4.1. No-Relocation Strategy
We use the superscript “B” to denote this case. The supplier provides key components exclusively from the HPB. Since the supplier’s HPB has excellent production technology and there is reliable supply, the manufacturer’s product quantity Q in the market exactly equals the order quantities allocated with the supplier’s HPB. However, it is important to note that all the key components sourced by the manufacturer will incur additional tariffs. In this case, the supplier’s profit solely comes from sales at its HPB, . The event sequence is as follows: First, the supplier determines the HPB’s wholesale prices . Next, the manufacturer determines orders . Finally, the manufacturer completes production and sells the final product. We use the backward induction method to solve the problem.
For a given
, the manufacturer’s profit function is as follows:
Due to the second-order sufficient condition, i.e.,
, the profit function is concave with respect to
. Therefore, we have a response function of
with respect to
through
as follows:
The supplier anticipates the manufacturer’s reaction and determines the optimal wholesale price through the profit function:
Similarly, we have , so by setting , we obtain the optimal . Consequently, we can derive the equilibrium decisions for all members. We derive the subgame perfect equilibrium in Theorem 1.
Theorem 1. Under strategy B, the supplier’s wholesale price is , and the manufacturer’s order quantity is . Correspondingly, the expected profits of the supply chain members are and .
In addition, the following results hold in equilibrium:
- (i)
is decreasing in γ;
- (ii)
is a constant and not affected by γ;
- (iii)
is decreasing in γ; is a constant and not affected by γ.
Theorem 1(i) demonstrates that the HPB’s whole price is monotonically decreasing with respect to tariffs. As tariffs escalate, the manufacturer experiences higher sourcing costs, resulting in a reduction in the product’s marginal profit. The supplier is not exempt from this, as her marginal profits also decline, resulting in a lower wholesale price as tariffs increase. Interestingly, in Equation (
4),
to
is monotonically increasing in both
and
, but the optimal equilibrium solution of
remains constant and is unaffected by
. This is because the increase in
causes
to decrease, and the interaction between the two keeps the manufacturer’s sourcing price unchanged, and thus
remains unaffected by tariffs. This indicates that the supplier absorbs the tariff cost through the wholesale price, thereby preventing tariffs from impacting the manufacturer’s ordering quantity.
Furthermore, Theorem 1(iii) shows the effect of tariffs on
and
. As the ordering quantity remains unchanged and the wholesale price decreases with tariffs, the supplier’s profit
decreases with tariffs. However, since both the manufacturer’s sourcing cost and ordering quantity remain constant with tariffs, the manufacturer’s profit
remains constant and is unaffected by tariffs.
4.2. Partial-Relocation Strategy
We use the superscript “P” to denote this case. The supplier maintains her HPB and builds a new production base in preferential tariff regions, providing key components from both production bases. When the manufacturer sources from the HPB, it ensures a stable and reliable supply but incurs additional tariff costs. Conversely, sourcing from a preferential tariff region’s production base, referred to as the duty-free production base (DFPB), is duty-free but may lead to unreliable supply. The event sequence is as follows: First, the supplier simultaneously determines wholesale prices for different production bases, and . Next, the manufacturer allocates and based on wholesale prices and the production technology of each production base. Finally, the manufacturer completes production and sells the final product.
For a given
and
, the manufacturer’s profit function is as follows:
The manufacturer makes a sourcing decision before the realization of production uncertainty, and Equation (
6) can be rewritten as
Since Equation (
7) requires simultaneous optimization with respect to
and
, we need to judge whether
is concave in
and
.
Because , we can determine that is concave in and .
Next, we derive the second-order Hessian matrix for
and
. Given that
, the Hessian matrix is
as follows:
And
. Thus, we have the best response functions by setting
and
as follows:
The supplier anticipates the manufacturer’s reaction and determines the optimal wholesale price through her profit function:
Substitute Equation (
8) into Equation (
9). Equation (
9) is also optimized with respect to
and
, following the same procedure as the previous solution.
Firstly,
,
, so we can judge that
is concave in
and
.
