Outsourcing without Cost Advantages

Abstract

This paper explores the incentives of competing firms to outsource to a common supplier and shows that firms outsource even when the supplier does not have a cost advantage in input production. The suppliers contract offers generate cost asymmetry, alter product market competition, and improve the competitive position of one of its customers. The use of nonlinear contracts is crucial for the emergence of outsourcing. The supplier purposefully avoids industry profit maximization to enlarge its profits share. Both consumers and welfare benefit from the presence of an otherwise redundant supplier in the market.