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.