Abstract

This paper studies the make-or-buy decisions of firms that require a common input but have different ideal input characteristics. Firms can outsource input production either to one of the firms themselves or to a third party. We show that outsourcing to a third party can occur although this party does not add value to the industry.

The rationale is that, if input contracts are incomplete, a third party balances the demands for specialisation and the benefits from economies of scale in a better way than firms do. We further find that the payoff of the third party is non-monotonic in its bargaining power. We also characterise under which conditions make-or-buy decisions are distorted from the efficient ones.

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