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Integration vs. Outsourcing in Industry Equilibrium

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  • Gene Grossman
  • Elhanan Helpman

Abstract

We develop an equilibrium model of industrial structure in which the organization of firms is endogenous. Differentiated consumer products can be produced either by vertically integrated firms or by pairs of specialized companies. Production of each variety of consumer good requires a unique, specialized component. Vertically integrated firms can manufacture the components they need in the quantity and type that maximizes profits, but they face a relatively high cost due to diseconomies of scope. Specialized firms can produce at lower cost, but outsourcing imposes costs due to search frictions and imperfect contracting. We study the equilibrium mode of organization when inputs are fully or partially specialized. We consider how the degree of competition in the industry, the nature of the search technology, the division of bargaining strength between intermediate and final producers, and the sensitivity of manufacturing costs to input characteristics affect the equilibrium organizational form.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 460.

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Date of creation: 2001
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Handle: RePEc:ces:ceswps:_460

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  1. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1846, Harvard - Institute of Economic Research.
  2. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(4), pages 691-719, August.
  3. Diamond, Peter A, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 49(2), pages 217-27, April.
  4. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  5. McAfee, R. Preston & McMillan, John., 1990. "Organizational Diseconomies of Scale," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 728, California Institute of Technology, Division of the Humanities and Social Sciences.
  6. Ricardo Lagos, 2000. "An Alternative Approach to Search Frictions," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(5), pages 851-873, October.
  7. Jose Campa & Linda S. Goldberg, 1997. "The Evolving External Orientation of Manufacturing Industries: Evidence from Four Countries," NBER Working Papers 5919, National Bureau of Economic Research, Inc.
  8. Riordan, Michael H. & Williamson, Oliver E., 1985. "Asset specificity and economic organization," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 3(4), pages 365-378, December.
  9. Coles, Melvyn G & Smith, Eric, 1996. "Cross-Section Estimation of the Matching Function: Evidence from England and Wales," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 63(252), pages 589-97, November.
  10. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, Econometric Society, vol. 62(2), pages 257-82, March.
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  12. David Hummels & Dana Rapoport & Kei-Mu Yi, 1998. "Vertical specialization and the changing nature of world trade," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Jun, pages 79-99.
  13. Perry, Martin K., 1989. "Vertical integration: Determinants and effects," Handbook of Industrial Organization, Elsevier, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 4, pages 183-255 Elsevier.
  14. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 21(2), pages 297-326, October.
  15. Oliver Jean Blanchard & Peter Diamond, 1989. "The Beveridge Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 1-76.
  16. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  17. John McLaren, 2000. ""Globalization" and Vertical Structure," American Economic Review, American Economic Association, American Economic Association, vol. 90(5), pages 1239-1254, December.
  18. Yeats, Alexander J., 1998. "Just how big is global production sharing?," Policy Research Working Paper Series 1871, The World Bank.
  19. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 57-82, January.
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