ECONOMIES OF SCOPE IN INDUSTRY EQUILIBRIUM: VERTICAL INTEGRATION VS. OUTSOURCING

Deficiencies in existing theories used to explain outsourcing activities, often stem from the fact that the underlying incentives and constraints are far more complex than what these theories presume. At the theoretical level, hardly any attempt has been made to model economies of scope when the organization of firms is endogenous. This is particularly conspicuous as the process of outsourcing inevitably involves “slicing the value chain ” which is evident in international trade data. Building on Grossman and Helpman (2002), and without violating any assumptions of the original model, this paper examines the equilibrium mode of organization with economies of scope, and also identifies a condition that is both necessary and sufficient for the existence of outsourcing, in a model of differentiated consumer products that can be produced either by vertically integrated firms or by pairs of specialized companies