Outsourcing decisions: the effect of scale economies and market structure

Abstract

Outsourcing decisions are typically based on the potential to realize cost savings through economies of scale and specialization by the outsourcing provider. However, markets with significant scale economies frequently generate concentrated market structures, which may render them less attractive for the outsourcing client due to the loss of bargaining power when dealing with a dominant outsourcing supplier. This article shows that this (negative) effect always dominates unless scale effects increase at an increasing rate, which the authors call progressive scale economies. Using a simple analytical model, the article derives implications for empirical work and formalizes some of the practitioner literature on outsourcing.