Electronic Markets, Search Costs, and Firm Boundaries
Authors: Sankaranarayanan, Ramesh; Sundararajan, Arun
Journal: Information Systems Research (2010)
<jats:p> We study how interorganizational systems (IOS) such as electronic markets and other enabling information technologies that facilitate broader interfirm transactions affect the extent of outsourcing in firms. We do so by modeling firms in a three-tier value chain consisting of buyers, intermediaries, and suppliers, who can interact using IOS that lower the procurement search costs associated with finding appropriate trading partners. In the context of complex business-to-business (B2B) search, we study how decreasing search costs affect a firm's decision to insource or outsource the procurement function, depending on whether the search process is information intensive or communication intensive. Variation in search costs changes the transaction costs of interaction between firms, as well as the contracting costs associated with outsourcing, owing to changes in the costs of moral hazard for delegated search. We study these effects in a new model that integrates search theory into the principal-agent framework, and establish that the optimal outsourcing contract has a simple “all or nothing” performance-based structure under fairly general assumptions. Our model predicts tha…