Electronic Markets, Search Costs and Firm Boundaries

Ramesh Sankaranarayanan () and Arun Sundararajan ()

No 563, Econometric Society 2004 North American Summer Meetings from Econometric Society

Abstract: We study how firm boundaries are affected by the reduction in search costs when business-to-business electronic markets are adopted. Our paper analyzes a multi-tier industry in which upstream parts suppliers incur procurement search costs, and downstream manufacturers incur incentive contracting costs with these parts suppliers. We develop a model that integrates search theory into the hidden-action principal-agent model and characterize the optimal contract, showing that the delegation of search results in an outcome analogous to an effective increase in the search cost of the intermediary, reflected in the magnitude of the cutoff price in the second-best stopping rule. This contract is used to specify the manufacturer's make versus buy decision, and to analyze how the technological changes associated with electronic markets affect vertical organizational scope. Our main results show that when search is information-intensive, electronic markets will result in constant decreases in search costs that reduce the vertical scope of organizations. In contrast, when search is communication-intensive, electronic markets will result in proportionate reductions in search costs that lead to an increase in vertical integration; the latter outcome also occurs if search costs converge. We also discuss the implications of our results for the general problem of designing contracts that optimally delegate costly search to an intermediary

Keywords: firm boundaries; vertical integration; search; moral hazard; incentives; principal-agent; electronic markets; B2B markets. (search for similar items in EconPapers)
JEL-codes: D83 L14 L22 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-com and nep-mic
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://repec.org/esNASM04/up.1364.1075598262.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecm:nasm04:563

Access Statistics for this paper

More papers in Econometric Society 2004 North American Summer Meetings from Econometric Society Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().