The Make-or-Buy Decision in the Presence of a Rival: Strategic Outsourcing to a Common Supplier

Firms routinely decide whether to make essential inputs themselves or buy the inputs from independent suppliers. Conventional wisdom suggests that a firm will not buy an input for a price above its in-house cost of production. We show that this is not necessarily the case when a monopolistic input supplier also serves the firm's retail rival. In this case, the decision to buy the input (and thus become one of the supplier's customers) can limit the incentive the supplier would otherwise have to provide the input on particularly favorable terms to the retail rival. Thus, a retail competitor may pay a premium to outsource production to a common supplier in order to raise its rivals’ costs.