Strategic Outsourcing Revisited

This paper analyzes a sequential game where firms decide about outsourcing the production of a non-specific input good to an imperfectly competitive input market. We apply the taxonomy of business strategies introduced by Fudenberg and Tirole (1984) to characterize the different equilibria. We find that outsourcing generally softens competition in the final product market. If firms anticipate the impact of their outsourcing decisions on input prices, there may be equilibria where firms outsource so as to collude or to raise rivals’ costs. We illustrate our analysis using a linear Cournot model. JEL Classification: D43, L22, L23, L24. ∗We are grateful to Ralf Dewenter, Dennis Gärtner, Daniel Halbheer, Armin Schmutzler, and seminar participants at the University of Zurich. Patrick Eugster provided excellent research assistance. †University of Zurich, Hottingerstrasse 10, CH-8032 Zurich, Switzerland; e-mail: [email protected]. ‡University of the Federal Armed Forces Hamburg, Institute for Economic Policy, Holstenhofweg 85, D-22043 Hamburg, Germany; e-mail: [email protected].