Outsourcing to Limit Rent

In the 1920s, Henry Ford famously built a factory in which the raw materials for steel came in on one end and finished automobiles came out the other. But extreme vertical integration such as this is not the fashion today. Ford Motor has recently spun off a significant portion of its parts making operations as a separate company and General Motors has done the same. While General Motors has not attemped to spin off final assembly plants, they are currently trying to outsource to outside contractors the janitorial services within an assembly plant as well as forklift operations. Northwest Airlines has recently begun outsourcing the cleaning of airplanes to outside contractors. The mantra underlying much of the dicussion about outsourcing by business consultants is that companies need to focus on their core competencies and they should consider outsourcing the rest. This idea of specializing according to comparative advantage would be very familar to Ricardo. Surely comparative advantage based on production efficiency is a major force behind outsourcing. But it is not the only force and it has little to do with why General Motors wants to outsource janitorial services. GM’s motivation is no secret and is not disputed: Janitors who work for General Motors are members of the United Auto Workers and they get a union salary of $28 an hour; janitors through an outside contracter would receive approximately $12.1 Analogously, Northwest Airlines is hiring outside contractors to clean airplanes because the contractors’ wages are lower than the union wages Northwest would be paying if they did the job themselves. This paper develops a theory of outsourcing in which the circumstances under which factors of production can grab rents play the leading role. One factor has some monopoly 1 See “GM to UAW: Let’s cut costs," Workforce Management: News in Brief, April 16, 2007.