Outsourcing horizontally differentiated tasks under asymmetric information

Abstract

We explore how asymmetric information affects task assignment between a manufacturer and its supplier when tasks are horizontally differentiated, and when the comparative advantage in terms of marginal costs differs during the production process. We show that the manufacturer over-outsources to a generalist supplier and under-outsources to a specialist supplier depending on its level of efficiency. The presence of countervailing incentives drives these results. When the manufacturer’s internal costs are sufficiently low, it can externalize some of its best tasks and internalize its worst tasks. These two distortions simultaneously affect the contract offered to the generalist supplier.