In Defense of Limited Manufacturing Cost Control : Disciplining Acquisition of Private Information by Suppliers

When a firm's input supplier can acquire private information to gain an edge in negotiations, we show that the firm can blunt the supplier's informational advantage by permitting cost inefficiencies in internal production. Specifically, we establish that a modest increase in the cost of the input(s) a firm makes internally credibly commits it to be more aggressive in negotiations with a supplier for the input(s) it buys. Recognizing its potential information rents will be limited, the supplier, in turn, becomes less aggressive in information acquisition. The paper fully characterizes the equilibrium – the firm's cost-cutting investments, the supplier's information acquisition decision, and the terms of trade – to demonstrate that often-maligned internal bloat can be an endogenous facilitator of efficient outsourcing