Next, we derive the second-order Hessian matrix for
and
. Due to
, the Hessian matrix is
, as follows:
And we find that , if . Thus, we can determine the equilibrium decisions for and by setting and . Substituting equilibrium decisions of and into Equations (6), (8), and (9) will yield the equilibrium decisions for the supply chain members. We summarize the equilibrium decisions of the players in Theorem 2. Next, we reorganize and analyze the results using .
Theorem 2. Under strategy P, if , the manufacturer will allocate all orders to the DFPB, and strategy P is no longer an executable strategy. If , the equilibrium outcomes are as follows: wholesale prices are and ; order quantities are and ; and correspondingly, the expected profits of the supply chain members are and , respectively.
In addition, the following results hold in equilibrium:
- (i)
is decreasing in γ and increasing in x; is first decreasing and then increasing in γ, and increasing in x;
- (ii)
is decreasing in γ and decreasing in x; for any σ, is increasing in γ and increasing in x.
Theorem 2(i) illustrates that the wholesale price of the HPB decreases with tariffs. As shown in Equation (
8),
is monotonically decreasing in
, while
is monotonically increasing in
. In other words, given the wholesale price of the DFPB, the higher wholesale price of the HPB will encourage the manufacturer to allocate more orders to the DFPB, reducing both the supplier’s and manufacturer’s tariff costs and thereby benefiting both parties. However, it is important to note that a higher wholesale price of the HPB will decrease the actual demand quantity of the HPB. The gains from order relocation by the supplier cannot compensate for the losses caused by the reduced demand of the HPB. Therefore, as tariffs increase, the supplier will set a lower wholesale price of the HPB to mitigate the loss resulting from the decrease in the actual demand of the HPB.
Unlike the wholesale price of the HPB, the wholesale price of the DFPB exhibits non-monotonic behavior with respect to tariffs. By further examining Equation (
8), we observe that the actual delivery quantity (
) obtained by the manufacturer is
, independent of
. Instead, the wholesale price of the HPB is the key factor that truly influences the manufacturer’s actual delivery quantity. Here, the wholesale price of the DFPB acts as a tool for the supplier to adjust the manufacturer’s order allocation to maximize profits. When
is relatively low, the impact of tariffs on the manufacturer’s sourcing cost of the HPB is not significant, and the manufacturer lacks strong motivation to relocate orders to the DFPB. In this case, the supplier may lower the wholesale price of the DFPB to attract more orders and reduce the additional tariff burden from the HPB. However, when
is high, tariffs substantially increase the manufacturer’s sourcing cost of the HPB, prompting the manufacturer to allocate a significant portion of orders to the DFPB to avoid tariff expenses. In this case, the supplier will raise the wholesale price of the DFPB to maximize profit extraction from the manufacturer.
Theorem 2(i) also illustrates that, for any given , the wholesale prices at both the HPB and the DFPB increase with the production technology of the DFPB. The higher production technology of the DFPB encourages the manufacturer to allocate more orders to this base, reducing tariff costs from the HPB. For the supplier, the wholesale price of the DFPB is a key tool for extracting profit from the manufacturer. As the manufacturer allocates more orders to the DFPB, the supplier raises the wholesale price of the DFPB to further increase its profit. However, as the wholesale price of the DFPB rises, the manufacturer’s order-allocation strategy may change, leading to a reallocation of more orders back to the HPB. This order reallocation will increase tariff costs, prompting the supplier to raise the wholesale price of the HPB to discourage the manufacturer from shifting more orders back to the HPB.
Theorem 2(ii) is directly derived from the manufacturer’s sourcing cost. For any given and x, the sourcing cost of the HPB for the manufacturer increases, causing to decrease with both and x. On the other hand, the relative sourcing cost advantage of the DFPB increases with and x, leading to increase with both and x. It is important to note that the scale of the manufacturer’s order transfer is not solely dependent on the sourcing cost difference between the two bases but is also significantly influenced by the production technology level of the DFPB. The higher the production technology of the DFPB, the more inclined the manufacturer is to transfer additional orders there, aiming to reduce the overall sourcing cost.
