ARTICLE IN PRESS

Int. J. Production Economics 112 (2008) 723–741

www.elsevier.com/locate/ijpe

Product design with multiple suppliers for component variants

Nagraj (Raju) Balakrishnana,, Amiya K. Chakravartyb
a
Department of Management, Clemson University, 101 Sirrine Hall, Clemson, SC 29634-1305, USA
b
College of Business Administration, Northeastern University, Boston, MA 02115, USA
Received 4 May 2004; accepted 21 November 2005
Available online 10 July 2007

Abstract

The issue of vendor choice has traditionally not been considered in determining the optimal set of products to produce.
That is, component purchase has typically been considered only at the MRP explosion stage, well after the set of products
to produce and their production quantities has been decided. This decoupling of roles may sometimes result in high
acquisition cost of components. To control costs, it is crucial that unit prices of component variants, fixed costs of doing
business with vendors, and their capabilities to supply different component variants be assessed before deciding which set
of models to include in a product line. In our analysis, we have explicitly provided for this coupling between product choice
and vendor selection, and have gone a step further by bringing in customers to determine the sales potential of the different
models of a product that may be produced. We use our analysis to study the following issues: (1) how can a manufacturer
decide which product models to offer and which vendors to select to offer components for these models, (2) under what
situations are general vendors (who offer a larger variety of component variants) preferred to more focused vendors, (3)
how much discount do focused vendors need to offer to compensate for their lack of versatility, (4) how does the fixed cost
of vendor relationships influence the vendor selection decision, (5) how does the intensity of market competitiveness
influence this decision, (6) how can a manufacturer work with a general vendor to exploit new market opportunities, and
(7) how much incentive can a manufacturer offer focused vendors to get them to become more versatile in their
capabilities. For each problem scenario, the output of our procedure tells us the set of models that should be chosen for a
product line, production quantities of each model, specific vendors from whom component variants needed to produce
these models should be procured, and profits to the manufacturer and each vendor selected.
r 2007 Elsevier B.V. All rights reserved.

Keywords: Product mix; Product design; Vendor selection; Math programming

1. Introduction in PCs). In deciding which specific models to offer

Consider a product that consists of a specific
number of components. By using different variants
of these components, it may be possible for a firm to
offer several models of the product (e.g., CPU units
Corresponding author. Tel.: +1 864 656 3769;
fax: +1 864 656 2015.
E-mail address: nbalak@clemson.edu (N. Balakrishnan).
for sale, issues a firm should consider are customers’
preference of different product attributes and unit
manufacturing costs (Chakravarty and Baum,
1992). While customers would prefer a large number
of models to choose from, the number of different
component variants required to achieve this variety
could be high. The resulting total manufacturing
cost can be substantial especially if component
variants and/or processes used for different models

0925-5273/$ - see front matter r 2007 Elsevier B.V. All rights reserved.
doi:10.1016/j.ijpe.2005.11.011
 ARTICLE IN PRESS
724 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
are unique (Ishii et al., 1995; Macduffie et al., 1996).
The use of common components and processes is a
way to keep manufacturing costs down while
increasing product variety, thereby creating a
competitive advantage (Fisher et al., 1995).
For most products, some components would be
manufactured in-house, while others would be
outsourced. In this analysis, we focus only on those
components that are outsourced. For such compo-
nents, the issue of vendor selection has traditionally
been considered only after the set of models to
produce has been decided. However, since the
component variants to be procured may possess
different cost characteristics depending on the
choice of vendors, it becomes imperative that we
consider vendor choice concurrently with the
product choice issue.
Gupta and Krishnan (1999) point out that a fixed
cost is incurred in developing relationships with a
vendor, different from the vendor’s cost of devel-
oping a component variant. Sun Microsystems has
been able to quantify this vendor-related fixed cost
for its vendors (Farlow et al., 1996). While it may
therefore be beneficial from this fixed cost perspec-
tive to reduce the number of vendors, the capabil-
ities of individual vendors (in terms of component
variants they can supply) implicitly determine the
minimum number of vendors that must be used.
While a general vendor would be capable of
supplying a larger set of component variants, it
would possibly be at higher unit costs than a
focused vendor who can supply fewer variants.
Consideration of the trade-off between a small
group of general vendors and a much larger group
of focused vendors must, therefore, be included in
product choice decisions. It may be necessary to
identify the group of vendors that, together, are
synergistic with the market-driven choice of product
models. One can then assess whether it makes
commercial sense to help this group of vendors
develop new capabilities so that the company may
exploit new opportunities in the market place.
Page and Rosenbaum (1987) describe how
decisions related to product choice were made in a
food-processor product line at Sunbeam Appliance
Company. They identified 9 different component
attributes and possible choices of each, as shown in
Table 1. Since 4 of the 9 characteristics have 3
choices each, and the other 5 have 2 choices each,
the total product variety possible is 34  25 ¼ 2592.
Sunbeam chose just 5 of these 2592 models for a
detailed study in terms of market share, and finally
Table 1
Food-processor components and variants
Component Attribute Choices
Motor assembly Motor capacity Regular, heavy duty,
professional
Number of blades 3, 5, 7
Number of speeds 1, 2, 7
Bowl assembly Bowl size 1.5 quarts, 2.5
quarts, 4 quarts
Bowl type Regular, side
discharge
Bowl shape Cylindrical, spherical
Feed-tube Feed-tube type Regular, large
assembly
Feed-tube pusher Regular,
interchangeable
Pouring spout Availability Present, absent
decided on a product line comprising three models,
resulting in an increase in their market share by
10%. In their decision-making process, Sunbeam
did not appear to be concerned about manufactur-
ing cost, outsourcing, or overall profitability,
relying instead on market share.
In this paper, we investigate product choice
decisions such as those faced by Sunbeam, but also
incorporate the impact of outsourcing components
in these decisions. While Gupta and Krishnan
(1999) consider the choice of a single product for
a given demand, we (like in the Sunbeam case)
permit choice of multiple models with different
bundling of attribute strengths, and explicitly
incorporate market dynamics based on these
attribute strengths. In terms of outsourcing, we
provide for fixed cost of building vendor relation-
ships, and varying capabilities of individual ven-
dors. Specifically, we study the following research
questions: (1) how does the choice of product
models the manufacturer should offer in the market
influence the vendor choice decision, and vice versa,
(2) under what circumstances would general ven-
dors be preferred to more focused vendors, (3) how
much discount do focused vendors need to offer to
compensate for their lack of versatility, (4) how does
the fixed cost of vendor relationships influence the
product line and vendor choice decisions, (5) how
does market competition influence these decisions,
and (6) how can a manufacturer induce a general
vendor to offer a discount so that, together, the
manufacturer and the vendor can exploit new
market opportunities, and (7) how much incentive
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
can a manufacturer offer a focused vendor to get
him to become more versatile in his capabilities.
In our analysis, as in Balakrishnan and Chakra-
varty (1996), we consider the problem of a market
leading OEM and base our analysis on life cycle
demands and costs. Specifically, we study the
problem from the OEM’s perspective in terms of
increasing their profit. However, we show how an
increase in the OEM’s profit may be accompanied
by a concurrent increase in the profit for certain
vendors. We also show how the commonality of
components used in product choice leads to using
only a few of the possible vendors. Price discounts
by vendors (based on volume of sales) could
obviously limit the chosen vendor set even further.
However, since our primary focus is to study the
impact of component commonality on product and
vendor choice, we do not include price discount
effects in our analysis. The inclusion of price
discounts adds an additional layer of complexity
to the model and we plan to address it in a future
research project.
This paper is organized as follows. In Section 2,
we discuss demand and cost issues that could affect
the choice of specific models to produce and the
selection of vendors to supply outsourced compo-
nent variants for these models. Based on this
discussion, we derive an expression for calculating
the OEM’s profit. In Section 3, we describe an
efficient procedure adapted from Chakravarty and
Balakrishnan (2001) that may be used to identify
the optimal set of models to offer and the vendors
who should be used to facilitate their production.
In Section 4, we describe computational tests
designed to answer the research questions posed
earlier, and discuss managerial implications of the
results. We conclude this paper in Section 5 with a
summary of our findings and statements of our
contributions.
The primary contributions of this paper are the
mathematical model that has been developed for
this comprehensive problem and more importantly,
the various managerial insights derived from the
computational results obtained by the efficient
solution of this model for different problem
environments and parameters. These insights into
how an OEM can work with different types of
vendors (general and focused) in different ways so
that they can jointly exploit the marketplace are
especially interesting, and could be very useful to
other researchers working on supply chain design
issues.
725
2. Product demands and component costs
The commercial success of a model of a product
(referred to hereafter simply as model) depends on
how much of it can be sold at a given price, and at
what cost it can be produced. We therefore discuss
demand- and cost-related issues that may impact the
product choice and vendor selection decisions.
2.1. Products and vendors
Let N denote the number of outsourced compo-
nents used in manufacturing the product. Each
component may have several variants depending on
the levels at which that component’s attributes are
set. The selection of 1 variant for each component
would, together, create a model denoted by i (iAI,
where I is the set of all models). Each model i will be
an N-vector corresponding to specific component
variant choices. For example, the product (food
processor) in the Sunbeam case has 4 components
(i.e., N ¼ 4). The motor assembly component has 27
possible variants (three attributes at three choices
each), while the bowl assembly, feed-tube assembly,
and pouring spout components have 12, 4, and 2
possible variants, respectively. The total number of
models for Sunbeam is therefore 2592 ( ¼ 27 
12  4  1), although, in practice, this number will
be smaller since some combinations of component
variants may not be compatible with each other.
It is clear that the same component variant could
be present in several models. For example, as shown
in Table 2, in the 5 models selected by Sunbeam for
detailed in-depth analysis (Page and Rosenbaum,
1987), the same motor assembly variant (heavy duty
capacity, 5 blades, 7 speed) is used in both models 3
and 4.
It is reasonable to expect that all possible variants
of a component may not be available from a given
vendor. Thus, if we choose to produce all 5 models
in Table 2, the set of vendors chosen must, together,
possess the capability to supply all the component
variants required. If there are (say) 4 vendors, we
may choose to do business with any number (p4) of
them, depending on their combined capabilities,
costs, and models chosen.
Gupta and Krishnan (1999) point out that for
every vendor who is chosen, a certain vendor-
related fixed cost is incurred. These costs comprise
issues such as vendor certification, contract agree-
ment, and progress monitoring costs, and are
independent of the volume and type of component
 ARTICLE IN PRESS
726 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

