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

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.