Outsourcing versus FDI in oligopoly equilibrium

We consider the make-or-buy decision of oligopolistic firms in an industry in which final good production requires specialized inputs. Factor price considerations dictate that firms acquire the intermediate abroad, by either producing it in a wholly owned subsidiary or outsourcing it to a supplier who must make a relationship-specific investment. Firms’ internationalization mode depends on cost and strategic considerations. Crucially, asymmetric equilibria emerge, with firms choosing different modes of internationalization, even when they are ex ante identical. With ex ante asymmetries, lower cost producers have a stronger incentive to vertically integrate (FDI), while higher cost firms are more likely to outsource.