Table 2
Models selected by Sunbeam

Component Attribute Model 1 Model 2 Model 3 Model 4 Model 5

Motor assembly Motor capacity Professional Regular Heavy duty Heavy duty Heavy duty
Number of blades 5 3 5 5 5
Number of speeds 1 1 7 7 2
Bowl assembly Bowl size 4 quarts 2.5 quarts 1.5 quarts 1.5 quarts 2.5 quarts
Bowl type Regular Regular Regular Side discharge Regular
Bowl shape Cylindrical Cylindrical Cylindrical Cylindrical Cylindrical
Feed-tube assembly Feed-tube type Large Regular Large Large Large
Feed-tube pusher Interchangeable Regular Interchangeable Interchangeable Regular
Pouring spout Absent Present Absent Absent Absent

variants supplied. Thus, the buyer would like to OEM, the total sales revenue may be expressed as
minimize the number of vendors used. Clearly, if the X
number of vendors chosen is small, these vendors Revenue ¼ Pi Qi , (4)
i2I^
have to be more general (i.e., capable of supplying
several different variants of several components). where Qi is the quantity of model i sold. It is clear
that
2.2. Product demand and revenue Qi pDi 8i 2 I. (5)

To estimate demand of model i, we follow a

procedure similar to that used in conjoint analysis
(Lillien and Rangaswamy, 1998). The customer 2.3. Cost of component acquisition
rating Li of model i is determined first, and these
ratings are then used to calculate its attractiveness As there are multiple vendors, a component
factor Ri as in the multinomial logit model (Cooper variant may be acquired from more than 1 vendor.
and Nakanishi, 1988). In our current model, we assume that vendors are
not capacity constrained and can therefore supply
Ri ¼ ExpðLi Þ 8i 2 I. (1)
the entire quantity of a particular component
The market share Si of model i can now be variant if the OEM chooses to place an order with
expressed as them. While this may seem to be a somewhat
," # restrictive argument, we could argue that in many
X
S i ¼ Ri RC þ Rj , (2) situations, vendors may themselves be able to
j2I outsource orders. This implies that while an entire
order is being fulfilled by a single vendor from the
where RC is the attractiveness factor of the
OEM’s perspective, the actual production of com-
competitors’ potential products. Although we as-
ponent variants for this order may occur at more
sume RC to be a known constant in our model, we
than 1 vendor.
however study and report the results of sensitivity
Let V denote the set of all vendors, and U(CV)
analysis on the value of RC. The demand of model i
denote the set of vendors currently being considered
can therefore be written as
," # for use by the OEM. Note that there are a total of
X (2jVj1) combinations of set U. For instance, if
Di ¼ OS i ¼ ORi RC þ Rj , (3) there are 3 vendors denoted by v1, v2, and v3,
j2I
possible combinations for set U would be {v1}, {v2},
where O is the total size of the market (i.e., the total {v3}, {v1,v2}, {v1,v3}, {v2,v3}, and {v1,v2,v3}.
number of potential customers). Let the cost of purchasing 1 unit of variant k of
Let the unit sales price of model i be denoted by component j from vendor v be denoted by Cjkv.
^ IÞ denotes the set of models
Pi. Then, if Ið Then, for a given set U of vendors being considered
currently being considered for production by the for use by the OEM, the lowest cost at which this
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
variant can be bought may be written as
C jk ¼ Minimumfv2Ug C jkv .
As noted earlier, we do not consider the impact of
price discounts based on volume of sales in our
current analysis. Therefore, by adding up the costs
C jk for all component variants in model i, the lowest
cost of acquiring the purchased components of that
model using set U of vendors may be easily
determined. Let this cost be denoted by CiU. Then,
for a given set I^ of models and set U of vendors
from whom to acquire component variants for these
models, the total profit may be expressed as
X X X ,"
PðI; ^ UÞ ¼ Pi Qi  C iU Qi  dv , (7)
i2I^ i2I^ v2U
where dv is the vendor-related fixed cost of devel-
oping and maintaining a relationship with vendor v.
The overall optimal profit P* for the OEM may
then be written as
" #
X X
P ¼ MaximumfUV ;IIg
^ Pi Qi  C iU Qi 
i2I^ i2I^
3. Profit-driven decision making
The OEM, to maximize profit, needs to increase
revenue by increasing market share, and decrease
the variable cost of purchasing component variants
and the fixed cost of developing vendor relations.
The major decisions, therefore, would be: (a) which
models to manufacture (i.e., the composition of set
^ (b) what quantities of different component
I),
variants need to be purchased, and (c) which
vendors should be used to acquire these variants
(i.e., composition of set U). The objective would be
to maximize the profit in expression (8), subject to
the constraint in expression (5). Note that in order
to solve this problem, the optimal set of models I^
must be identified for each of the (2jVj1) combina-
tions of the vendor set U.
From Theorem 1 below, the optimal value of Qi
will be equal to either 0 or the demand Di. We use
this property to link the profit expression (7) to
market characteristics such as customer preferences
and market size. Theorems 1–3 in this paper are
adapted from Chakravarty and Balakrishnan (2001)
and the proofs are therefore, omitted here.
727
Theorem 1. The value of Qi that maximizes profit
^ U; Þ in expression (7), will be equal to Di if
PðI;
(6) PiXCiU, and equal to zero if PioCiU.
In our current model, we assume that the OEM
does not have a total capacity constraint with
respect to all its models. As such, we can substitute
for Qi with Di in our model. Here again, while this
assumption may be rather restrictive in some
situations, it could be quite logical in other
situations depending on the availability of out-
sourcing capabilities for the OEM.
Substituting for Qi with Di in expressions (3) and
(7), we have
#
X X X
^ UÞ ¼
PðI; ðPi  C iU ÞORi RC þ Ri  dv .
i2I^ i2I^ v2U
(9)
Expression (9) is a generalization of the profit
expression used in Chakravarty and Balakrishnan
(2001) in that it includes vendors’ unit costs and
vendor-related fixed costs, in addition to production
X
dv . quantities and unit selling prices. Thus, the OEM
v2U must select which models i to include in set I^ so as to
(8) maximize PðI; ^ UÞ as defined in expression (9).
Using the binary variables yi( ¼ 1 if model i 2 I; ^ ¼
^ UÞ can be rewritten as
0 else), PðI;
," #
X X X
^ UÞ ¼
PðI; ðPi  C iU ÞORi yi RC þ R i yi  dv ,
i2I i2I v2U
(10)
which is a non-linear function of binary variables
and hence, very difficult to solve using standard
branch and bound solution procedures.
To facilitate an efficient solution of this model for
a given vendor set U, we exploit dominance
properties of the optimal solution to transform the
model to a simple 1-dimensional search with a
powerful stopping rule. We then apply this solution
procedure to each of the (2jVj1) combinations of
the vendor set U. While this approach does solve the
vendor selection and product choice issues in a
sequential manner (i.e., it solves the product choice
issue separately for each vendor set), it turns out
that the search procedure is so computationally
efficient that the total computation time required to
evaluate all vendor combinations is not very large
even for problems with many vendors. As such, our
procedure should be applicable in many practical
settings.
 ARTICLE IN PRESS
728 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