Next, we analyze the impact of tariffs and the production technology of the DFPB on the profits of both the supplier and manufacturer. To distinguish the profits obtained by the supplier and manufacturer through different channels, we define () and () in the following analysis as the profits earned by the supplier from selling the key components produced at the HPB (DFPB) and the profits earned by the manufacturer from selling products assembled using the key components procured from the HPB (DFPB), respectively.
Theorem 3. Under strategy P,
- (i)
For a given x, and are both decreasing in γ; and are decreasing in γ and and are increasing in γ.
- (ii)
For a given γ, is increasing in x while is decreasing in x; and are increasing in x and and are increasing in x.
Theorem 3(i) shows that both the supplier’s and manufacturer’s expected profits decrease with tariffs, which is intuitive. For any x, tariffs will raise sourcing costs for the manufacturer at the HPB, leading to a reduction in actual demand for key components deliveries and a contraction of the market size. For the supplier, in the HPB channel, the impact of tariffs forces the supplier to lower the wholesale price to mitigate the demand reduction caused by the rising sourcing cost. However, despite these efforts, the order quantity of the HPB decreases, resulting in a decline in the supplier’s profits from the HPB sales under the influence of tariffs. In the DFPB channel, the supplier sets a wholesale price higher than that in the HPB but still lower than the manufacturer’s sourcing cost of the HPB. This pricing decision allows the supplier to extract more profit from the DFPB as tariffs increase, along with an increase in the actual delivery quantity of the DFPB. However, although the supplier can partially offset the losses by increasing the profits of the DFPB, this is insufficient to compensate for the overall losses caused by the shrinking whole market size and the reduced profits of the HPB. Therefore, the supplier’s total profit decreases as tariffs increase. Similarly, the manufacturer’s profits are negatively impacted by higher tariffs, as the increased profits of the DFPB are not enough to counterbalance the adverse effects of a shrinking market and the reduced profits of the HPB.
We investigated the preferences of the supplier and the manufacturer regarding x. An intuitive expectation about the attitudes of supply chain members toward x is that both of them would prefer a higher x, as a higher x implies lower unreliable supply, allowing them to better manage the impact of tariffs. However, our study reveals a surprising result: while the supplier prefers higher, the manufacturer exhibits an aversion to a higher x. For the supplier, a higher x results in a contraction of the whole market size, as it raises the manufacturer’s sourcing cost of the HPB. However, the wholesale prices of both production bases also increase in x. The gains from the rise in the wholesale prices outweigh the losses due to the shrinking market size, allowing the supplier to benefit from the improved production technology of the DFPB.
For the manufacturer, in the HPB channel, the supplier sets higher wholesale prices, which reduces the total product quantity and raises the product’s sale price. However, this also increases the manufacturer’s sourcing cost, leading to a decrease in the sourcing quantity. In fact, as x increases, the increase in the sourcing cost outpaces the rise in product prices, causing the marginal profit of the products procured at the HPB to decrease. Consequently, the manufacturer’s profit in the HPB channel decreases as x increases. In the DFPB channel, although the marginal profit of products also decreases with x, the supplier encourages the manufacturer to increase the sourcing quantity of the DFPB by offering more favorable wholesale prices. As a result, the manufacturer’s profit in the DFPB channel rises in x. However, since the decrease in profit from the HPB channel outweighs the increase in the DFPB channel, the manufacturer’s whole profit decreases monotonically with x. In other words, the higher production technology of the DFPB exacerbates the double marginalization effect within the supply chain, benefiting the supplier while harming the manufacturer as the DFPB’s production technology improves.
Theorem 3 reveals that tariffs always have a negative impact on supply chain members, but the supplier consistently benefits from a high
x. This implies that the supplier has a strong incentive to improve the production technology of the DFPB to avoid the burden of high tariff costs. However, the manufacturer’s profit will decrease as the production technology of the DFPB improves. Recalling Theorem 1, the supplier absorbed all the tariff costs by lowering the wholesale price of the HPB. So, in strategy P, as
x increases, is the supplier still the primary bearer of tariff costs? This is a central topic in recent research on trade conflicts, specifically addressing the question of who pays for tariffs [
28,
29,
30]. Next, we will compare the sensitivity of the players’ expected profits to tariffs to investigate this issue, and we summarize the analysis results in the following Proposition 1:
Proposition 1. Under strategy P, there exists a threshold, , such that when , ; when , , where .
