Firms specializing in product design but not in production often outsource manufacturing to a third party, but in the process of sharing intellectual property (IP), face the risk of IP theft. Overproduction occurs when the manufacturer produces additional identical units beyond the contracted amount and sells those units at a discount. Split manufacturing, where the design is separated to allow two manufacturers to each produce half of the design, has been proposed to protect IP. The purpose of this paper is to investigate the strategic dynamics between designer and manufacturer when the designer is able to engage in split manufacturing as a countermeasure to overproduction.
This paper models the buyer−supplier dynamics between a designer and an untrustworthy foundry as an iterated game, where the designer has the option to not innovate, engage in split manufacturing or outsource the full design, in which case the foundry can either expropriate or not expropriate the IP.
The main findings are that in repeated interactions, successful outsourcing is possible if the designer can credibly threaten to cease contracting as punishment for IP theft, but the designer’s capacity to engage in split manufacturing can make it more difficult to sustain cooperation. The authors also find that the relationship between the design firm’s capacity to engage in split manufacturing and its equilibrium profit is sometimes positive and sometimes negative, dependent upon the common discount rate.
While the paper is motivated by the semiconductor industry, the results are extendable to any industry where the design and manufacturing of products can be split. The implications highlight the importance of trust across the supply chain. The best way to reduce counterfeiting in the supply chain is to deal only with trusted and authorized suppliers, but when this is not possible, a risk-based analysis about the trustworthiness of the supply chain partner is necessary. This paper explores the cost-security tradeoffs in supply chain management.
Very few studies apply game theory techniques for IP protection, especially within the context of overproduction and split manufacturing. By developing a novel methodology for analyzing strategic outsourcing decisions, this study provides practical insights into anti-counterfeiting and supply chain risk management.
