Distribution Strategy, Capability Investment, and Government Regulation.

This article investigates how a supplier’s distribution strategy and government-imposed trade regulations influence an independent manufacturer’s internal sourcing capability investment and sourcing decisions within a supply chain comprising a supplier, an independent manufacturer with in-house production capability, and a dependent manufacturer without such capability. The supplier can choose between dual selling (to both manufacturers) or exclusive selling agreements, with the independent manufacturer potentially investing in component quality to strategically affect the supplier’s choice. The study finds that exclusive contracts with either manufacturer arise depending on the independent manufacturer’s quality level and contract terms, while government-mandated exclusion of the independent manufacturer from supplier trade alters investment incentives, generally hurting the supplier and sometimes benefiting the dependent manufacturer and consumers. Additionally, when the profit sharing rate in exclusive contracts is endogenously negotiated, the independent manufacturer’s bargaining power and quality investment cost critically shape equilibrium outcomes, with mandatory exclusion often leading to over-investment in internal capability.