Scope economies, market information, and make-or-buy decision under asymmetric information

This paper presents a make-or-buy (M-B) model in which a firm (say Firm 1) may produce in-house, or outsource a product to the unique vendor, the monopolist in the outsourcing market. Demand for the finished product is stochastic and price-sensitive, and Firm 1's information forecast about the base market demand and corresponding precision are known when the M-B decision is faced. Firm 1 is risk-neutral and owns a constant-return-to-scale technology, while the vendor is risk-averse and enjoys the advantage of scope economies. A traditional solution is provided under perfect information. Under asymmetric information, we demonstrate that when outsourcing is realized, both parties' expected profits increase with (Firm 1's) forecast accuracy only if the forecasted market demand is higher than the base demand (i.e.; "good" news). 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 hide information at first and decide whether or not to share information only after the vendor's supply price is announced. However, the vendor's profit is constrained by the trade-off between the coordination effort for impelling Firm 1 to share information and the advantages of its monopoly on outsourcing market, low production costs, as well as scope economies.