Strategic outsourcing and optimal procurement

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International Journal of Industrial Organization, ISSN: 0167-7187, Vol: 50, Page: 91-130

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Frank Rosar
Elsevier BV
Business, Management and Accounting; Engineering
article description
I study a procurement problem where each seller can ex ante decide to become an intermediary by outsourcing production to a subcontractor. Production costs are independently distributed and privately learned by the producer in each supply chain. I provide a rationale for outsourcing that relies on procurement and subcontracting mechanisms being designed in a sequentially rational way but not on cost savings. I show how my rationale extends to the case with cost savings and I discuss the sellers’ incentives to engage in nested outsourcing. The driving force behind my rationale is that outsourcing makes the distribution of a seller’s cost of providing the product more dispersed. I explain also how my analysis extends to problems where such a dispersion arises for other reasons than outsourcing.