Proposition 1 indicates that the impact of tariffs on the expected profits of the supplier and the manufacturer is not always the same; in some cases, the effect of tariffs on the supplier may even surpass that on the manufacturer. The tariff cost primarily arises when the manufacturer procures key components from the HPB. Therefore, the manufacturer’s order-allocation decision directly determines the tariff cost within the supply chain. When the manufacturer allocates more orders to the HPB, the supply chain faces higher tariff costs; conversely, when more orders are allocated to the DFPB, tariff costs are lower. In addition, the wholesale price can regulate the allocation of the tariff cost in the supply chain. Recalling Theorem 1, when the HPB’s wholesale price is low, the supplier bears the majority or even all the tariff costs. Consequently, tariffs have a significant impact on the supplier’s profit. On the other hand, when the HPB’s wholesale price is high, the manufacturer bears a larger share of the tariff cost, meaning that the tariff’s impact is more substantial on the manufacturer’s profit. The DFPB’s wholesale price acts as a tool for the supplier to adjust the manufacturer’s order allocation to maximize profits (Theorem 2). The higher DFPB’s wholesale price allows the supplier to extract more profit from the manufacturer (Theorem 3(ii)), effectively transferring the burden of the tariff cost onto the manufacturer.
When x is relatively low, meaning that the production technology of the DFPB is not advanced, the cost difference for the manufacturer between sourcing from different bases is small. This situation makes the manufacturer more inclined to allocate a significant portion of orders to the HPB, resulting in higher tariff costs. In this case, the supplier tends to set a lower wholesale price of the DFPB, but this lower HPB whole price leads to the supplier bearing a large share of tariff costs in the HPB channel. Additionally, the lower wholesale price of the DFPB fails to extract significant profits from the manufacturer, making it difficult to effectively transfer the tariff cost to the manufacturer. Consequently, the impact of tariffs on the supplier’s profit is substantial. Therefore, under any given tariffs, when the production technology of the DFPB is not advanced, the supplier bears most tariff costs, meaning that the tariff’s impact on the supplier’s expected profit is greater than its impact on the manufacturer’s expected profit.
When
x is high, meaning that the supplier’s production technology at the DFPB is advanced, the cost difference for the manufacturer between sourcing key components from different bases is large. At that time, the manufacturer will allocate more orders to the DFPB. Moreover, a higher
x further enhances the manufacturer’s incentive to allocate orders to the DFPB due to cost differences. In this case, the supplier tends to set higher wholesale prices at both production bases. The higher HPB’s wholesale price allows the supplier to avoid bearing more of the tariff cost. At the same time, the higher wholesale price of the DFPB allows the supplier to extract more profit from the manufacturer, further transferring the burden of the tariff cost onto the manufacturer. Thus, under any given tariffs, when the production technology at the DFPB is advanced, the manufacturer bears most tariff costs, meaning that the tariff’s impact on the manufacturer’s expected profit is greater than its impact on the supplier’s expected profit. We summarize the above discussion in
Figure 2.
4.3. Full-Relocation Strategy
We use the superscript “F” to denote this case. The supplier completely abandons her HPB and builds a fully substitutable production base in a preferential tariff region, relocating all production activities to the DFPB. It is worth noting that the manufacturer needs to consider unreliable supply in the DFPB. The supplier’s expected profit only comes from the DFPB, . The event sequence is as follows: First, the supplier determines the DFPB’s wholesale prices . Next, the manufacturer determines orders . Finally, the manufacturer completes production and sells the final product.
For a given
, the manufacturer’s profit function is as follows:
The function can be written as
Due to
. Therefore, we can determine the optimal response function of
with respect to
by solving by
. Thus, we have
The supplier anticipates the manufacturer’s reaction and determines the optimal wholesale price through the following profit function:
Due to , we can obtain by setting . Substituting into Equations (11)–(13) will yield all equilibrium decisions. We summarize the equilibrium decisions of the players in Theorem 4.
Theorem 4. Under strategy F, the supplier’s wholesale price is , and the manufacturer’s order quantity is . Correspondingly, the expected profits of the supply chain members are and , respectively.
