Sourcing strategies under agglomeration economies, capacity risks and retail competition

Abstract

We study two sourcing scenarios where in the first scenario, two symmetric buyers procure capacity from a common cluster of suppliers (or agglomerate) and in the second scenario the symmetric buyers procure capacity from different geographies. The buyers sell differentiated products and compete in the final downstream market. Further, there are disruption risks associated with suppliers and the common cluster. In this research, we determine how factors in the downstream market competition and upstream agglomeration scale economies affect the buyers' sourcing strategy in both the scenarios. We find some interesting insights on the buyers' sourcing strategy due to downstream market parameters like demand substitution and price sensitivity. Our analysis also reveals that the optimal capacity to be procured by the buyer in both the scenarios follows a threshold policy on the downstream demand substitution factor.