To develop out search procedure, we make use of points. We establish this property, called the
Theorems 2 and 3 below. Letting, consecutiveness property, in Theorem 3.
xiU ¼ ðPi  C iU ÞORi , (11) ^ I^  IÞ
Theorem 3. For a given vendor set U, the set Ið
we rewrite expression (9) as corresponds to an extreme point eAE if for any i 2 I^
^ xiU =Ri 4xjU =Rj .
and jeI,
," #
Y X X X
^ UÞ ¼
ðI; xiU RC þ Ri  dv , Theorem 3 is extremely useful in our context, as it
i2I^ i2I v2U allows us to rank order the models i (iAI) in
(12) decreasing order of xiU/Ri values. Items from the
^ so as long
top end of this list will be placed in set I,
which, in turn, can be rewritten as as profit PðI; ^ UÞ as in expression (13) keeps
Y  X
^ UÞ ¼ X ^ ½RC þ Y ^  
ðI; dv , (13) increasing. For optimality,
IU I Y Y
P P
v2U
ðI^ þ j; UÞp ðI; ^ UÞ and xiU =Ri 4xjU =Rj
where XIˆU ¼ iAIˆ xiU and YIˆ ¼ iAIˆ Ri. Thus, the
8i 2 I^ and jeI.
^ ð17Þ
problem reduces to:
For model i in the optimal set I, ^ purchase
Program P1. quantities will be determined as
Y X
Maximize ^ UÞ ¼ X ^ =½RC þ Y ^  
ðI; dv ,2 3
IU I X
v2U Qi ¼ ORi 4RC þ Rj 5 8i 2 I.
^ (18)
(14) j2I^

In a situation where the cardinality of set I is large

subject to I^  I (15)
and
U  V. (16)
NotePthat for a given vendor set U, the second
term ( vAUdv) in expression (14) is a constant and
can therefore be ignored in solving the optimization
problem. To visualize the feasible space of Program
P1 with respect to the first term in the objective
function, consider a 2-dimensional space with the
values of X IU
^ and Y I^ plotted along the horizontal
and vertical axes, respectively. Consider T, the set of
all subsets of set I resulting from the partition of set
C
I into 2 subsets, I^ and I^ . Obviously I^ 2 T, and
each set I^ corresponds to a point in the (X IU ^ ; Y I^ )
(as in the Sunbeam example), the cardinality of set I^
can also be very large. However, note that Sunbeam
chose only 5 of the 2592 possible models for detailed
analysis and subsequently selected 3 of these 5 in the
final product line. Thus, to ensure that the solution
resulting from our procedure is realistic and can be
implemented in practice, we constrain the cardin-
ality of the optimal set I^ to a pre-specified value (say
f). We, however, analyze the problem for different
values of f.
Thus, the revised problem is written as
Program P2.
Y X
Maximize ^ UÞ ¼ X ^ =½RC þ Y ^  
ðI; dv
IU I
v2U

plane. Next, define E as the set of extreme points in (19)