In addition, the following results hold in equilibrium:
- (i)
is a constant;
- (ii)
For any given σ, is unimodal in x;
- (iii)
and are monotonically increasing in x.
Theorem 4(i) states that in strategy F, the supplier’s wholesale price remains unchanged with respect to the production technology of the DFPB. Here, the production technology does not directly impact the manufacturer’s sourcing cost. Therefore, the manufacturer adjusts the sourcing quantity to maintain the supplier’s actual delivery quantity at a stable level. Since production orders do not fluctuate significantly due to changes in the production technology, the wholesale price remains stable with respect to the production technology of the DFPB.
Theorem 4(ii) shows that the ordering quantity first increases and then decreases with respect to the production technology of the DFPB. Given that the supplier provides a stable wholesale price, the manufacturer only needs to focus on maintaining a stable actual delivery quantity. When the production technology of the DFPB is not advanced, the manufacturer increases order quantities to keep actual deliveries stable. As the production technology of the DFPB improves, the manufacturer reduces order quantities to avoid excessive actual deliveries, which could lead to a decrease in product marginal profit and potential losses.
Theorem 4(iii) indicates that the higher production technology of the DFPB benefits both the supplier and manufacturer. For the supplier, even though the manufacturer dynamically adjusts the sourcing quantities, the actual delivery quantity increases in the production technology of the DFPB, directly enhancing the supplier’s profits. Although the marginal profit of the product decreases with increased actual deliveries, the manufacturer can benefit through a strategy of “small profits but quick turnover”. This result also suggests that the supplier has a strong incentive to enhance the production technology of the DFPB to create a win–win situation.
4.4. Strategies Comparison
Next, we are interested in comparing the expected profits of supply chain members under different strategies. This will help us understand the impact of the interaction between tariffs and the production technology of the DFPB on the players.
Proposition 2.
Comparing strategy B and strategy F holds that
- (i)
For any γ and x, and ;
- (ii)
If , ; if , ; for any γ and x, .
Proposition 2(i) indicates that, compared to strategy F, the supplier offers a lower wholesale price under strategy B. This is because, under strategy B, the manufacturer encounters tariff costs when sourcing key components from the HPB, leading to increased sourcing costs. To mitigate the impact of the tariff cost on sourcing orders, the supplier proactively reduces the wholesale price to maintain order stability (). Under both strategy B and strategy F, the manufacturer’s sourcing costs are the same (). However, under strategy B, since the HPB has advanced production technology, the manufacturer’s order quantity matches the supplier’s actual delivery quantity. Therefore, the manufacturer only needs to make sourcing decisions based on the sourcing cost. In contrast, under strategy F, the manufacturer must consider not only the sourcing cost but also the production technology of the DFPB to determine a larger order quantity to manage the unreliable supply due to the not-advanced production technology of the DFPB (). However, even if the manufacturer increases the order quantity, the not-advanced production technology of the DFPB still leads to a smaller actual delivery quantity ().
Proposition 2(ii) demonstrates the relationship between the expected profits of the supplier and manufacturer under the two strategies. For the supplier, switching from strategy B to strategy F may be either advantageous or disadvantageous. Under strategy F, the supplier can provide key components at a higher wholesale price, but the lower production technology results in reliable supply, which might lead to fewer actual deliveries. When tariffs are low, the supplier has insufficient incentive to shift all capacity to a preferential tariff region, because even though the wholesale price of the DFPB is higher, it cannot compensate for the reduction in actual deliveries due to the lower production technology. When tariffs are high, the wholesale price of the HPB under strategy B will be significantly lower, which harms the supplier’s profits. For the manufacturer, switching from strategy B to strategy F is always disadvantageous. Although the sourcing costs are the same under both strategies, the reduction in the actual delivery quantity under strategy F leads to a decrease in the sales quantity in the end-user market. Even if the marginal profit of the product increases, it cannot offset the losses caused by the reduction in the product quantity. Therefore, under any tariff, the decision for the supplier to relocate all capacity to the preferential tariff region is always detrimental to the manufacturer’s profit.
