Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction∗
Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction∗ Simon Loertscher† Michael H. Riordan‡ University of Melbourne Columbia University November 16, 2017 Abstract Globalization reshaped supply chains and the boundaries of firms in favor of outsourcing. Now, even vertically integrated firms procure substantially from ex- ternal suppliers. To study procurement and the structure of firms in this reshaped economy, we analyze a model in which integration grants a downstream customer the option to source internally. Integration is advantageous because it allows the customer sometimes to avoid paying markups, but disadvantageous because it dis- courages investments in cost reduction by independent suppliers. The investment- discouragement effect more likely outweighs the markup-avoidance effect if the upstream market is more competitive, as is so in a more global economy. Keywords: outsourcing, vertical integration, make and buy. JEL-Classification: C72, L13, L22, L24 ∗We are grateful to the editor (John Asker) and three anonymous referees for comments and sugges- tions that have improved the paper considerably. The paper has also benefitted from comments by Malin Arve, Patrick Bolton, Roberto Burguet, Jacques Cr´emer, Jean de Bettignies, Yassine Lefouili, Hans- Theo Normann, Eric Rasmusen, Patrick Rey, Antonio Rosato, Yossi Spiegel and workshop participants at the 2011 Industrial Economics Conference at Zhejiang University, at the 2013 Kick-off Workshop of the D¨usseldorf Institute for Competition Economics, at Ecole Polyt´echnique in Paris, at Indiana Uni- versity, at the Organizational Economics Workshop at the University of Sydney 2012, the Workshop of Public Private Collaboration 2013 at IESE Business School in Barcelona, the 2013 Canadian Economics Association Meetings in Montreal, the 2014 Australasian Economic Theory Workshop in Canberra, the 2014 Searle Conference on Antitrust Economics in Chicago, and the Conference in honour of Jacques Cr´emer on Advances in the Economics of Organizations and the New Economy in Toulouse in 2016.
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