Economising, Strategising and the Decision to Outsource

Abstract

Abstract:We study the make-or-buy decision of oligopolistic firms in an industry in which final good production requires specialised inputs. Firms' mode of operation decision depends on both the incentive to economize on costs and on strategic considerations. We explore the strategic incentives to outsource and show that asymmetric equilibria emerge, with firms choosing different modes of operation, even when they are ex-ante identical. With ex-ante asymmetries, higher cost firms are more likely to outsource. We apply our model to a number of different international trading setups.(86 words)JEL classification: F12, L13, L14.

Strategic investment and international outsourcing in unionised oligopoly

“…Over a range of G, outsourcing is a best response to a rival's vertical integration but vertical integration is a best response to a rival's outsourcing. This result is analogous to that obtained by Leahy and Montagna (2011), in a model without unions and with an endogenous choice of the mode of internationalisation, who show how cost and strategic considerations are entwined in determining the mode-of-operation decision of firms.…”

“…Finally, the existence of strategic interaction between downstream firms allows for the emergence of asymmetric mode-ofoperation equilibria, in which the firms choose different organisational forms even when they are ex-ante identical; this is in sharp contrast to the results obtained in the monopolistically competitive framework in which asymmetric equilibria only arise in the presence of ex-ante efficiency differences. Despite the additional complexity arising from unionisation, this result is consistent with Leahy and Montagna (2011) who show that outsourcing -by softening the investment behaviour of rivals -can be viewed as a defensive business strategy that can be the best response to rivals' choice of vertical integration. However, the presence of unionisation, by endogenising the wage paid by firms, results in this model in the emergence of asymmetric wages, even when the firms' underlying cost parameters are the same.…”

“…it reduces the latter's aggressiveness in investment. This results in a 'strategic motive' to outsource which is explored in more depth in Leahy and Montagna (2011).…”

“…via the emergence of hold-up problems) and interacts with their strategic behaviour with respect to both competitors and unions. To incorporate these features into our analysis, we extend the oligopoly outsourcing framework developed by Leahy and Montagna (2011) to allow for unionisation and the partial outsourcing of labour. 7 Specifically, we consider the choice that oligopolistic firms facing unionised domestic labour markets make between producing a highly specialised intermediate input in-house and outsourcing it to a non-unionised foreign supplier.…”

“…Grossman and Helpman, 2002, 2005 that highlight the role of market 'thickness' in determining outsourcing (see also McLaren, 2000). To our knowledge, in the oligopoly literature Leahy and Montagna (2011) were the first to incorporate issues related to incomplete contracts and relationship-specific investment and their role in determining the nature of the trade-offs facing firms when making their make-or-buy decision. The oligopoly literature on outsourcing typically abstract from these issues (e.g.…”