Working Papers, Department of Economics, Lund University
On the Cost-vs-Quality Tradeoff in Make-or-Buy Decisions
Abstract: The make-or-buy decision is analyzed in a simple two-task
principal-agent model. There is a cost-saving/quality tradeoff in effort
provision. The principal faces a dichotomous choice between weak ("make")
and strong ("buy") cost-saving incentives for the agent; the dichotomy is
due to an incomplete-contracting limitation necessitating that one party be
residual claimant. Choosing "buy" rather than "make" leads to higher
cost-saving effort and -- in a plausible "main case" -- to lower quality
effort; this in spite of stronger direct quality-provision incentives in
the former case.
Keywords: make-or-buy decision; manipulation; outsourcing; (follow links to similar papers)
JEL-Codes: D23; L24; L25; (follow links to similar papers)
19 pages, March 26, 2010
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