Outsourcing versus technology transfer: Hotelling meets Stackelberg

We consider a Hotelling duopoly with two firms <InlineEquation ID="IEq1"> <EquationSource Format="TEX">$$A$$</EquationSource> </InlineEquation> and <InlineEquation ID="IEq2"> <EquationSource Format="TEX">$$B$$</EquationSource> </InlineEquation> in the final good market. Both can produce the required intermediate good, firm <InlineEquation ID="IEq3"> <EquationSource Format="TEX">$$B$$</EquationSource> </InlineEquation> having a lower cost due to a superior technology. We compare two contracts: outsourcing (<InlineEquation ID="IEq4"> <EquationSource Format="TEX">$$A$$</EquationSource> </InlineEquation> orders the intermediate good from <InlineEquation ID="IEq5"> <EquationSource Format="TEX">$$B$$</EquationSource> </InlineEquation>) and technology transfer (<InlineEquation ID="IEq6"> <EquationSource Format="TEX">$$B$$</EquationSource> </InlineEquation> transfers its technology to <InlineEquation ID="IEq7"> <EquationSource Format="TEX">$$A$$</EquationSource> </InlineEquation>). An outsourcing order is equivalent to building an endogenous capacity and it generates a Stackelberg leadership effect for firm <InlineEquation ID="IEq8"> <EquationSource Format="TEX">$$A,$$</EquationSource> </InlineEquation> 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 <InlineEquation ID="IEq9"> <EquationSource Format="TEX">$$B$$</EquationSource> </InlineEquation> has a relatively large bargaining power in its negotiations with <InlineEquation ID="IEq10"> <EquationSource Format="TEX">$$A,$$</EquationSource> </InlineEquation> then both firms prefer technology transfer while all consumers prefer outsourcing. Copyright Springer-Verlag Wien 2014