Abstract
This paper considers a Hotelling duopoly with two firms A and B in the final good market. BothA andB can produce the required intermediate good, firmB having a lower cost due to a superior technology. We compare two contracts: outsourcing (A orders the intermediate good from B) and technology transfer (B transfers its technology to A). First we show that an outsourcing order acts as a credible commitment on part of A to maintain a certain market share in the final good market. This generates an indirect Stackelberg leadership eect, which is absent in a technology transfer contract. We show that compared to the situation of no contracts, there are always Pareto improving outsourcing contracts but no Pareto improving technology transfer contracts. Finally, it is shown that whenever both firms prefer one of the two contracts, all consumers prefer the other contract.
Highlights
In this era of globalization, it has become increasingly common for firms to outsource their required inputs rather than produce them in-house
We study two contracts that naturally arise in this situation: outsourcing and technology transfer
In that the price set by a firm affects the market share and profit of its rival. Due to this strategic aspect, outsourcing and technology transfer contracts generate different incentives for any firm. We show that this difference alters the strategic interaction between firms and has important implications on prices
Summary
In this era of globalization, it has become increasingly common for firms to outsource their required inputs rather than produce them in-house. In that the price set by a firm affects the market share and profit of its rival Due to this strategic aspect, outsourcing and technology transfer contracts generate different incentives for any firm. When the cost difference of two firms is sufficiently large, there are strictly Pareto improving outsourcing contracts, i.e., both firms prefer outsourcing over no contracts and both set a lower price for φ that makes all consumers better off. The papers mentioned above implicitly assumes an alternative sequence where the input-seeking firm places its outsourcing order with its rival after firms set their prices in the final good market. Under this sequence, outsourcing does not transmit any information to the supplier firm prior to price competition.
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