Journal article

Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction

S Loertscher, MH Riordan

American Economic Journal: Microeconomics | American Economic Association | Published : 2019

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..

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University of Melbourne Researchers

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Funding Acknowledgements

Financial support through a faculty research grant and an ERS grant by the Faculty of Business and Economics and an early career research award at the University of Melbourne is also gratefully acknowledged. Riordan is grateful to the Toulouse School of Economics for its hospitality and research support in 2012 and 2013. Ellen Muir and Lan Nguyen provided outstanding research assistance. An earlier version of this paper circulated under the title "Outsourcing, Vertical Integration, and Cost Reduction."