Two game models are developed based on production costs and scope economies to investigate the widely observed multi-client outsourcing (MCO) phenomenon. Analytical results demonstrate that outsourcers’ high in-house production costs and the advantage of scope economies motivate firms to outsource collectively to an independent vendor. Under certain conditions, if both firms make their outsourcing decisions simultaneously, collective outsourcing is one of the two equilibria; if both firms make decisions sequentially, collective outsourcing becomes the unique equilibrium. Furthermore, the comparative statics of the critical degree of scope economies are examined for the occurrence of MCO with regard to diverse market parameters. Finally, it is proved that market prices decrease as the degree of scope economies increases when MCO occurs. This research helps explain some widely observed phenomena such as malls, supply chain cities, and the China price.
A value chain can usually be divided into several components such as design, manufacturing and marketing departments, with each handling a special (operational) function. However, it is not necessary for a firm to own all these functional departments. Instead, the firm may outsource one or more of these functions to an outside vendor. When two or more firms outsource to a same vendor, MCO (one vendor vs multiple clients) is observed (Sharma and Yetton, 1996), which is sometimes referred to as co-sourcing (e.g. Gallivan and Oh, 1999). Without causing confusion, we always use “firms” to represent companies that seek potential outsourcing opportunities and let “vendor” denote the company that provides outsourcing services.
MCO is widely observed in this era of increasingly competitive and globalizing economies. For example, firms in different industries turn their information systems over to relatively few computer companies such as IBM (Dibbern et al., 2004), and more and more firms now outsource their logistics needs, resulting in the rapid growth of the third-party logistics business (Berglund et al., 1999; Stefansson, 2002). Recently, the newly observed supply chain cities, located in Guangdong, China, can also be viewed as an outcome of MCO where several world-renowned apparel companies such as Polo Ralph Lauren, Liz Claiborne and Dillard's, and Fast Retailing outsource their production functions to Luen Thai Holdings Ltd. (Kahn, 2004; Kusterbeck, 2005). Even at the macro level, the observation that many multi-national companies in developed countries are moving their manufacturing facilities to developing countries such as China can also be treated as MCO.
Academia, business professionals, and even government officials have been extensively discussing the increasing trend of outsourcing manufacturing to China. As a direct consequence, products labeled both “Made in China” and a western brand are widely available in the marketplace and usually sold at a much lower price. The lower price is coined as “the China price” by Engardio et al. (2004) in a Business Week's special report. The China price implies that US companies that manufacture in the United States must reduce their costs by at least 30 percent. Otherwise, they will lose their market to Chinese-made products.
This paper develops two game models based on production costs and scope economies to investigate the widely observed MCO phenomenon. Main analytical results include: (1) if the degree of scope economies is low or in-house production costs are low, it is impossible for both firms to outsource collectively (Corollary 1); (2) if they reach sufficiently high levels (c>c0 for the symmetric cost case or (c1,c2)∈E for the asymmetric cost case, and k<k0) and both firms move simultaneously, collective outsourcing is on an equilibrium path (E2) of GO, exhibiting a possibility of MCO (see Lemma 1 and the summary of Section 3); (3) if scope economies and in-house production exceed their threshold levels and both firms make their outsourcing decision sequentially, collective outsourcing becomes the unique perfect equilibrium of the modified MOB game and, then, E2 arises as the unique subgame perfect equilibrium of G′O (see Proposition 2), implying that MCO is a viable prediction in the presence of high enough in-house production costs and strong enough scope economies. As supply chain cities can be viewed as an outcome of MCO, our results thus help account for the emergence of supply chain cities.
Moreover, Proposition 3 examines the comparative statics of the critical degree of scope economies (k0) with regard to the market parameter (r), firms’ technology parameter c∈(c0,1), the vendor's risk attitude (ρ), and the exogenous uncertainty (σ2). These results are valuable for practitioners to anticipate how the critical degree of scope economies changes as those parameters change.
Finally, it is proved that market prices decrease as the degree of scope economies increases in the presence of MCO and market prices under MCO are lower than those when both firms produce in-house within a certain range of scope economies. The empirical implication is that MCO can serve as a means to exploiting scope economies and, then, leading marker prices lower even if both in-house and the vendor's production costs are high. Therefore, this result facilitates us to understand the universally observed “China price” phenomenon.
