《系统工程》课程教学资源（英文文献）A Study on the Loss of Profit from Logistics Outsourcing

A Study on the Loss of Profit from Logistics OutsourcingAbstract:This paperdiscusses the possible loss of profitfrom logistics non-internalization ofexternality,inefficientallocationof inputs,and industrial organization are used inthe outsourcing interms of double price-cost mark-ups. The theories of information economics industrial organizationare used in thepaper.Key words: logistics outsourcing, information; industrial organizationO The definition of logistics outsourcing and the focus of this paperLogistics Outsourcing"is defined in this papers an economic activity in which the upstreammembers and the downstream members in a logistics chain re-place their vertical integration with amarketrelation-shipThere are so many segments along a logistics chain that it is almost impossible for one companyto cover every segment. Therefore, in deciding whether to integrate the upstream and downstreamsegments or to outsource some segments, one needs to compare the potential differences in profit. Inregards to the benefits of outsourcing, there is already research on efficiency in specializationHowever the focus of this paper is to study the potential cost that may follow the outsourcing based onthe theory of information economics and industrial organization.1 Logistics outsourcing and transaction costsTransaction cost includes all opportunity costs related to the transaction and is the scarceresource consumed in the transaction process. When the vertical integration between the upstream andthe downstream gives way to outsourcing, new transaction costs will appear, such as cost ofinformation collection before the transaction, cost of negotiation, cost of execution and cost offollow-upactions.1.1Cost of information collection before the transactionWhen a logistics company intents to outsource, it will try to locate a suitable supplier from manypotential suppliers in a competitive market. This will cost both energy and money. Information is to becollected to locate the supplier, the quality, the price, reliability, reliability, etc. Also, due to defects inmethod, judgment of information or even moral hazards from information source, the informationcollected can be distorted or erroneous, which imposes a further cost to the process

A Study on the Loss of Profit from Logistics Outsourcing Abstract: This paper discusses the possible loss of profit from logistics non-internalization of externality, inefficient allocation of inputs, and industrial organization are used in the outsourcing in terms of double price-cost mark-ups. The theories of information economics industrial organization are used in the paper. Key words: logistics outsourcing; information; industrial organization 0 The definition of logistics outsourcing and the focus of this paper “Logistics Outsourcing” is defined in this papers an economic activity in which the upstream members and the downstream members in a logistics chain re-place their vertical integration with a market relation-ship. There are so many segments along a logistics chain that it is almost impossible for one company to cover every segment. Therefore, in deciding whether to integrate the upstream and downstream segments or to outsource some segments, one needs to compare the potential differences in profit. In regards to the benefits of outsourcing, there is already research on efficiency in specialization. However the focus of this paper is to study the potential cost that may follow the outsourcing based on the theory of information economics and industrial organization. 1 Logistics outsourcing and transaction costs Transaction cost includes all opportunity costs related to the transaction and is the scarce resource consumed in the transaction process. When the vertical integration between the upstream and the downstream gives way to outsourcing, new transaction costs will appear, such as cost of information collection before the transaction, cost of negotiation, cost of execution and cost of follow-up actions. 1.1Cost of information collection before the transaction When a logistics company intents to outsource, it will try to locate a suitable supplier from many potential suppliers in a competitive market. This will cost both energy and money. Information is to be collected to locate the supplier, the quality, the price, reliability, reliability, etc. Also, due to defects in method, judgment of information or even moral hazards from information source, the information collected can be distorted or erroneous, which imposes a further cost to the process

1.2 Cost of negotiationTo outsource is to negotiate beforehand. Costs involved in this process including losses that mayincur from limits of perception, the asymmetry of information and the asymmetry of the expression inthe agreement.1.3Corm of executionWhen a trade agreement is executed, the work of the outsourced supplier needs to be supervisedin some form and to some extent. This will bring extra cost to the logistics company. Additional costmay incur due to the asymmetry of information and moral hazard of the outsourced supplier1. 4 Cost or follow-up scionsNo matter how much effort has been put by both sides into the agreement, it will not stipulate allrights and responsibilities for all incidents that may happen afterwards. Therefore, there will be thecost of follow-up actions when the logistics company and the supplier amend the agreement or settledisputes and there will be losses brought by uncertain factors.2 Outsourcing and loss from non-internalization of external economyWhen the upstream or downstream segments with a network character (e. g. interregionaltransportation) of a prestigious logistics company are integrated, clients will recognize the high-levelservice quality of all these segments. This is a benefit from the internalization of external economyHowever,outsourcingwill notenjoythisadvantage.3 Outsourcing and the non-efficient combination of a downstreamcompany's input3.1Basicassumptions ofthemodelWe assume thatthe upstream logistics company is Awhile the downstream logistics company isB, i.e. A is the supplier of B. We further assume that A is dominant in the market, while B is facedwith competition in the market. B not only acquires services from A but also purchases a second inputfactor. The production marginal cost of A is MCA. The price of services sold to B from A is PA. Theprice of the second input factor purchased by B from another channel is Po. The price of services soldto clients from B is PB. (SeeFigure 1)The services provided by A is QA. The second input factor in B's production is Qo. The servicessoldtoclientsfromB isQB.Wearetofind out if theintegrationofAandBwill resultinadditionalprofit

