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This study aims to investigate the effect of the reference quality on the optimal production strategy of a component manufacturer (CM), which mainly concerns whether to sell its high quality self-branded products and whether to supply critical components to a competitive original equipment manufacturer (OEM) who produces low quality products.

The study considers a supply chain comprising an OEM, a CM and a third-party component manufacturer (TCM), who produces components with uncertain quality. The OEM selects a supplier between the CM and the TCM to produce products. Anticipating the OEM’s supplier selection, the CM chooses among three alternative production strategies. For each alternative strategy of the CM, the authors derive the equilibrium solutions between the OEM and the CM with or without the reference quality effect. Then, the authors obtain the effect of the reference quality on the CM by comparing the CM’s optimal strategy between the two situations.

First, the reference quality has opposite effects on the CM’s production strategy depending on the competition results. A high reference quality effect motivates the CM to solely sell the self-branded products if the OEM can always enter the final product market when purchasing from the TCM, and to sell both self-branded products and components if the OEM cannot enter the market when using the TCM’s low quality components. Second, the reference quality effect motivates the OEM to accept a higher wholesale price from the CM. Third, the reference quality effect can make the CM benefit from a more stable TCM in competition.

This paper first considers the impact of the reference quality effect on the CM’s production strategy. By considering consumers’ behavior in a co-opetitive supply chain, this paper contributes to both literature and practice.