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Efficient organization of production: Nested versus horizontal outsourcing

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  • Shy, Oz
  • Stenbacka, Rune

Abstract

We characterize equilibrium and efficient modes of production by comparing nested (vertical) outsourcing with horizontal outsourcing. Nested outsourcing is found to be inefficient unless the cost of monitoring outsourced production lines increases sharply with the number of subcontractors and not only with the number of outsourced components. We characterize a market failure in which nested outsourcing is the market outcome even though horizontal outsourcing is the efficient outsourcing mode. This failure occurs at an intermediate range of the costs of monitoring outsourcing to several subcontractors.

Suggested Citation

  • Shy, Oz & Stenbacka, Rune, 2012. "Efficient organization of production: Nested versus horizontal outsourcing," Economics Letters, Elsevier, vol. 116(3), pages 593-596.
  • Handle: RePEc:eee:ecolet:v:116:y:2012:i:3:p:593-596 DOI: 10.1016/j.econlet.2012.06.009
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    References listed on IDEAS

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    1. Anil Arya & Brian Mittendorf & David E. M. Sappington, 2008. "The Make-or-Buy Decision in the Presence of a Rival: Strategic Outsourcing to a Common Supplier," Management Science, INFORMS, vol. 54(10), pages 1747-1758, October.
    2. Chaim Fershtman & Ehud Kalai, 1993. "Complexity Considerations and Market Behavior," RAND Journal of Economics, The RAND Corporation, pages 224-235.
    3. Nickerson, Jack A. & Vanden Bergh, Richard, 1999. "Economizing in a context of strategizing: governance mode choice in Cournot competition," Journal of Economic Behavior & Organization, Elsevier, vol. 40(1), pages 1-15, September.
    4. 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.
    5. Shy, Oz & Stenbacka, Rune, 2003. "Strategic outsourcing," Journal of Economic Behavior & Organization, Elsevier, vol. 50(2), pages 203-224, February.
    6. Legros, Patrick & Newman, Andrew F., 1996. "Wealth Effects, Distribution, and the Theory of Organization," Journal of Economic Theory, Elsevier, vol. 70(2), pages 312-341, August.
    7. Gene M. Grossman & Elhanan Helpman, 2002. "Integration versus Outsourcing in Industry Equilibrium," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 85-120.
    8. Oz Shy & Rune Stenbacka, 2005. "Partial outsourcing, monitoring cost, and market structure," Canadian Journal of Economics, Canadian Economics Association, vol. 38(4), pages 1173-1190, November.
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    Cited by:

    1. Antelo, Manel & Bru, LluĂ­s, 2016. "Option contracts in a vertical industry," MPRA Paper 79241, University Library of Munich, Germany, revised 14 Apr 2017.
    2. Rosar, Frank, 2017. "Strategic outsourcing and optimal procurement," International Journal of Industrial Organization, Elsevier, vol. 50(C), pages 91-130.

    More about this item

    Keywords

    Outsourcing; Subcontracting; Nested outsourcing; Horizontal outsourcing; Efficient organization of outsourcing;

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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