Vertical Outsourcing and Location Choice

Most regional literature focuses on competition among final goods, but little of it integrates an intermediate goods market into the models used. This paper develops a variant of Hotelling's model involving an intermediate goods market in order to explore the location choices of firms. We consider interactions among three firms: a wholesale supplier of an essential input and two retail producers. One of these retailers is a vertically integrated firm. The other is an independent downstream firm. Within this framework, this paper will discuss the role of strategic vertical outsourcing in determining optimal locations for firms, and it will also explore the input pricing of wholesale suppliers. In general, the two firms were located more closely when the vertically integrated firm had a cost advantage without taking strategic outsourcing into consideration. However, the price of the input may increase when we take strategic vertical outsourcing into account in the model, and this may cause the two firms to move farther away, giving rise to the Principle of Minimum Differentiation.