Strategic outsourcing revisited

Working Papers, 2011

We analyze the outsourcing decision of a firm for a key input of a final good production to an independent input supplier even though the firm has an option of producing that key input in-house at a lower cost with a better technology. We find that for smaller technology gap with the independent input supplier the firm would outsource and for larger technology gap it would produce the input in-house for itself and for its rivals. The outsourcing occurs in order to take advantage of its sale of superior technology to the independent input supplier at a high payment although it involves a high price for the input to be acquired from the monopoly input supplier. Though the firm gains from strategic outsourcing, consumers' welfare as well as social welfare goes down.

Kinerja, 2017

This paper analyzes how domestic government sets its optimal export policy in a duopoly model when its domestic firm can only outsource its input while the rival firm is able to both produce and outsource its input. First we analyze the strategic outsourcing behavior of the foreign firm. We find that the foreign firm’s decisions on whether to outsource input or to make it by itself depend on the trade policy taken by the domestic government. The foreign firm will strategically outsource the entire quantity of its input production to the supplier with an input price higher than its in-house cost, if the domestic firm is subsidized by the domestic government. However, when the domestic firm is being charged a positive export tax by the domestic government, the foreign firm will decide to make input by itself despite the lower input price under the outsourcing regime. From the domestic government’s point of view, we find that the conditions for the foreign firm’s decisions correspond to the domestic social welfare maximization problem. When the foreign firm chooses to outsource its input to the supplier, the domestic government will impose a negative export tax on its firm, namely subsidy. While when the foreign firm chooses to make input by itself, the domestic government will impose an export tax on its firm as trade policy. Keywords: Trade Policy, Export Tax, Subsidy, Outsourcing

2004

Abstract: This paper considers the outsourcing choice of a downstream firm with its own upstream production assets. Using both a standard linear pricing model and a bilateral bargaining approach, we examine the equilibrium pricing outcomes that emerge if there are two downstream and two upstream assets. We then characterize the downstream firm's decision as to whether to outsource to an independent or established upstream firm.

Strategic Management Journal, 2008

Our research uses laboratory experiments to examine the theoretical results of competition between suppliers in an outsourcing setup. We consider a supply chain in which a single buyer needs to outsource the manufacturing of a product among N potential suppliers. The buyer allocates demand to suppliers not on the basis of price, but rather on service. We analyze the levels of service suppliers will decide to provide when competing on three different criteria specified by the buyer. For the first, suppliers compete by providing the buyer a specific service level (fill-rate), and for the second by maintaining a specific quantity of on-hand inventory. For the third criteria, suppliers compete based on a parameter designed to optimize the supply chain in favor of the buyer. Prior research and existing theory predict that the decisions will reach stability at the Nash equilibrium for all three types of competition. Theory also predicts these equilibrium points will be ordered, from competitions based on service level as the lowest and those based on the optimal criteria as the highest. Our experimental results show that the equilibrium points reached by subjects are in fact ordered as theory predicts. However, there are large and statistically significant differences between those equilibrium points and the theoretical predictions. Using the Quantal Response Equilibrium (QRE) we show that random errors can explain some of these discrepancies. Our analyses also suggest that, under optimal criteria for competition, other behavioral factors such as rival chasing and loss aversion can play an influential role.

2006

Abstract This paper builds on the Antras-Helpman property theory of international production by allowing heterogeneous final good firms to choose between the use of specific and generic inputs in completely input-intensive sectors. In this setting, final good firms face a trade-off between the lower productivity of generic inputs and the reduced hold-up friction that generic outsourcing entails.

Management Science, 2007

We consider a single buyer who wishes to outsource a fixed demand for a manufactured good or service at a fixed price to a set of potential suppliers. We examine the value of competition as a mechanism for the buyer to elicit service quality from the suppliers. We compare two approaches the buyer could use to orchestrate this competition: (1) a Supplier-Allocation (SA) approach, which allocates a proportion of demand to each supplier with the proportion allocated to a supplier increasing in the quality of service the supplier promises to offer, and (2) a Supplier-Selection (SS) approach, which allocates all demand to one supplier with the probability that a particular supplier is selected increasing in the quality of service to which the supplier commits. In both cases, suppliers incur a cost whenever they receive a positive portion of demand, with this cost increasing in the quality of service they offer and the demand they receive. The analysis reveals that (a) a buyer could indeed orchestrate a competition among potential suppliers to promote service quality, (b) under identical allocation functions, the existence of a demand-independent service cost gives a distinct advantage to SS type competitions, in terms of higher service quality for the buyer and higher expected profit for the supplier, (c) the relative advantage of SS versus SA depends on the magnitude of demand-independent versus demand-dependent service costs, (d) in the presence of a demand-independent service cost, a buyer should limit the number of competing suppliers under SA competition but impose no such limits under SS competition, and (e) a buyer can induce suppliers to provide higher service levels by selecting an appropriate allocation function. We illustrate the impact of these results through three example applications.

2008

Abstract: This paper presents a game theoretic analysis of the impact of both production and transaction costs on the single-or-multiple source purchasing decision. Both dyadic interactions involving a buyer and a seller, and triadic interactions involving a buyer and two suppliers, are examined to gain a more precise understanding of how small number interactions might influence transaction cost. We show that transaction cost is maximized when a buyer follows a single source strategy and learning specificity is present.

Journal of International Economics, 2004

This paper develops a model of strategic outsourcing. With trade liberalization in the intermediate-product market, a domestic firm may choose to purchase a key intermediate good from a more efficient foreign producer, who also competes with the domestic firm for a final good. This has a strategic effect on competition. Unlike the outsourcing motivated by cost saving, the strategic outsourcing has a collusive effect that could raise the prices of both intermediate and final goods. Trade liberalization in the intermediate-good market has a very different effect compared with trade liberalization in the final-good market. D

Social Science Research Network, 2011

We introduce a two-period Stackelberg game of a supplier and buyer. We recognize that learning based on manufacturing experience has many advantages. Consistent with much of the literature, we assume both the buyer and supplier realize reductions in their respective production costs in period 2 due to volume-based learning from period 1 production. Additionally, we introduce another learning concept, the future value, to capture the benefits of transferring current manufacturing experience for the design and development of future products and technologies. In contrast to the literature, we allow the supplier two mechanisms to impact the buyer's outsourcing decision: price and the investment in integration process improvement that reduces the buyer's unit cost of integration. Integration process improvement may include the investment in new materials, specialized technology, or the redesign of the integration process. Conditions are given whereby the buyer partially outsources component demand as opposed to fully outsourcing or fully producing in-house. We explore when the supplier's price and investment in integration technology are substitute strategies versus complements. We analyze the effect on the buyer and supplier's decisions due to: the buyer's base integration cost, the supplier's cost of integration process improvement, the rates of learning for both the buyer and supplier, and dynamic demand.