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Outsourcing versus technology transfer: Hotelling meets Stackelberg

Pierce, Andrea and Sen, Debapriya (2009): Outsourcing versus technology transfer: Hotelling meets Stackelberg.

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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 is equivalent to building an endogenous capacity and it generates a Stackelberg leadership effect for firm A which is absent in technology transfer. We show that compared to the situation of no contracts there are always Pareto improving outsourcing contracts (making both firms better off and all consumers at least weakly 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.

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