Outsourcing, Complementary Innovations and Growth

of supplier and assembler entrants are similar. This suggests that outsourcing tends to take place
in situations where it accelerates innovation. Nonetheless, the overlap is not complete. Recall from
inequality (26) that all firms choose to outsource if λ is sufficiently high. On the other hand, (27),
(29) and (30) reveal that whether outsourcing promotes faster innovation than vertical integration
is independent from λ. The reason is that, once all firms have chosen to vertically integrate or
outsource, λ no longer enters their profits, as they all enjoy the same market share (E∕v or E∕f
respectively). This creates circumstances under which all firms outsource when vertical integration
would lead to a higher speed of innovation. Specifically, using (27), (29) and (30) to set g^lf = g&
and g& = g^,ff, we can determine the range of ω in which outsourcing speeds innovation. The upper
and lower bounds of this range are

k_s L(l — a)     ʌ     k_m L(l — a) — apk_υ

ω_s = l---and ω_m =----------------.

kυ L T apk_s          ky L(l — a) — apk_m

They correspond to the two scenarios of η(r) = l and η(r) < l respectively and can be ranked
ω_s > ω_m as long as k_υ > L[k_s(l — a) + k_m]/ (L + apk_s). The range [ω_mpω_s] in which outsourcing
brings faster innovation is wider the higher the relative R&D cost advantage for specialized blueprints
with respect to vertically integrated ones (the smaller k_s∕k_υ and k_m∕k_υ). We can then write:

Proposition 2 Firms choose outsourcing rather than vertical integration and their decision leads
to accelerated innovation if and only if λ> λ and ω _m < ω < ω _s.

If λ > λ and ω < ω_m or ω > ω_s, firms choose outsourcing when vertical integration maximizes the
speed of innovation. If λ < λ and ω_m < ω < ω_s, firms choose vertical integration when outsourcing
maximizes the speed of innovation. If λ < λ and ω < ω_m or ω > ω_s, firms choose vertical integration
and this promotes innovation.

The patterned region in Figure 3 represents the combinations of λ and ω where outsourcing is
chosen by firms for given parameter values. The figure then illustrates whether the organizational
decisions of firms coincide with a higher speed of innovation in the economy. The shaded pattern
area shows the region where firms outsource and their decision to do so accelerates the rate of
innovation. On the other hand, the white patterned area shows the area where firms’ decision to

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