Business practices have demonstrated that a contract manufacturer (CM) can introduce an own-label product and thus compete with its original equipment manufacturer (OEM), i.e., factory encroachment, which has not been obtained much attention in literature. Considering a three-level outsourced supply chain consisting of a CM, an OEM, and a retailer, this paper analyzes the impact of factory encroachment on players’ gains. We show that factory encroachment could implement Pareto improvement, i.e., all supply-chain players’ gains increase under encroachment. We also demonstrate that factory encroachment always offers more surplus to the entire supply chain and the consumer. In addition, the most preferred channel for the supply-chain players, the entire supply-chain system, and the consumer are investigated. We find that an encroachment strategy could be simultaneously favored by all involved parties, provided there is no integration between the OEM and the retailer. However, if the OEM and the retailer act as a single entity, only the no-encroachment strategy could be favored by all parties simultaneously.

Introduction

As outsourcing becomes more persuasive in business practices, many contract manufacturers (CMs) start to encroach on original equipment manufacturers’ (OEMs) territories and produce and sell its own-label products that compete with its customer OEMs’ brand. Recently, for example, a project titled ‘China Quality Manufacturing (CQM)’, which is developed by the giant electronic retailer TAOBAO, aims to push tens thousands of Chinese CMs (factories) onto online platforms for selling its own-label products (Alibaba, 2016). Thus, in the following years, the involved factories (CMs) will serve both offline customer firms (OEMs) and online consumers. It indicates that CMs’ encroachment could emerge as an important business model in O2O outsourcing practices. CMs’ managers may face two strategic decisions with regard to producing and selling own-label products. The first one is the strategic decision on introducing own-label products; and the other one is which market a CM should enter. Two markets that a CM can encroach on are obvious: the wholesale market vs. the retail market. For example, some CMs involved in the CQM project sell their products through an online wholesale market (see http://www.1688.com); while the other enterprises establish web shops on a direct-to-consumer platform (see http://q.taobao.com). These practices imply that the CMs should simultaneously satisfy the offline demand incurred by its customer firms (OEMs) and the online demand incurred by consumer or online retailers. Thus, traditional CMs with single offline channel are involved in strategic decisions of multi-channel operations.