Market information, scope economies, and make-or-buy decision under information asymmetry

This paper studies a make-or-buy (M-B) model in which a firm (say Firm 1) may outsource a product to the unique vendor, the monopolist in the outsourcing market, or produce in-house. A traditional solution is provided based on both parties´ perfect information (PI). In the case of asymmetric information (AI), the vendor abandons the virtual information reported by Firm 1 and announces its “supply menu” to guarantee a certain yield for itself. We demonstrate, when outsourcing occurs under AI, both parties´ expected profits increase with (Firm 1´s) forecast accuracy if and only if “good” news is received. Outsourcing strictly dominates in-house production if the yield of the vendor´s production input is sufficiently low or its economies of scope are remarkably attractive. Furthermore, it is optimal for Firm 1 to hold information at first and decide whether or not to pool information only after the vendor´s “supply menu” is announced. However, the vendor´s profit is constrained by the trade-off between the coordination effort that invested on pursuing Firm 1 to pool information and the advantages resulting from its status of outsourcing market, production cost, as well as scope economies.