the convex hull of set T, so that ECT. Each point in
set E is also known as an extreme point of the subject to U V (20)
convex feasible space. Thus, the feasible space of and
Program P1 is defined by eAE. Theorem 2 now ^ ¼ f.
applies. jIj (21)
0
Let T consist of all subsets resulting from
Theorem 2. The solution of Program P1 is obtained C
at a point eAE. partitions of set I into 2 subsets (I^ and I^ ), with
^ ¼ f. Now I^ 2 T 0 , but set T 0
the condition that jIj
Theorem 2 tells us that the optimum solution will will be a subset of set T. That is, some of the
be at an extreme point of the convex hull, but it does extreme points in set E will now be excluded from
not help in identifying these points. Extreme points, consideration. Therefore, a solution with the top f
in the context of our model, have an important models in I^ may not be optimal. However, starting
property that distinguishes them from non-extreme with this solution of the top f models, it may be
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
possible to improve the solution by swapping model
i in set I^ with some model j not in set I.
^ Such a
swapping procedure, in general, will be combina-
torial in nature. Using additional dominance
properties, however, we show how the swapping
procedure can be simplified, at least for one-to-one
swaps. This property is stated in Theorem 4, and the
proof of this theorem is given in Appendix A.
Theorem 4. For a given vendor set U, for any models
i 2 I^ and jeI,
^ PðI^ þ j  i; UÞ4PðI;
^ UÞ if and only if
xjUXxiU and RjXRi.
Using the analysis described above, the procedure
to identify the set I^ of models that should be
selected by the OEM may be summarized as
follows:
Procedure P.
Step 1. Select current set U(CV) of vendors.
Compute CiU for each iAI.
Step 2. Compute xiU for each iAI, as defined in
expression (11).
Step 3. Identify and sort the top f (pre-specified)
models in descending order of xiU/Ri. Set
r ¼ 1.
Step 4. Let X rIU r turer offer focused vendors to get them to become
^ ¼ Si¼1 to r xiU and Y I^ ¼ Si¼1 to r Ri .
r
Determine profit PðI^ UÞ ¼ X rIU
^ =½RC þ Y I^ Þ.
r r1 r1
Step 5. If PðI^ UÞoPðI^ UÞ, I^ is optimal. Stop.
Else, go to Step 6.
r r1
Step 6. If PðI^ UÞXPðI^ UÞ, Set r’r+1. If,
rpf, go to Step 4. Else, go to Step 7.
f
Step 7. Swapping procedure. Identify i 2 I^ and
f
jeI^ such that xjUXxiU and RjXRi. If no
f
such (i,j) pair exists, or if PðI^ þ j 
f f
i; UÞoPðI^ UÞ for all such (i,j) pairs, I^ is
optimal. Stop. Else, go to Step 8.
f 4.1. Generation of problem data
Step 8. Find the (i,j) pair that causes ½PðI^ þ j 
f
i; UÞ  PðI^ UÞ to be the maximum. Set
f f
I^ I^ þ j  i. Go to Step 7.
Since the swapping procedure (Step 7) considers
only one-to-one swaps in the improvement stage of
the procedure, it does not guarantee that the
solution obtained is a global optimum. Therefore,
to test the level of sub-optimality of our approach,
we also developed a completely enumerative proce-
dure that examined all possible combinations of
models for the set I. ^ Clearly, such an enumerative
procedure becomes computationally intractable for
729
problems of large size. However, in all our extensive
tests even with problems where there were multiple
vendors, we were unable to find a single instance
where Procedure P yielded a profit that was more
than 0.1% away from the optimal profit (found
using the completely enumerative procedure). This
seems to indicate that our procedure will yield near-
optimal solutions for problems of practical size.
In what follows, we describe the results of several
computational tests conducted to study the 7
research questions stated earlier. These are: (1)
how does the choice of product models the
manufacturer should offer in the market influence
the vendor choice decision, and vice versa, (2) under
what circumstances would general vendors be
preferred to more focused vendors, (3) how much
discount do focused vendors need to offer to
compensate for their lack of versatility, (4) how
does the fixed cost of vendor relationships influence
the product line and vendor choice decisions, (5)
how does market competition influence decisions
related to product choice and vendor selection, (6)
how can a manufacturer induce a general vendor to
offer a discount so that, together, the manufacturer
and the vendor can exploit new market opportu-
nities, and (7) how much incentive can a manufac-
r more versatile in their capabilities? For each
question that is studied, we also point out the
managerial implications of our findings.
4. Computational results
Procedure P is coded in Visual Fortran and
implemented on a PC. We first describe the
procedure used to randomly generate the data for
a given problem scenario.
In all our tests, we assume the product consists of
5 components (i.e., N ¼ 5), all of which are
purchased from vendors. For each component, we
first randomly generate its number of variants
(discrete uniform distributed between 4 and 7).
Next, for each component variant, we randomly
generate its base cost (discrete uniform distributed
between $10 and $30). This base cost is the unit
purchase cost paid by the OEM to a general vendor
capable of supplying that item. A focused vendor
capable of supplying that item would discount this
base cost by a specified factor. To compute vendor
 ARTICLE IN PRESS
730 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
profits, we set the unit manufacturing cost (for the
vendor) of a component variant at 80% of its base
cost.
Using the list of variants available for each
component, we create set I of all possible product
models i (note that each model i is an 5-element
vector). In the extreme case where each component
variant is fully compatible with every variant of all
other components, the number of possible models is
simply the product of the number of variants
available for each component. However, in most
practical situations, the actual number would be
much less since several component variants may be
incompatible with other variants. Without loss of
generality, we assume full compatibility of all
component variants in our tests.
Using this set of product models I, for each model
i, we randomly generate its rating Ri (uniform
0.7–1.0 of the total base cost of the component
variants in the model) and selling price Pi (uniform
1.05–1.30 of the total base cost).
Finally, we specify the capabilities of each
vendor. We assume that there are 7 vendors, of
whom 3 are general vendors and the remaining 4 are
focused vendors. For each vendor, we randomly
generate the actual number of component variants
offered, and the actual identity of these variants. To
do so, we assume in our tests that each general
vendor is capable of supplying between 70% and
90% of the total set of component variants
(randomly identified), and that each focused vendor
is capable of supplying between 20% and 40% of
this set (also randomly identified).
In our analysis, we do not permit price competi-
tion between vendors of the same type. That is, for
example, we assume that all general vendors capable
of supplying a specific component variant charge
the same price. Hence, vendors of the same type
compete against each other only based on the
variety of their offerings. Likewise, we assume that
the fixed costs of vendor relationships are the same
for all vendors (i.e., dv ¼ d for all vendors v).
4.2. Selection of model factors, and their
experimental values
To study the problem under different problem
scenarios, we identify 4 experimental factors as
follows:
 Discount factor (a). The first factor is the
purchase price discount offered by a focused
vendor for a component variant to compensate
for the lack of versatility in his capabilities, when
compared to a general vendor. In our tests, we set
this factor at levels of 5%, 10%, and 15%.
Clearly, as the discount rate increases, we expect
focused vendors to be able to easily compensate
for their lack of versatility, and become more
competitive.
 Competition ratio (b). The second factor specifies
the level of market competition for the product
models offered by the OEM. We define the
competition ratio as the ratio of RC, the total
attractiveness factor of competitors’ potential
products, to Si2I^ Ri , the total attractiveness factor
of all the models the OEM offers for sale (i.e.,
b ¼ RC =Si2I^ Ri ). Note that a competition ratio of
0.5 implies that total model rating of the
competition is only 50% that of the OEM. That
is, the OEM dominates the market. In contrast, if
the ratio is 1.5, the OEM’s competitors are
significantly more dominant in the market than
the OEM. In our tests, we set this factor at levels
of 0.5, 1.0, and 1.5.
 Number of product models (f). The third factor is
the number of product models that the OEM
plans to offer. As noted earlier, we specify this
parameter in our analysis to ensure that the
resulting solution is practical and can be im-
plemented by the OEM. The objective of the
procedure would be to then optimally select this
specified number of models from the entire set I
of models. Clearly, as the number of models to be
selected increases, the number of component
variants needed (and hence, the vendors neces-
sary to supply these variants) would also
increase. In our tests, we set this factor at levels
of 10, 15, and 20
 Vendor fixed cost (d). The final factor is the fixed
cost of developing and maintaining relationships
with vendors. As this cost increases, we would
expect the OEM to prefer working with general
vendors in order to keep the vendor set down. In
our tests, we set this factor at levels of $50,000,
$100,000, and $150,000. As noted earlier, we
assume that this fixed cost is the same for all
vendors. That is, the vendors do not compete
against each other based on differentials in the
fixed cost of vendor relationships.
Since there are 4 factors with 3 levels each, the
total number of experimental combinations is 81
( ¼ 3  3  3  3). In the remainder of this section,
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
we first describe our computational tests to examine
question nos. 1–5 posed earlier. To determine the
statistical significance of these results, we also
analyze the experimental results using the ANOVA
procedure. Finally, we describe additional results
conducted on a specific problem environment to
study question nos. 6 and 7.
4.3. Product model choice and vendor selection
For each of the 81 combinations of factor values
studied, 20 replications (each with a different
random number seed) are performed. The total
number of replications is therefore 1620. For each
replication, Procedure P is used to select the
specified number (f) of product models for inclu-
sion in the optimal set.
Selected details of a sample problem are shown in
Table 3. In this example, there are a total of 3360
product models possible, of which the procedure
has to select f models. For each model, the table
shows its rating, total base cost (which is the sum of
base costs of all component variants in the model),
and selling price. For each component variant, the
table shows the purchase cost from each vendor
capable of supplying that item. A blank entry
implies the vendor does not have the capability to
supply that item. Note that focused vendors (vendor
nos. 1–4) discount the unit cost of a variant by a
factor a, when compared to general vendors (vendor
nos. 5–7).
A typical output (for a given set of factor levels) is
shown in Table 4. The output lists the factor levels
for the current problem, the OEM’s profit (after
paying the total fixed cost of vendor relationships),
the vendors (focused and general) selected and their
respective profits, the product models that are to be
included in set I, ^ and the specific vendors from
whom the component variants required for each
model should be sourced. For each product model,
the output also includes its production quantity, as
well as the sales revenue and total purchase cost of
all component variants in that model. For example,
the first model selected includes variants 4, 2, 2, 3,
and 5 of components 1, 2, 3, 4, and 5, respectively.
The variants required for components 2, 4, and 5
are supplied by vendor no. 1, and the variants
required for the other 2 components are supplied by
vendor no. 4. The total sales quantity of this model
is 6399 units, yielding a total revenue of $844,720
for the OEM (unit price is $132). The total purchase
cost is $645,059.
731
Although we compute several output measures
using our procedure (as presented in Table 4), we
focus our discussion here on the following key
performance measures: (1) OEM’s profit, (2) total
number of general vendors selected, (3) total
number of focused vendors selected, (4) total profit
for all general vendors selected, and (5) total profit
for all focused vendors selected.
To verify the statistical significance of the output
measures for the 4 experimental factors, we first
analyze the computational results using the ANO-
VA procedure. Prior to interpreting the ANOVA
results, the necessary diagnostic checks are per-
formed using standard graphical analysis of the
residuals to verify homogeneity of error variances.
The residual plots are found satisfactory.
The ANOVA results are summarized in Table 5.
For each of the 4 main factors and the 6 two-way
interactions, the table shows the F-ratios and the
corresponding p-values for the 5 output measures
listed earlier.
Examination of the ANOVA results indicates
that with the exception of 1 main effect, all of the
main effects involving the 4 factors are statistically
significant at the 7% level. In fact, most are
significant even at the 1% level. With the exception
of some 2-way interactions involving the factor a,
other 2-way interactions are not significant for all
the output measures indicating that interpretation
of the main effects is valid.
The only non-significant main effect in the
ANOVA table is the total profit of general vendors
with regards to factor b. To explore the reason why
this is the case, we present (in Table 6) the least-
squared means for all the output measures for each
level of each experimental factor.
The table reveals that unlike other output
measures that monotonically either increase or
decrease as the factor level increases, the total profit
of general vendor first increases as b increases from
0.5 to 1.0, and then decreases as b increases further
from 1.0 to 1.5. A possible explanation for this
phenomenon is as follows. As we will illustrate
shortly, when the market becomes more competitive
there is a shift away from focused vendors toward
the general vendors. Hence, as b increases from 0.5
to 1.0, the general vendors see an increased level of
business and hence, increased profits. However, as b
increases further from 1.0 to 1.5, the OEM’s market
share suffers even more. Under this situation, even
with the increased level of business, the general
vendors experience a decline in their total profit.
 ARTICLE IN PRESS
732 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

