The Make-or-Buy Decision in the Presence of a Rival: Strategic Outsourcing to a Common Supplier

Abstract

Firms routinely decide whether to make essential inputs themselves or buy the inputs from independent suppliers. Conventional wisdom suggests that a firm will not buy an input for a price above its in-house cost of production. We show that this is not necessarily the case when a monopolistic input supplier also serves the firm's retail rival. In this case, the decision to buy the input (and thus become one of the supplier's customers) can limit the incentive the supplier would otherwise have to provide the input on particularly favorable terms to the retail rival. Thus, a retail competitor may pay a premium to outsource production to a common supplier in order to raise its rivals' costs.make-or-buy, strategic outsourcing, supply chains

Strategic sourcing for entry deterrence and tacit collusion

“…Outsourcing may arise even when production exhibits economies of scale, as shown in Section 5. Arya et al (2008b) find that, outsourcing to a monopoly supplier pre-entry can induce the supplier to favor the entrant less in the post-entry period, hence makes entry unprofitable to the entrant. Instead, in our work the incumbent orders directly from the entrant to deter its entry.…”

Input Markets and the Strategic Organization of the Firm

“…As demonstrated in Arya et al (2008a), the organization of a firm in terms of the make-or-buy decision is altered by a rival's reliance on an external supplier. In effect, given a rival relies on a particular supplier, a firm's decision to internally make an input creates a de facto strategic partnership between the rival and its supplier.…”

Market Size and Vertical Structure in the Railway Industry

“…Several researchers have investigated how the structure of vertical organizations is determined in competitive environments (Bonanno and Vickers (1988), Gal-Or (1999), Choi and Yi (2000), Chen (2001Chen ( , 2005, Lin (2006), Arya et al (2008), Matsushima (2009) Laussel (2008) and Matsushima and Mizuno (2009) who explicitly incorporate complementary inputs in attempts to examine why vertical integration does not occur. Besides several differences in the setup, the present paper differs from Laussel (2008) and Matsushima and Mizuno (2009) as our focus is primarily on the relation among vertical separation, market size, and the difficulty to reduce operation costs.…”