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The Organization of Supply: a Vertical Equilibrium Analysis

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  • Nadav Levy

Abstract

In this paper I study how the make-or-buy decision of a firm depends on the organization of its peers. I consider a multi-firm framework in which firms choose whether to integrate into the supply of an intermediate input or to outsource its production, and choose the size of their supplier network if outsourcing. Firms find it optimal to share the same set of suppliers, as there are economies of scope in investment to suppliers taking multiple designs. These economies are due to spillovers of technical or operational know-how between projects and to savings in the setup costs on physical capital. The model admits multiple vertical equilibria that are Pareto-ranked, the one with the highest level of outsourcing being most efficient. Outsourcing is more likely in larger markets and when the economies of scope are stronger. The size of the optimal supplier network however typically decreases when the spillovers are stronger. These findings provide an insight to the patterns of reorganization of vertical supply relations observed over the last two decades

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 142.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:142

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Keywords: utsourcing; Vertical Integration; Spillovers; Supply relations;

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  1. Oliver Hart & John Moore, 1988. "Property Rights and the Nature of the Firm," Working papers 495, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. George J. Stigler, 1951. "The Division of Labor is Limited by the Extent of the Market," Journal of Political Economy, University of Chicago Press, vol. 59, pages 185.
  3. Robert C. Feenstra, . "Integration Of Trade And Disintegration Of Production In The Global Economy," Department of Economics 98-06, California Davis - Department of Economics.
  4. Thomas J. Holmes, 1999. "Localization Of Industry And Vertical Disintegration," The Review of Economics and Statistics, MIT Press, vol. 81(2), pages 314-325, May.
  5. Raghuram G. Rajan & Luigi Zingales, . "Power in a Theory of the Firm," CRSP working papers 335, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  6. J. Yannis Bakos & Erik Brynjolfsson, 1997. "From Vendors to Partners: Information Technology and Incomplete Contracts in Buyer-Supplier Relationships," Working Paper Series 154, MIT Center for Coordination Science.
  7. 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, vol. 94(4), pages 691-719, August.
  8. Gene M. Grossman & Elhanan Helpman, 2002. "Integration Versus Outsourcing In Industry Equilibrium," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 85-120, February.
  9. Katharine G. Abraham & Susan K. Taylor, 1993. "Firms' Use of Outside Contractors: Theory and Evidence," NBER Working Papers 4468, National Bureau of Economic Research, Inc.
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