Strategic input outsourcing and equilibrium location choice

Abstract

This study incorporates the strategic behavior of outsourcing with a variant Hotelling model to explore the role of input outsourcing in determining equilibrium locations for firms under quadratic transportation. Given that strategic input outsourcing occurs, we show that the cost-efficient integrated firm will locate as far away from its rival as possible, so as to increase its rival’s input price when its own cost advantage is small; at the same time, the cost-inefficient downstream firm likes to locate closer to its rival to lower the input price. Hence, there is an interior locational equilibrium, and the principle of maximum differentiation does not hold. When an integrated firm’s cost advantage is large, the principle of maximum differentiation is valid. However, when the integrated firm’s own cost advantage is even larger, the integrated firm can become a monopolist through strategic input outsourcing. Under this case, the equilibrium location depends on the magnitude of the input homemade ratio when the input homemade ratio is small. Otherwise, the integrated firm would like to locate at the middle of the market.