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Integration vs. Outsourcing in Industry Equilibrium

  • Gene Grossman
  • Elhanan Helpman

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. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
  2. Coles, Melvyn G & Smith, Eric, 1994. "Cross-Section Estimation of the Matching Function: Evidence from England and Wales," CEPR Discussion Papers 966, C.E.P.R. Discussion Papers.
  3. Yeats, Alexander J., 1998. "Just how big is global production sharing?," Policy Research Working Paper Series 1871, The World Bank.
  4. Diamond, Peter A, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 217-27, April.
  5. 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, issue Jun, pages 79-99.
  6. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  7. Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994. "Renegotiation design with unverifiable information," ULB Institutional Repository 2013/9591, ULB -- Universite Libre de Bruxelles.
  8. 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.
  9. Perry, Martin K., 1989. "Vertical integration: Determinants and effects," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 4, pages 183-255 Elsevier.
  10. Abraham, Katharine G & Taylor, Susan K, 1996. "Firms' Use of Outside Contractors: Theory and Evidence," Journal of Labor Economics, University of Chicago Press, vol. 14(3), pages 394-424, July.
  11. 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.
  12. 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, vol. 21(2), pages 297-326, October.
  13. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  14. Riordan, Michael H. & Williamson, Oliver E., 1985. "Asset specificity and economic organization," International Journal of Industrial Organization, Elsevier, vol. 3(4), pages 365-378, December.
  15. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  16. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  17. John McLaren, 2000. ""Globalization" and Vertical Structure," American Economic Review, American Economic Association, vol. 90(5), pages 1239-1254, December.
  18. Ricardo Lagos, 2000. "An Alternative Approach to Search Frictions," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 851-873, October.
  19. McAfee, R Preston & McMillan, John, 1995. "Organizational Diseconomies of Scale," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 399-426, Fall.
  20. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
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