Proposition 3. Comparing strategy P and strategy F, if , the manufacturer will allocate all orders to the DFPB, and strategy P is no longer an executable strategy. If , there holds
- (i)
For any γ and x, ;
- (ii)
For any γ and x, and ;
- (iii)
For any γ and x, and .
Proposition 3(i) indicates that, compared to strategy F, the supplier will offer a lower wholesale price under strategy P. It is straightforward that the supplier generally responds to the order fluctuations caused by tariffs by lowering the wholesale price in the HPB. However, when setting the wholesale price of the DFPB, the supplier encounters an opposite motivation. From a channel coordination perspective, the supplier aims to avoid tariffs by supplying key components through the DFPB, so she balances the manufacturer’s sourcing cost across different bases by setting the wholesale price of the DFPB lower than the HPB to achieve channel coordination (). From a profit-maximization standpoint, since the manufacturer’s sourcing cost at the DFPB is lower, the supplier seeks to increase the wholesale price of the DFPB to extract more profit. Therefore, the supplier sets a higher wholesale price of the DFPB (), but it cannot exceed the wholesale price under strategy F, or else strategy P would fail to be effective ().
Proposition 3(ii) shows that order quantity is significantly higher under strategy F than under strategy P, but the actual delivery quantity is greater under strategy P. The order quantity is influenced not only by the sourcing cost of the manufacturer but also by the production technology of the DFPB. When the manufacturer acquires more key components through the DFPB, he must place larger orders to cope with unreliable supply (). Under strategy F, the supplier’s actual delivery quantity decreases due to production uncertainty ().
Proposition 3(iii) illustrates that the incentives of the supplier and manufacturer are aligned—they both prefer strategy P over strategy F. For the manufacturer, it can be concluded that strategy F is the worst strategy because it results in the lowest profit. Under strategy F, the manufacturer does not need to pay additional tariffs, but the supplier tends to charge a higher wholesale price, keeping the manufacturer’s sourcing cost at a high level. Moreover, the insufficient actual delivery quantity from the supplier significantly harms the manufacturer’s profits. For the supplier, the profit under strategy P is higher than under strategy F, mainly because the manufacturer allocates many orders to the DFPB, allowing the supplier to extract profit through the higher wholesale price of the DFPB.
Based on Propositions 2 and 3, we can determine the manufacturer’s profit preferences across the three strategies: the manufacturer achieves the highest profit under strategy B, followed by strategy P, and finally, strategy F. This indicates that the supplier’s capacity-relocation decisions have a negative impact on the manufacturer’s profits, with full relocation (strategy F) resulting in the lowest profits for the manufacturer. However, the underlying driving factors behind this preference are still unclear. Additionally, the supplier’s preferences for capacity-relocation decisions are also uncertain. Next, by comparing the equilibrium decisions and profit relationships of supply chain members under strategies P and B, we will further analyze why the manufacturer prefers strategy B and identify the supplier’s capacity-decision preferences.
Proposition 4. Comparing strategy B and strategy P, if , the manufacturer will allocate all orders to the DFPB, and strategy P is no longer an executable strategy. If , there holds
- (i)
For any γ and x, ;
- (ii)
For any γ and x, and ;
- (iii)
For any γ and x, and .
Proposition 4(i) indicates that under strategy P, compared to strategy B, the supplier will charge a higher wholesale price of the HPB to encourage the manufacturer to source more key components from the DFPB. The supplier’s motive for doing this is to set a higher wholesale price of the DFPB (), thereby extracting more profit from the manufacturer. This strategy leads to higher sourcing costs for the manufacturer in the HPB (), which negatively impacts the manufacturer. Proposition 4(ii) is directly derived from Proposition 4(i).
According to the above analysis, we find that when the supplier can effectively implement strategy P, they prefer strategy P over strategy B. The reason is that, under strategy B, the supplier needs to lower the wholesale price to mitigate the negative impact of tariffs on the manufacturer’s order quantity, which reduces the supplier’s profit. However, in strategy P, the supplier can obtain more profit from the manufacturer by raising the wholesale price of the DFPB, resulting in higher expected profits for the supplier in strategy P. Despite the higher profits that strategy P brings to the supplier, we find that the manufacturer’s expected profit is lower under strategy P. This result is surprising. The reason behind it is that the supplier’s more aggressive whole pricing of the HPB under strategy P leads to a decrease in the actual quantity of key components that the manufacturer can obtain, which in turn reduces the number of products available for sale in the market. The profit loss from the reduced sales quantity exceeds the gains from the lower sourcing cost, resulting in higher expected profits for the manufacturer under strategy B.
