Entry Mode in the Presence of International Outsourcing

International outsourcing affects firms’ decisions in various ways. We develop a model to analyze the entry mode behavior of a foreign firm on entering a domestic market when international outsourcing takes place. Being vertically integrated, the foreign firm can either produce in-house input or (partially) outsource it from an outside input supplier. Such practices can be widely observed in real life, in which a firm may outsource some input despite being able to produce the input by itself for various strategic advantages. Depending on its strategy of obtaining input, we consider two entry modes, export and FDI, and derive conditions under which the foreign firm chooses one entry mode over the other. Among the findings, we present a case in which an increase in tariff may raise the likelihood of the foreign firm choosing export. The reason is that the tariff raises the input price and, hence, the rival’s marginal cost. Therefore, such a case prevails when the tariff is high enough to weaken the domestic firm but not too high that it harms the foreign firm. We feature several other interesting cases highlighting the roles of entry costs and in-house input production costs.