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Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction

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  • Simon Loertscher
  • Michael H. Riordan

Abstract

Globalization reshaped supply chains and the boundaries of firms in favor of outsourcing. Now, even vertically integrated firms procure substantially from external suppliers. To study procurement and the structure of firms in this reshaped economy, we analyze a model in which integration grants a downstream customer the option to source internally. Integration is advantageous because it allows the customer to avoid paying markups sometimes, but disadvantageous because it discourages investments in cost reduction by independent suppliers. The investment-discouragement effect more likely outweighs the markup-avoidance effect if the upstream market is more competitive, as is so in a more global economy.

Suggested Citation

  • Simon Loertscher & Michael H. Riordan, 2019. "Make and Buy: Outsourcing, Vertical Integration, and Cost Reduction," American Economic Journal: Microeconomics, American Economic Association, vol. 11(1), pages 105-123, February.
    • Handle: RePEc:aea:aejmic:v:11:y:2019:i:1:p:105-23
    Note: DOI: 10.1257/mic.20160347
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    Citations

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    Cited by:

    1. Chrysovalantou Milliou & Joel Sandonis, 2020. "Vertical foreign direct investment: Make, buy, and sell," Review of International Economics, Wiley Blackwell, vol. 28(3), pages 884-912, August.
    2. Huashu Wang & Zhenyi Li & H. Holly Wang, 2022. "Does Backward Integration Improve Food Safety of the Tea Industry in China in the Post-COVID-19 Era?," Sustainability, MDPI, vol. 14(4), pages 1-15, February.
    3. Philippe Choné & Laurent Linnemer & Thibaud Vergé, 2021. "Double Marginalization and Vertical Integration," CESifo Working Paper Series 8971, CESifo.
    4. Wang, Xuefeng & Liu, Haiyun, 2023. "FDI in services and firm innovation," Finance Research Letters, Elsevier, vol. 56(C).
    5. Ping Lin & Tianle Zhang & Wen Zhou, 2020. "Vertical integration and disruptive cross‐market R&D," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(1), pages 51-73, January.
    6. Simon Loertscher & Leslie M. Marx, 2022. "Incomplete Information Bargaining with Applications to Mergers, Investment, and Vertical Integration," American Economic Review, American Economic Association, vol. 112(2), pages 616-649, February.
    7. Wei‐Jen Wen & Wen‐Chieh Lee & Chung‐Yen Lo, 2023. "To make or to buy from a common supplier? Strategic considerations and welfare consequences," International Journal of Economic Theory, The International Society for Economic Theory, vol. 19(1), pages 39-61, March.
    8. Simon Loertscher & Leslie M. Marx, 2019. "Mix‐and‐match divestitures and merger harm," The Japanese Economic Review, Japanese Economic Association, vol. 70(3), pages 346-366, September.
    9. Tomoeda, Kentaro, 2019. "Efficient investments in the implementation problem," Journal of Economic Theory, Elsevier, vol. 182(C), pages 247-278.
    10. Loertscher, Simon & Marx, Leslie M., 2020. "Digital monopolies: Privacy protection or price regulation?," International Journal of Industrial Organization, Elsevier, vol. 71(C).
    11. Chul-Hi Park & Toshihiro Matsumura & Sang-Ho Lee, 2022. "Procurement of advanced inputs and welfare-reducing vertical integration," Journal of Economics, Springer, vol. 135(3), pages 255-283, April.
    12. Simon Loertscher & Leslie M. Marx, 2019. "Mix‐and‐match divestitures and merger harm," The Japanese Economic Review, Japanese Economic Association, vol. 70(3), pages 346-366, September.

    More about this item

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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