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On the Cost-vs-Quality Tradeoff in Make-or-Buy Decisions

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Abstract

The make-or-buy decision is analyzed in a simple two-task principal-agent model. There is a cost-saving/quality tradeoff in effort provision. The principal faces a dichotomous choice between weak ("make") and strong ("buy") cost-saving incentives for the agent; the dichotomy is due to an incomplete-contracting limitation necessitating that one party be residual claimant. Choosing "buy" rather than "make" leads to higher cost-saving effort and -- in a plausible "main case" -- to lower quality effort; this in spite of stronger direct quality-provision incentives in the former case.

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  • Andersson, Fredrik, 2010. "On the Cost-vs-Quality Tradeoff in Make-or-Buy Decisions," Working Papers 2010:2, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2010_002
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    File URL: http://project.nek.lu.se/publications/workpap/Papers/WP10_2.pdf
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    1. Andersson Fredrik, 2011. "Make-or-Buy Decisions and the Manipulability of Performance Measures," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 11(1), pages 1-30, December.
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    6. Gibbons, Robert, 2005. "Four forma(lizable) theories of the firm?," Journal of Economic Behavior & Organization, Elsevier, vol. 58(2), pages 200-245, October.
    7. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
    8. Domberger, Simon & Jensen, Paul, 1997. "Contracting Out by the Public Sector: Theory, Evidence, Prospects," Oxford Review of Economic Policy, Oxford University Press, vol. 13(4), pages 67-78, Winter.
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    10. Corneo, Giacomo & Rob, Rafael, 2003. "Working in public and private firms," Journal of Public Economics, Elsevier, pages 1335-1352.
    11. repec:hrv:faseco:30727607 is not listed on IDEAS
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    More about this item

    Keywords

    make-or-buy decision; manipulation; outsourcing;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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