The Role of Brand Spillover on Firm’s Sourcing and Contract Decisions

When a technology provider (entrant) enters an emerging end market, he may outsource critical components from a competing conventional manufacturer (incumbent) or insource critical components. Under the outsourcing strategy, brand reputation spills over from the incumbent to the entrant—a phenomenon termed brand spillover. This paper investigates the sourcing strategy (insourcing or outsourcing) and contract choice (wholesale price contract or revenue share contract) in markets subject to brand spillover. We develop a game theoretic model consisting of one entrant with a new technology and one incumbent who sells the traditional product in the end market and the critical component to the entrant. We find that the entrant adopts the insourcing strategy only if his optimal quantity, including original market power and brand spillover, is intermediate. Otherwise, the outsourcing strategy with wholesale price contract is selected when his optimal quantity is low, while revenue-sharing contracts dominate at high quantity. Interestingly, when brand spillover intensity exceeds a threshold, both parties benefit from a higher level of brand spillover under the wholesale price contract.