Second Sourcing Vs. Sole Sourcing With Capacity Investment and Asymmetric Information

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Executive Summary

In a sole-sourcing strategy, the buyer commits to source from a single supplier (the incumbent) over the entire horizon. In a second-sourcing strategy, the buyer keeps the option open to source from a new supplier (the entrant) in the future. Supplier costs are private information, and the incumbent's cost may change in the future due to learning. The buyer is relatively sure about current demand but uncertain about future demand. A supplier has to invest in capacity in order to produce the inputs for the buyer. With future private cost information, the incumbent earns rent in the future, and this prospective rent influences the incumbent's decision early in the horizon.

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