Optimal procurement and outsourcing of production in small industries

I study the interaction between optimal procurement and outsourcing of production in small industries. First, two sellers decide about outsourcing. By outsourcing, a seller loses information about the costs of producing to his supplier. Then the buyer designs the procurement mechanism and sellers who outsourced production subcontract with their respective suppliers. The focal equilibrium might exhibit bilateral outsourcing although outsourcing is modeled to have no direct positive effects. When a seller is able to extract his supplier s rent ex ante, the focal equilibrium exhibits bilateral outsourcing for any distribution of production costs satisfying a regularity condition.