \eta -{\theta }^{2})}\))/(2λη − θ2)]πC, while 2λη − θ2 > 0 from Condition 3. Since [(2λη − \(\sqrt{2\lambda \eta (4\lambda \eta -{\theta }^{2})}\))/(2λη − θ2)]πC < 0, we have the condition πO > [(2λη + \(\sqrt{2\lambda \eta (4\lambda \eta -{\theta }^{2})}\))/(2λη − θ2)]πC to have \({\Pi }_{O}^{OD}>{\Pi }_{O}^{CDI}\). Furthermore, comparing \({\Pi }_{O}^{CD}\) and \({\Pi }_{O}^{CDI}\), we obtain \({\Pi }_{O}^{CDI}-{\Pi }_{O}^{CD}\) = (2γη − δθ)2(πO − πC)2/(8η(4λη − θ2)). Hence, \({\Pi }_{O}^{CDI}>{\Pi }_{O}^{CD}\) always holds. If we combine the two comparison results above with πO < [8λη/(4λη − θ2)]πC to have \({\Pi }_{O}^{CD}>{\Pi }_{O}^{OD}\) in Theorem 1(1), while also considering πO > πC in Condition 4 for Case CDI to exist, we obtain the result of Theorem 2(1). Additionally, combining the comparison results involving the optimal solution of Case CDI with the results of Theorems 1(2) and 1(3) as above, we can obtain the results of Theorems 2(2) and 2(3). □

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Yoo, S.H., Jung, D. & Park, K.S. Product design outsourcing in a supply chain: impact of the design and conformance quality trade-off. Oper Res Int J (2021). https://doi.org/10.1007/s12351-021-00668-9

Download citation

Keywords

  • Supply chain management
  • Outsourcing
  • Design quality
  • Conformance quality