Table 3
Sample problem data

Number of components in product ¼ 5

Variants for each component (1–5) ¼ 4,6,4,5,7
Number of possible models ¼ 3,360 ( ¼ 4  6  4  5  7)
Number of focused vendors ¼ 4 (vendors no. 1–4)
Number of general vendors ¼ 3 (vendors no. 5–7)
Market size (O) ¼ 100,000
Product model Rating Total base cost Selling price Component variants

C1 C2 C3 C4 C5

1 91 97 102 1 1 1 1 1
2 77 88 93 1 1 1 1 2
3 81 82 89 1 1 1 1 3
^
3,358 73 86 96 4 6 4 5 5
3,359 74 84 94 4 6 4 5 6
3,360 70 73 80 4 6 4 5 7

Component Variant Unit purchase cost from vendors (blank implies not available)

Focused vendors General vendors

Ven 1 Ven 2 Ven 3 Ven 4 Ven 5 Ven 6 Ven 7

1 1 28.0 28.0
1 2 9.5 9.5 10.0 10.0
1 3 21.9 23.0 23.0
1 4 26.6 28.0 28.0 28.0
2 1 16.1 17.0 17.0 17.0
2 2 20.9 20.9 22.0 22.0 22.0
2 3 19.0 19.0
2 4 29.0 29.0
2 5 17.1 18.0 18.0 18.0
2 6 12.4 12.4 13.0 13.0
3 1 11.4 11.4 12.0 12.0 12.0
3 2 18.0 18.0 19.0 19.0 19.0
3 3 10.0 10.0 10.0
3 4 9.5 9.5 10.0 10.0 10.0
4 1 13.0 13.0 13.0
4 2 23.0 23.0
4 3 17.1 17.1 17.1 18.0
4 4 29.0 29.0 29.0
4 5 9.5 10.0
5 1 27.0 27.0 27.0
5 2 17.1 17.1 18.0 18.0 18.0
5 3 11.4 12.0
5 4 19.0 19.0 20.0
5 5 23.8 25.0 25.0 25.0
5 6 21.9 23.0
5 7 11.4 12.0 12.0 12.0

Detailed examination of the F-ratios in Table 5
indicates the following. The OEM’s profit is affected
most by the competitive conditions in the market
(measured by the factor b), followed by the discount
a offered by focused vendors. With regard to all
other measures, the discount a is the most influential
measure. While the effect of the vendor fixed costs
(measured by the factor d) is also dominant for the
number of focused vendors, it has a much smaller
effect on their profits.
The preceding discussion indicates that with
regard to research question (1) listed earlier, all 4
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741 733

Table 4
Solution for a given problem environment

Discount from focused vendors (a) ¼ 10%

Competition ratio (b) ¼ 0.50
^
Number of models to include in optimal set IðfÞ ¼ 10
Fixed cost of vendor relationships (d) ¼ $100,000
Total number of models possible for the product ¼ 3,360
Number of focused vendors selected ¼ 2
Number of general vendors selected ¼ 1
Total fixed cost of vendor relationships ¼ $300,000
OEM’s profit ¼ $1,553,066
Focused vendors (ID, profit) ¼ (no. 1, $269,477) (no. 4, $249,906)
General vendors (ID, profit) ¼ (no. 5, $397,421)
Model (Variant, vendor) Sales quantity Sales revenue ($) Purchase cost ($)

C1 C2 C3 C4 C5

1 (4,4) (2,1) (2,4) (3,1) (5,1) 6,399 844,720 645,059

2 (4,4) (4,5) (2,4) (2,5) (5,1) 6,772 995,510 790,990
3 (4,4) (5,5) (2,4) (4,5) (5,1) 6,089 858,513 680,722
4 (1,5) (1,1) (2,4) (4,5) (5,1) 6,524 919,836 729,997
5 (4,4) (2,1) (2,4) (4,5) (3,1) 5,840 765,070 595,119
6 (4,4) (2,1) (1,1) (3,1) (4,1) 6,027 717,167 542,395
7 (3,4) (2,1) (2,4) (4,5) (5,1) 6,027 831,673 657,504
8 (3,4) (4,5) (1,1) (3,1) (5,1) 6,462 827,075 640,983
9 (4,4) (2,1) (2,4) (3,1) (1,5) 6,648 890,821 700,026
10 (4,4) (2,1) (2,4) (1,5) (1,5) 6,648 864,229 678,752

Table 5
ANOVA results

Factor OEM’s profit No. of focused No. of general Focused vendors’ General vendors’
vendors vendors profit profit

F p F p F p F p F p

a 1610.53 0.0001 456.03 0.0001 190.87 0.0001 605.43 0.0001 433.27 0.0001
b 3296.11 0.0001 50.17 0.0001 2.79 0.0617 412.01 0.0001 0.07 0.9308
f 978.73 0.0001 19.00 0.0001 2.89 0.0561 112.33 0.0001 3.25 0.0391
d 307.85 0.0001 349.55 0.0001 27.84 0.0001 49.67 0.0001 29.94 0.0001
ab 36.16 0.0001 2.14 0.0736 0.56 0.6892 35.61 0.0001 0.17 0.9540
af 9.86 0.0001 0.48 0.7494 0.67 0.6115 9.64 0.0001 0.12 0.9766
ad 1.56 0.1814 2.15 0.0724 3.38 0.0092 30.52 0.0001 26.08 0.0001
bf 4.05 0.0029 0.61 0.6545 0.13 0.9714 0.39 0.8175 0.07 0.9919
bd 0.43 0.7848 0.32 0.8620 0.35 0.8430 0.55 0.7020 0.60 0.6595
fd 0.36 0.8343 0.19 0.9455 0.09 0.9848 0.07 0.9919 0.05 0.9949

experimental factors seem to impact the choice of
product models and the vendor choice decision. To
address research questions (2)–(5), we now examine
the main factor for each output measure for all
combinations of factor levels. These results are
summarized in Table 7(a) (for d ¼ $50,000), Table
7(b) (for d ¼ $100,000), and Table 7(c) (for
d ¼ $150,000), for all combinations of the other 3
factors (namely, a, b, and f). For each combination
of these factors, the tables show the average (based
on 20 observations) for the 5 output measures.
Examination of the means reveals several inter-
esting observations. In response to question (3) that
focuses on the discount offered by focused vendors,
we note that as the discount increases (all other
factors held constant), the OEM’s profit increases
appreciably. This increase in profit is accompanied
by an increase in the number of focused vendors
 ARTICLE IN PRESS
734 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

Table 6
Least-squared mean values

Average values based on 20 replications

Factor Level OEM’s profit No. of focused No. of general Focused vendors’ General vendors’
vendors vendors profit profit

a 5 1,283,410 1.41 0.80 649,301 502,583

10 1,546,357 2.21 0.48 588,852 157,551
15 1,852,015 2.48 0.28 311,659 78,180
b 0.5 1,995,488 2.23 0.48 675,266 244,612
1.0 1,497,692 2.02 0.53 493,658 249,451
1.5 1,188,602 1.86 0.54 380,888 244,252
f 10 1,325,366 1.91 0.49 433,654 226,954
15 1,590,387 2.07 0.52 528,863 245,351
20 1,766,030 2.12 0.55 587,295 266,009
d 50,000 1,689,226 2.56 0.64 567,901 188,860
100,000 1,551,685 1.94 0.47 517,143 242,164
150,000 1,440,872 1.60 0.45 464,768 307,290