According to Propositions 2–4, we can derive the following Propositions 5 and 6:
Proposition 5. If , the supplier prefers to adopt strategy P. If , the supplier prefers to adopt strategy F; the manufacturer always prefers strategy B.
Proposition 5 illustrates that when tariffs are relatively low, the supplier choosing either the full-relocation strategy or no-relocation strategy instead of the partial-relocation strategy will lead to a lose situation. This means that the supplier always benefits from a strategy of production base diversification. It suggests that if tariff levels have not reached a certain threshold, hastily relocating all production capacity to a preferential tariff region is not a wise decision for the supplier. Specifically, in strategy F, the supplier sets a higher wholesale price, resulting in fewer actual delivered orders, which leads to greater losses. In strategy B, although the supplier delivers more orders, she must bear all tariff costs alone, and the increased number of orders cannot offset the losses caused by the tariff cost. Therefore, the supplier’s best choice is strategy P. Through strategy P, the supplier can balance the tariff cost and reliable supply between two bases, thereby profiting from the production-base-diversification strategy. When tariffs are high, due to the manufacturer’s order-allocation incentives, strategy P is no longer a viable strategy. At that time, the supplier can only choose between strategy B and strategy F. The key lies in comparing the impact of tariffs with the impact of reduced actual delivered orders. When the tariff cost exceeds the losses caused by order reduction, strategy F becomes the supplier’s best choice.
For the manufacturer, the optimal strategy is strategy B. In this case, the supplier adjusts the wholesale price to absorb the impact of tariff fluctuations on the manufacturer’s orders, shielding the manufacturer from direct tariff volatility. In contrast, under strategy F, the manufacturer faces higher sourcing costs and greater shortage risks. Although product prices may be higher, the increased revenue is insufficient to compensate for the loss in profit. In strategy P, the rise in sourcing cost also negatively affects the manufacturer’s profits. Therefore, the manufacturer performs best under strategy B.
Proposition 6. If , the supply chain equilibrium strategy is strategy B. If , the supply chain equilibrium strategy is strategy F.
The equilibrium strategy of the supply chain is jointly determined by members of the supply chain. When the supplier adopts either strategy B or strategy F, the manufacturer can choose to adhere to the supplier’s decision or exit the supply chain. However, exiting would result in zero profit for the manufacturer, which is clearly not in his best interest. In the case where the supplier adopts strategy P, the manufacturer determines the final equilibrium strategy of the supply chain by deciding how to allocate orders. If the manufacturer allocates all orders to the supplier’s HPB, it effectively forces the supply chain back to strategy B; if all orders are allocated to the DFPB, the supply chain is effectively using strategy F.
When is low (), the supplier can effectively execute all three strategies. According to the previous analysis, the supplier’s preferred strategy is strategy P. However, since the manufacturer would face higher sourcing costs under strategy P, his expected profit would decrease. As analyzed in Proposition 5, the manufacturer’s expected profit is highest under strategy B. Therefore, the manufacturer is more likely to distort the supplier’s strategy F by allocating all orders to the supplier’s HPB, causing the supply chain’s equilibrium strategy to revert to strategy B. Interestingly, according to the conclusions from Propositions 2 and 5, when , the supplier’s expected profit under strategy B is the lowest. This indicates that, under moderate tariff levels, implementing strategy P can significantly harm the supplier.
When
is high (
), if the supplier adopts strategy P, the manufacturer may reject this strategy due to higher sourcing costs. In this case, the supplier is left to choose between strategy B and strategy F. As previously analyzed, under such a high-tariffs environment, the supplier is more likely to adopt strategy F. Strategy F allows the supplier to completely avoid the cost pressure brought by high tariffs. Therefore, the supply chain equilibrium strategy is strategy F. This result is illustrated in
Figure 3.