Mutual Outsourcing Between Downstream Firms on Endogenous Competition

ABSTRACT In vertically related markets with exclusive channels, we demonstrate endogenous choice of competition mode under mutual outsourcing between downstream manufacturers. In contrast to previous results, the upstream supplier charges the downstream manufacturer an input price lower (higher) than the unit production cost under Bertrand (Cournot) competition. Thus, asymmetric competition can emerge as equilibrium with the possibility of achieving the highest social welfare when the level of product differentiation is moderate. Finally, when the degree of differentiation is low (high), Bertrand (Cournot) competition emerges as equilibrium, leading to Pareto efficiency (prisoner's dilemma) under fierce (mild) competition.