Coordinating Supply Chains

Many goods have complex supply chains and a variety of specialized production inputs. Notable examples include airplanes, lasers, and photolithography machines. Manufacturers of such goods often face the problem of coordinating suppliers (i.e. convincing them to produce specialized inputs). We build a model to analyze this problem. A manufacturer endowed with capital needs a specialized input from each of n suppliers. The manufacturer can pay a markup to overcome a supplier's reluctance to produce. Alternatively, the supplier's reluctance can be overcome by integrating them; but integration inflates costs when there is a lack of congruence between the manufacturer and supplier (we model integration and the associated cost inflation along the lines of Aghion and Tirole (1997)). We derive sharp predictions about firm structure and apply our model to a number of applications including international trade and industry policy.