Title: Selection into Outsourcing versus Integration Strategies for Heterogeneous Multinationals

Author: Sangho Shin(BOK)

 We propose a complex global sourcing model in which heterogeneous multinational firms can utilize outsourcing as an additional strategy, connect it to the location choice, and choose firm boundaries based on productivity. With the benchmark that is the generalized version of existing models of Foreign Direct Investment(FDI), the effect of outsourcing is analyzed at the margins. The analysis reveals that the equilibrium regime of firms is determined by industry characteristics such as the relative fixed costs and the outsourcing related parameter which represents the trade-off between reduction in the marginal costs and contractual friction of outsourcing. In the model, when the outsourcing option is available to firms under the conditions of fewer fixed costs with contractual friction, the most productive firms keep engaging in the complex FDI strategy. Mid-productive firms, however, change their strategy from integration to outsourcing, which enables them to have access to lower unit costs of production and higher operating profits. Additionally, the shift of the equilibrium regime in our model would hint the welfare effect of trade that can be measured substantially large when industrial organization matters.