Outsourcing, Information Leakage and Consulting Firms

Abstract

This paper offers a general equilibrium model to analyze the problem of R&D investment of firms that also face the decision between outsourcing and in-house production in the presence of R&D information leakage. A contractor hired by a firm learns the firm's technology and can diffuse the information to other firms, either by selling it or by "spilling" it involuntarily. I find that information leakage concerns tend to concentrate the outsourcing market with respect to a situation in which information leakage is not present. In particular, despite the fact that the original outsourcing market is perfectly competitive, I find that when a market for information arises in equilibrium, such a market is always monopolistic. I show that a market for information arises when contractors have a positive but low degree of control on the information they hold. If contractors do not have any control on the information they hold, the market splits into a positive measure of technologically advanced firms that never outsource and a positive measure of low-tech firms that always outsource. If contractors have full information control, all firms invest in technology and outsource, and a market for information never arises. The structure of the equilibria of the model captures several features observable in the management consulting industry.

Keywords: Outsourcing, Information Leakage

JEL Classification: L2, O3