selected, and a corresponding decrease in the
number of general vendors selected. However, the
total profit for both types of vendors typically
decreases. While the total profit for focused vendors
decreases by around 50% (as a increases from 5%
to 15%), the magnitude of the decrease in profits for
general vendors drops in excess of 70% in most
cases.
Interestingly, the tables also reveal that as the
discount factor a increases, the OEM may find it
optimal to change the mix of product models itself.
For example, consider the solution values in
Table 7(a) when a ¼ 5%, b ¼ 0.5, f ¼ 10, and
d ¼ $50,000. The profits in this case for the OEM,
focused vendors, and general vendors are
$1,583,766, $890,850, and $344,944, respectively.
Now assume the focused vendors increase their
discount from 5% to 10% (with no change from the
general vendors). If the OEM chooses to keep the
same mix of product models, their profit would
increase by 5% of the focused vendors’ total
revenue (which is $5,642,051; not shown in Table
7(a)). Hence, the OEM’s new profit would be
$1,583,766+0.05  $5,642,051 ¼ $1,865,868. How-
ever, we note that the OEM is actually able to
realize a profit of $1,910,953 in this scenario, as
shown in Table 7(a). That is, by altering the mix of
product models to take advantage of the additional
discount offered by the focused vendors, the OEM
is able to realize an increased profit. We see a similar
phenomenon for several other combinations of b, f,
and d values. A possible reason for this phenomen-
on is that when focused vendors increase their
discount percentage, the costs of expensive compo-
nent variants decrease by a larger amount (in
absolute terms) when compared to cheaper variants.
Hence, product models that include these expensive
component variants (which are unprofitable at
current prices) now become attractive. This is an
important insight since it clearly links vendor choice
to the product mix offered by the OEM.
As noted earlier, while the OEM’s profit increases
as a increases, the focused vendors’ profit typically
decreases. For example, for the factor levels
considered in the preceding discussion, while the
OEM’s profit increases by $327,187 as a increases
from 5% to 10%, the focused vendors see their
profit decrease by $202,677. In many cases, the
OEM may not have sufficient influence to demand
this additional discount from these vendors. In such
cases, it may even be possible for the OEM to offer
to compensate these vendors for their losses from
the OEM’s increased profit. That is, the OEM and
focused vendors can cooperate with each other and
jointly exploit the market conditions to reap
increased profit for both parties. This increase in
both their profits would typically be at the expense
of the general vendors. In such cases, it is of course
likely that the general vendors would also offer
some discounts to retain their share of business.
Next, we address research question (5) that
focuses on the impact of market competition. Table
7(a)–(c) indicate that as the competition ratio b
increases (i.e., the OEM’s models face more
competition in the market), the OEM’s profit
decreases rapidly as expected. Interestingly how-
ever, there is a shift away from focused vendors to
general vendors in this problem scenario. That is, in
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741 735

Table 7
Summary of results

a b f Average values based on 20 replications

OEM’s profit No. of focused No. of general Focused vendors’ General vendors’
vendors vendors profit profit

(a) d ¼ $50,000
5 0.5 10 1,583,766 2.10 0.80 890,850 344,994
15 1,790,039 2.30 0.85 1,017,805 359,538
20 1,911,765 2.25 0.90 1,080,295 394,362
1.0 10 1,128,177 1.90 0.80 636,682 284,616
15 1,369,230 2.05 0.80 763,335 338,234
20 1,530,731 2.15 0.90 862,889 356,454
1.5 10 865,661 1.70 0.85 478,730 264,937
15 1,102,372 1.85 0.80 605,024 312,463
20 1,271,927 1.90 0.85 696,342 347,426
10 0.5 10 1,910,953 2.80 0.60 688,173 140,754
15 2,157,186 2.95 0.60 773,128 152,264
20 2,302,958 2.90 0.60 817,264 176,284
1.0 10 1,360,104 2.60 0.60 495,808 129,359
15 1,649,294 2.75 0.65 596,386 148,178
20 1,842,860 2.75 0.80 654,589 185,434
1.5 10 1,043,887 2.35 0.50 389,333 104,669
15 1,327,232 2.65 0.70 486,848 140,891
20 1,530,678 2.60 0.80 546,460 176,841
15 0.5 10 2,261,228 2.95 0.45 356,661 77,271
15 2,551,284 3.15 0.35 401,072 82,103
20 2,722,228 3.20 0.35 428,153 80,676
1.0 10 1,615,939 2.85 0.40 259,464 77,251
15 1,957,326 2.95 0.45 311,149 90,005
20 2,181,920 3.00 0.45 344,851 99,471
1.5 10 1,244,730 2.65 0.40 204,450 67,936
15 1,579,129 2.95 0.45 256,269 77,811
20 1,816,500 2.95 0.45 291,314 89,007

(b) d ¼ $100,000
5 0.5 10 1,454,660 1.30 0.75 732,722 544,569
15 1,656,524 1.65 0.80 930,108 466,843
20 1,775,381 1.75 0.75 1,013,785 470,090
1.0 10 1,016,456 1.15 0.80 491,306 477,243
15 1,248,544 1.25 0.80 621,732 518,210
20 1,403,371 1.30 0.80 705,970 551,573
1.5 10 766,005 0.85 0.85 311,566 484,121
15 991,878 1.15 0.80 473,947 483,999
20 1,153,616 1.20 0.80 564,377 512,836
10 0.5 10 1,767,287 2.20 0.35 674,002 138,704
15 2,006,452 2.25 0.35 759,027 149,077
20 2,148,015 2.35 0.40 804,041 173,336
1.0 10 1,225,622 2.15 0.35 488,390 119,953
15 1,506,029 2.15 0.40 580,882 148,747
20 1,692,611 2.15 0.45 639,571 177,911
1.5 10 917,987 1.90 0.40 373,798 120,310
15 1,190,731 1.95 0.45 464,974 151,695
20 1,386,753 2.00 0.50 527,815 181,771
15 0.5 10 2,110,493 2.45 0.15 351,546 62,827
15 2,394,638 2.60 0.25 394,508 87,832
 ARTICLE IN PRESS
736 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

Table 7 (continued )

a b f Average values based on 20 replications

OEM’s profit No. of focused No. of general Focused vendors’ General vendors’
vendors vendors profit profit

20 2,563,152 2.60 0.25 419,926 94,952

1.0 10 1,475,233 2.25 0.20 254,143 63,855
15 1,805,583 2.35 0.25 304,543 84,254
20 2,027,019 2.55 0.25 341,148 86,704
1.5 10 1,113,289 2.15 0.15 201,361 43,132
15 1,434,166 2.30 0.25 250,011 70,156
20 1,663,991 2.50 0.25 287,674 73,738

(c) d ¼ $150,000
5 0.5 10 1,357,084 1.15 0.70 677,874 609,450
15 1,553,441 1.20 0.70 794,354 635,499
20 1,668,005 1.25 0.70 853,222 672,076
1.0 10 931,753 0.70 0.80 335,030 682,771
15 1,154,178 0.95 0.80 503,657 676,988
20 1,304,449 1.05 0.80 610,723 678,806
1.5 10 696,017 0.35 0.85 146,983 699,132
15 906,159 0.70 0.80 310,027 698,722
20 1,060,888 0.85 0.80 421,800 703,784
10 0.5 10 1,646,014 2.05 0.20 678,933 99,961
15 1,881,523 2.10 0.30 752,555 145,470
20 2,020,858 2.10 0.30 796,084 167,520
1.0 10 1,114,244 1.60 0.35 459,827 144,489
15 1,385,622 1.80 0.45 557,716 180,737
20 1,570,348 1.90 0.45 620,654 204,756
1.5 10 819,051 1.40 0.40 334,393 181,933
15 1,078,630 1.60 0.45 432,820 200,407
20 1,268,719 1.70 0.50 505,523 212,433
15 0.5 10 1,990,844 2.10 0.15 347,664 65,673
15 2,265,053 2.20 0.20 387,583 96,786
20 2,427,355 2.20 0.25 410,846 115,613
1.0 10 1,361,288 2.00 0.15 252,473 54,729
15 1,682,682 2.10 0.20 302,327 75,560
20 1,897,081 2.15 0.25 333,512 98,886
1.5 10 1,007,102 1.80 0.15 196,507 43,132
15 1,315,532 2.05 0.15 247,513 52,008
20 1,539,630 2.05 0.30 278,131 99,504

