Outsourcing, Information Leakage and Consulting Firms

M.Baccara

Abstract

This paper offers a model to analyze the problem of investment in technology of firms that also decide between outsourcing a productive activity or protecting their R&D investment from information leakage. A contractor hired by a firm learns its technology and can cause its diffusion to the rest of the market. Information diffuses either because the contractor sells it, or because he involuntarly "spills" it to a fixed set of other firms. Despite the fact that the original contractor market is competitive, I find that when a market for information arises in equilibrium, such market is always monopolistic. I show that a monopolistic market for information arises when contractors have a positive but low degree of information control. If contractors do not have information control, the market splits into technological advanced firms that never outsource and low-tech firms that always outsource. If contractors have full information control, all firms invest in technology and outsource.As the degree of information control of contractors increases, the equilibrium technology level decreases and the set of firms that adopt such technology increases. The structure of the equilibria of the model captures several features observable in the management consulting industry.