Economies of scope in industry equilibrium: Vertical integration vs. outsourcing

The underlying incentives and constraints in offshore outsourcing are far more complex than what the existing theories used to explain such activities presumed. 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), this paper identifies conditions that are sufficient for the existence of outsourcing in a model of differentiated consumer products that can be produced either by a vertically integrated firm or by a pair of specialized companies when technology is subject to economies of scope.