a highly competitive market, general vendors seem
to have an edge over more focused vendors. As a
consequence, while the total profit for both types of
vendors tends to eventually decrease as b increases,
the magnitude of the decrease is much less
pronounced for general vendors when compared
to the focused vendors. We note that we had used
this issue earlier in our explanation for the non-
significance of b for the general vendors’ profit. As
noted during that discussion, when competition
increases, the overall reduced demand for its
products causes the OEM to lose scale economies
in the purchase of component variants. Hence, the
OEM gravitates toward using fewer vendors to
offset the vendor fixed costs. Clearly, these fewer
vendors need to be general vendors so that they can
provide the OEM with the versatility needed to
produce the entire product line that it decides to
offer.
As the number of models the OEM plans to offer
(f) increases (all other factors held constant), all the
5 output measures tend to increase. This is not
surprising given that by offering more models, the
OEM can hope to capture a larger share of the
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
market. Note that as the level of market competi-
tion increases, the demand per product model
decreases. Under such situations, the OEM is forced
to offer a larger number of product models to
achieve the same level of profits.
We now discuss research question (4) that focuses
on the fixed cost of vendor relationships. As this
cost increases, Table 7(a)–(c) indicate that the OEM
tends to use fewer vendors of either type, and also
realizes decreased profits. Due to the decreased
overall number of vendors, the OEM is forced to
use the general vendors to a greater extent to supply
the required component variants. This is evidenced
by the fact that while the total profit for focused
vendors decreases as d increases, the profit for
general vendors tends to increase.
Finally, we discuss research question (2) that
focuses on the types of vendors used. Based on the
preceding discussion, the analysis indicates that the
OEM tends to gravitate towards using general
vendors in preference to focused vendors when
either the competition in the market increases
(measured by b) or the fixed cost of vendor
relationships (measured by d) increases.
The discussion so far has focused on an existing
set of vendor capabilities and conditions. That is, we
assume that vendors are static in terms of the
component variants they can offer, and the price
at which they can offer them. However, what
happens if a general vendor decides to compete
with focused vendors on price, or if a focused
vendor decides to compete with general vendors on
their range of offerings? Therefore, we now explore
situations where the OEM is able to induce 1 or
more vendors of a given type to work with it (OEM)
in a manner that could potentially be beneficial to
both parties.
4.4. Impact when a general vendor offers a discount
In this section, we explore the impact on the
OEM’s and vendors’ profits when a specific general
vendor can be induced (using incentives, as dis-
cussed below) to offer a discount on unit prices.
Note that while a focused vendor may wish to
match discounts offered by this vendor, it may not
be profitable for him to do so given his already
discounted prices. When a general vendor offers
such a discount, the attractiveness of focused
vendors would be expected to decline further as
now the general vendor becomes more competitive
in all variants offered by focused vendors.
737
To study this issue in detail, we consider the
specific problem for which the input was given in
Table 3. Although we study this problem for all 81
combinations of factor levels, we present and
discuss the results here only for the specific
environment for which the detailed results were
presented in Table 4. Results for the other factor-
level combinations exhibit a similar behavior to the
results discussed below.
As shown in Table 4, the specific problem
scenario considers the situation where a ¼ 10%,
b ¼ 0.5, f ¼ 10, and d ¼ $100,000. The current
optimal solution is to use focused vendor nos.
1 and 4, and general vendor no. 5. We now assume
that the OEM is able to induce general vendor no. 5
to offer a discount on the unit purchase costs of
the component variants supplied by the vendor.
We further assume that this discount is 50% of
the discount offered by the focused vendors.
That is, while vendor no. 5 is cheaper than
other general vendors, their unit costs are still
higher than that of focused vendors for the same
variant. The revised optimal results (with the 5%
discount from vendor no. 5) are presented in
Table 8.
Comparing the results in Table 8 with that in
Table 4, it is clear that the optimal course of action
for the OEM is to divert business away from the
focused vendors towards general vendor no. 5.
While the optimal solution is this specific example is
to divert all business to the general vendor,
solutions in other scenarios recommend only partial
diversion. Interestingly, this diversion of business
typically results not only in increased profits for the
OEM but also for the vendor. That is, the OEM and
vendor no. 5 together are able to exploit the market
to their mutual benefit. In fact, the percentage
increase in vendor no. 5’s profits far exceeds that
realized by the OEM. Also, we note that the identity
of the product models that the OEM should offer
changes appreciably (only 3 of the original 10
models remain in the optimal set).
The preceding discussion illustrates that a general
vendor’s versatility in variant offering has compe-
titive value, both for the vendor and for the OEM.
A general vendor can leverage its component variety
offering to increase profit even after reducing unit
prices. Observe that the OEM can, if needed,
provide additional incentives to a general vendor
to provide this discount by offering to share some of
their increased profits with the vendor. That is, the
OEM can essentially encourage a specific vendor to
 ARTICLE IN PRESS
738 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

Table 8
Results when general vendor no. 5 offers a discount

Discount from focused vendors (a) ¼ 10%

Competition ratio (b) ¼ 0.50
^
Number of models to include in optimal set IðfÞ ¼ 10
Fixed cost of vendor relationships (d) ¼ $100,000
Total number of models possible for the product ¼ 3,360
Discount from general vendor no. 5 ¼ 5%
Number of focused vendors selected ¼ 0
Number of general vendors selected ¼ 1
Total fixed cost of vendor relationships ¼ $100,000
OEM’s profit ¼ $1,703,598
Focused vendors (ID, profit) ¼ None
General vendors (ID, profit) ¼ (no. 5, $1,166,196)
Model (Variant, vendor) Sales quantity Sales revenue Purchase cost

C1 C2 C3 C4 C5

1 (1,5) (2,5) (2,5) (4,5) (1,5) 5,560 828,507 660,303

2 (4,5) (4,5) (2,5) (2,5) (5,5) 6,517 958,012 767,713
3 (1,5) (1,5) (2,5) (4,5) (5,5) 6,278 885,188 703,756
4 (4,5) (5,5) (2,5) (4,5) (5,5) 5,859 826,175 662,405
5 (1,5) (3,5) (3,5) (4,5) (1,5) 6,278 847,520 673,935
6 (1,5) (4,5) (1,5) (3,5) (5,5) 6,577 881,301 699,780
7 (4,5) (4,5) (2,5) (2,5) (1,5) 6,876 1,010,746 823,036
8 (1,5) (4,5) (4,5) (4,5) (1,5) 7,294 1,050,387 852,345
9 (1,5) (4,5) (2,5) (4,5) (3,5) 6,398 882,856 711,083
10 (1,5) (3,5) (2,5) (4,5) (1,5) 7,175 1,018,818 831,556

offer discounts that other vendors may not be able
to match. At the extreme, it may be possible for the
OEM to offer incentives and work closely with just
1 or 2 vendors to make them its only vendors, while
simultaneously increasing profits for all concerned
parties.
4.5. Impact when a focused vendor develops new
component variants
Now that we have studied the impact when a
general vendor offers a discount, we next study the
impact when the situation is reversed. That is, what
happens when a focused vendor can be encouraged
by the OEM to develop capabilities for supplying
additional variants that the vendor does not
currently offer. As in the preceding discussion, we
consider the specific problem presented in Table 3,
and focus our discussion on the specific environ-
ment presented in Table 4.
Examining the results in Table 4, it appears that
of all the component variants currently being
supplied by general vendor no. 5, variant 4 of
component 4 is the one that is used most by the
OEM. We now assume that the OEM can induce
focused vendor no. 4 to develop the capability to
supply this variant. We further assume that vendor
no. 4 can set the purchase price of this variant at the
non-discounted price charged by vendor no. 5. That
is, vendor no. 4 does not compete with vendor no. 5
on price for this additional variant. The revised
optimal solution under this problem environment is
presented in Table 9.
Comparing the results in Table 9 with that
shown in Table 4, it is apparent that the new
capability of focused vendor no. 4 makes it
beneficial for the OEM to divert business away
from general vendor no. 5. While this specific
example recommends complete diversion of busi-
ness from vendor no. 5, solutions in other scenarios
recommend partial diversion. This diversion is
accompanied by an increase in the OEM’s profit
compared to the current situation, as well as an
increase in profits for the focused vendors. As an
added incentive, if necessary, the OEM can even
subsidize development costs of additional variants
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Table 9
Results when focused vendor #4 develops a new variant

