Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction
American Economic Journal: Microeconomics
vol. 11,
no. 1, February 2019
(pp. 105-23)
Abstract
Globalization reshaped supply chains and the boundaries of firms in favor of outsourcing. Now, even vertically integrated firms procure substantially from external 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 to avoid paying markups sometimes, but disadvantageous because it discourages 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.Citation
Loertscher, Simon, and Michael H. Riordan. 2019. "Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction." American Economic Journal: Microeconomics, 11 (1): 105-23. DOI: 10.1257/mic.20160347Additional Materials
JEL Classification
- D21 Firm Behavior: Theory
- D24 Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
- D25 Intertemporal Firm Choice: Investment, Capacity, and Financing
- G31 Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
- L14 Transactional Relationships; Contracts and Reputation; Networks
- L22 Firm Organization and Market Structure
- L24 Contracting Out; Joint Ventures; Technology Licensing
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