How do Suppliers' Market Power Changes Affect A Buyer's Investment Decisions?

Supply chain tensions have become an issue often talked about. Our paper develops a set of stylized models studying the effect of an increase in suppliers' market power on a buyer's investment decisions. First, we study the case where the buyer regularly goes to the input market to source from a known set of oligopolistic suppliers and determine the buyer's optimal investment policy. We then study the conditions under which the buyer is better off committing at the time of investment on a production schedule signing with the set of suppliers a framework agreement regulating the input price. Finally, we endogenize the size of the pool of suppliers the buyer can source from by considering a supplier's decision to exit a market if the economic circumstances are not satisfactory. The degree of competition in the input market is a key driver of a buyer's investment decision. While supply contracts favor suppliers, they lead to a delayed investment by the buyer. Cost asymmetry among suppliers may lead the buyer to delay its investment as a tradeoff between waiting for clarity about the supplier base or securing better terms with a larger pool, which is less likely to sustain.