Discount from focused vendors (a) ¼ 10%

Competition ratio (b) ¼ 0.50
^
Number of models to include in optimal set IðfÞ ¼ 10
Fixed cost of vendor relationships (d) ¼ $100,000
Total number of models possible for the product ¼ 3,360
New variant developed by focused vendor no. 4 ¼ Variant 4 of component 4 (offered at non-discounted cost)
Number of focused vendors selected ¼ 2
Number of general vendors selected ¼ 0
Total fixed cost of vendor relationships ¼ $200,000
OEM’s profit ¼ $1,567,126
Focused vendors (ID, profit) ¼ (no. 1, $345,103) (no. 4, $379,097)
General vendors (ID, profit) ¼ None
Model (Variant, vendor) Sales quantity Sales revenue Purchase cost

C1 C2 C3 C4 C5

1 (4,4) (2,1) (2,4) (3,1) (5 1) 6,739 889,484 679,242

2 (4,4) (6,1) (2,4) (3,1) (5 1) 5,430 667,898 503,367
3 (4,4) (2,1) (2,4) (4,4) (3 1) 6,150 805,612 626,656
4 (3,4) (2,1) (1,1) (3,1) (5 1) 5,299 630,607 476,930
5 (4,4) (2,1) (1,1) (3,1) (4 1) 6,346 755,172 571,138
6 (3,4) (2,1) (2,4) (4,4) (5 1) 6,346 875,745 692,346
7 (4,4) (2,1) (2,4) (3,1) (7 4) 6,019 710,226 536,281
8 (4,4) (1,1) (1,1) (3,1) (4 1) 5,692 643,168 486,645
9 (4,4) (1,1) (4,1) (4,4) (5 1) 6,608 845,782 667,375
10 (3,4) (2,1) (1,1) (4,4) (4 1) 6,869 858,670 675,258

by offering to share some of their increased profits 5. Conclusions

with vendor no. 4.
When we compare the results in Table 4 with that
in Table 9, we note that while the OEM is able to
decrease the total number of vendors needed from 3
to 2, the resulting $100,000 savings in vendor fixed
costs is not directly added to their profit. In fact, the
OEM’s profit increases only by about $14,000. The
reason for this is that with the elimination of general
vendor no. 5 from the system, the OEM is forced to
make a change in the mix of product models
selected. That is, a part of the savings in vendor
fixed costs is offset by the forced change in the
product mix. Nevertheless, the OEM does realize an
increased profit, making this change beneficial.
As shown in the preceding example, development
of new capabilities by a focused vendor need not
always bring high dividends to the OEM. However,
our model allows us to easily evaluate the specific
impact of each new capability that may be devel-
oped, so that the OEM can decide which focused
vendor should be encouraged to develop which
component variant.
We have shown how a complex decision problem
that combines product choice with selection of
vendors, each of whom can supply a different set of
component variants at different costs, can be
effectively modeled. The ranking and swapping
properties that we have identified help us in
constructing an efficient search procedure for the
model. The optimal solution provides important
information such as: which models of a product are
chosen, what is the optimal number of vendors to
use, which vendor supplies which component
variant, what are the overall profits to the OEM
and each of the vendors, what is the total cost of
component acquisition, and how is this cost
distributed among the different vendors (as shown
in Table 4).
The model and the solution procedure we have
developed allow us to identify several interesting
managerial insights into the relationship between
the OEM and different types of vendors: general
vendors (who are capable of supplying a larger set
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740 N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741

of component variants, albeit at higher unit costs), competitive in terms of building additional capabil-
and focused vendors (who can supply fewer ities, although their unit prices may be comparable.
variants, but possibly at lower unit costs). First, as While many companies have expressed the need
market competition (measured by b) increases, we to involve vendors in the product choice process,
find that the OEM shifts more of its business to not many have figured out the best approach for
general vendors increasing their profit. The shift doing so. Our model does make 2 rather restrictive
occurs because the reduction in demand of the assumptions in that we assume there are no price
OEM’s products (with increasing b values) de- discounts based on volume, and that the OEM as
creases the volume of business it can award to well as the vendors are not capacity constrained. As
focused vendors. The fixed cost of using a focused such, while we cannot claim to have solved the
vendor is no longer justifiable in relation to the problem completely, we believe that our research is
volume of business handled by it. an important step in the right direction. In our
Second, at some high value of b, the focused future research we intend to use the framework
vendors’ business gets reassigned in its entirety, as developed here to analyze important issues such as
the OEM experiences a large drop in its revenue. demand uncertainties, pricing discounts, capacity
With no additional business to be had from focused constraints, and logistics.
vendors, the profits of general vendors decrease with
further increases in b. These 2 issues cause the Appendix A
general vendors’ profit not to be significantly related
to the OEM’s profit when b increases. Theorem 4. For a given vendor set U, for models
Third, we note that while a price discount i 2 I^ and jeI,
^ PðI^ þ j  i; UÞ4PðI;
^ UÞ if and only if
percentage (a) decreases the focused vendors’ profit, xjUXxiU and RjXRi.
the general vendors gain from such a discount—the
gain even exceeds the gain of the OEM. Note that Proof. Let X 0IU
^ ¼ Sk2I;kai
^ xkU and
0
with a larger discount percentage, the price of an Y I^ ¼ Sk2I;kai
^ Rk . Hence,
X
expensive component drops by a larger amount in PðI;^ UÞ ¼ X 0^ =½RC þ Y 0^   ^
dv if ieI. (A.1)
IU I
absolute terms. The OEM would like to exploit this v2U
by redesigning its product mix. The general vendors, ^ it follows that:
However, since i 2 I,
in contrast to focused vendors, are in a better
position to satisfy the OEM’s revised needs because X 0IU 0 0
^ =½RC þ Y I^ oðX IU
^ þ X IU
0
^ Þ=½RC þ Y I^ þ Rj 
they possess a large component variety, and so their (A.2)
profit increases appreciably. This clearly establishes,
which simplifies to
at least for this example, that economy of scope of
general vendors is more valuable than the economy ðX iU =Ri Þ4 þ X 0IU 0
^ =½RC þ Y I^ . (A.3)
of scale of focused vendors. Now, since i 2 I^ and jeI,
^ we have (xjU/Rj)oxiU/
It is interesting that developing new capabilities Ri, which simplifies to:
for a focused vendor does not necessarily bring high
dividends to the OEM. Since there is no price ðxe^U  xaU
^ Þoðye^  ya^ ÞðxaU
^ =ya^ Þ. (A.4)
advantage in using the new capability, the only way Consider a swap of i 2 I^ with jeI.
^ If the swap is
the OEM would gain is by saving the fixed cost of to be made, the profit must increase, i.e.,
the general vendor. To do so, the OEM needs to
ðX 0IU 0 0
^ þ xjU Þ=½RC þ Y I^ þ Rj 4ðX IU
0
^ þ X iU Þ=½RC þ Y I^ þ Rj .
redesign its product mix substantially, as the
component variety possessed by the focused vendor (A.5)
is not broad enough even when the new capability is The above expression can be simplified to
included. This reduces the OEM’s profit margin,
½RC þ Y 0I^ ðxjU  xiU Þ4X 0I^U ðRj  Ri Þ þ ðxiU Rj Þ  ðxiU Ri Þ.
although saving the fixed cost increases its total
profit by a small amount. As more capabilities are (A.6)
added and the component variety of the focused From expression (A.4), it follows that (xiU
vendors increase, the OEM may be able to increase Rj)(xjU Ri)40. Hence, expression (A.6) can be
its profit margin, and its total profit may exceed rewritten as
what it was before adding new capabilities. Note
that not all focused vendors would be equally ðxjU  xiU Þ4X 0IU 0
^ ðRj  Ri Þ=½RC þ Y I^ . (A.7)
 ARTICLE IN PRESS
N. Balakrishnan, A.K. Chakravarty / Int. J. Production Economics 112 (2008) 723–741
After multiplying both sides of expression (A.4)
by 1, and from expression (A.7), it follows that:
ðRj  Ri Þ½X 0IU 0
^ =ðRC þ Y I^ Þ  ðxiU =Ri Þo0. (A.8)
Since X 0IU 0
^ =ðRC þ Y I^ ÞoðxiU =Ri Þ from expression
(A.8), this implies that RjXRi. Using this relation-
ship in expression (A.7), it follows that xjUX-
xiU. &
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