Outsourcing versus technology transfer: Hotelling meets Stackelberg

We consider a Hotelling duopoly with two firms A and B in the final good market. Both can produce the required intermediate good, firm B having a lower cost due to a superior technology. We compare two contracts: outsourcing (A orders the intermediate good from B) and technology transfer (B transfers its technology to A). An outsourcing order acts as a credible commitment on part of A to maintain a specific market share, resulting in an indirect Stackelberg leadership effect that is absent in a technology transfer contract. We show that compared to the situation of no contracts, there are always Pareto improving outsourcing contracts making both firms and all consumers better off, but no Pareto improving technology transfer contracts. It is also shown that if firm B has a relatively large bargaining power in its negotiations with A, then both firms prefer technology transfer while all consumers prefer outsourcing