Insourcing Vs Outsourcing in Vertical Structure

Dongsoo Shin and Roland Strausz
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Dongsoo Shin: Santa Clara University

No 495, Rationality and Competition Discussion Paper Series from CRC TRR 190 Rationality and Competition

Abstract: We study an agency model with vertical hierarchy---the principal, the prime-agent and the sub-agent. The principal faces a project that needs both agents' services. Due to costly communication, the principal receives a report only from the prime-agent, who receives a report from the sub-agent. The principal can directly incentivize each agent by setting individual transfers (insourcing), or sets only one overall transfer to an independent organization in which the prime-agent hires the sub-agent (outsourcing). We show that insourcing is always optimal when the principal can perfectly process the prime-agent's report. When the principal's information process is limited, however, outsourcing can be the prevailing mode of operation. In addition, insourcing under limited information process is prone to collusion between the agents, whereas no possibility of collusion arises with outsourcing.

Keywords: information process; sourcing policy; vertical structure (search for similar items in EconPapers)
JEL-codes: D86 L23 L25 (search for similar items in EconPapers)
Date: 2024-02-14
New Economics Papers: this item is included in nep-com, nep-cta and nep-mic
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