Outsourcing without cost advantages

Abstract

This paper explores why competing firms outsource to an external common supplier that does not have a cost advantage relative to them in input production. The supplier, through its contract offers, manages to generate asymmetry, to alter product market competition, and to extract profits from the competing firms. Two-part tariffs and sequential contracting are both crucial for the emergence of outsourcing. The supplier purposefully avoids industry profit maximization to enlarge its profits share. Both consumer and total welfare benefit from the presence of an otherwise redundant supplier in the market.