1.2 Cost of negotiation To outsource is to negotiate beforehand. Costs involved in this process including losses that may incur from limits of perception, the asymmetry of information and the asymmetry of the expression in the agreement. 1.3 Corm of execution When a trade agreement is executed, the work of the outsourced supplier needs to be supervised in some form and to some extent. This will bring extra cost to the logistics company. Additional cost may incur due to the asymmetry of information and moral hazard of the outsourced supplier. 1. 4 Cost or follow-up scions No matter how much effort has been put by both sides into the agreement, it will not stipulate all rights and responsibilities for all incidents that may happen afterwards. Therefore, there will be the cost of follow-up actions when the logistics company and the supplier amend the agreement or settle disputes and there will be losses brought by uncertain factors. 2 Outsourcing and loss from non-internalization of external economy When the upstream or downstream segments with a network character (e. g. interregional transportation) of a prestigious logistics company are integrated, clients will recognize the high-level service quality of all these segments. This is a benefit from the internalization of external economy. However, outsourcing will not enjoy this advantage. 3 Outsourcing and the non-efficient combination of a downstream company’s input 3.1 Basic assumptions of the model We assume that the upstream logistics company is A while the downstream logistics company is B, i.e. A is the supplier of B. We further assume that A is dominant in the market, while B is faced with competition in the market. B not only acquires services from A but also purchases a second input factor. The production marginal cost of A is MCA. The price of services sold to B from A is PA. The price of the second input factor purchased by B from another channel is Po. The price of services sold to clients from B is PB. (See Figure 1) The services provided by A is QA. The second input factor in B’s production is QO. The services sold to clients from B is QB. We are to find out if the integration of A and B will result in additional profit

3. 2 On condition that the ratio between inputs is fixed for the downstream companyWe assume that the ratio between the two inputs in B's production is fixed. For example, 1 unitQAand I unit QO can produce 1 unit QB.If A integrates downstream, its dominance in market will pass on to the market of Q. Themarginal cost of the integrated company for output Q will be MLa+ Po. An integrated company willmake its marginal cost equal to its marginal revenue to achieve maximum profit. ( See Figure 2) P(Qs )is the demand curve of Qs.MR is the marginal revenue of the integrated company for the sale of Q.When the marginal revenue equals the marginal cost, for the integrated company, where the output isQB and the price is P*, the profit 元 is (Pg'-(MCA+Po)Qb*If A does not integrate downstream, the market for Q will remain a competitive one. Then, thedemand curveforAcanbederivedfromthedemand curveofBasthedemandforAis infactthehighestpricethatAcan chargeB atanyspecificQA.Asone ofthecompetingcompanies,Bcan sellits products at a unit price of PB while paying Pofor the second input factor Qo to generate 1 unit ofoutput. Thus, the maximum extra B is willing to pay for I unit QAis Pg-Po. So, the demand of A is thedemand of B minus Po. The demand curves are shown in figure 3.From above, we see that the demand curve P(QA) of A is acquired when the demand curve of B ismoved downwards by Po. MRA is the marginal revenue of A. When the marginal revenue equals themarginal cost for A, where the output is QA'and the price is PA, the profit 元 is(PA-MCA)QA*=(Pg*(MCA+Po)Qs'.Hence, profit is exactly the same with or without integration.To summarize, when the ratio between inputs is fixed for the downstream competitive company.profit will be the same whether the upstream dominant company integrates downstream or acts as anoutsourced supplier of the downstream company, the reason being that an increase of 1 dollar in theservice price of the upstream company will lead to 1 dollar increase in the marginal cost of thedownstream company and in turn, 1 dollar increase in the selling price to clients. That is to say, theupstream company can fully control the final selling price to clients even without vertical integration.3.3 On condition that the ratio between inputs is variable for the downstream companyWe assume that the ratio between the two inputs in B's production is variable. If A does notintegrate downstream, A will not have full control over B as B will replace part of A's service withalternative Qo when A increases price. We know that to achieve efficient production, the slope of theIsoquant Curve should be the same as the cost of input. In the above case, however, B employs toomuch Qo and too little QA, and therefore, the replacement will lead to non-efficient production of B

3. 2 On condition that the ratio between inputs is fixed for the downstream company We assume that the ratio between the two inputs in B’s production is fixed. For example, 1 unit QA and 1 unit QO can produce 1 unit QB. If A integrates downstream, its dominance in market will pass on to the market of QB. The marginal cost of the integrated company for output QB will be MLA+ PO. An integrated company will make its marginal cost equal to its marginal revenue to achieve maximum profit. ( See Figure 2) P(QB ) is the demand curve of QB.MR is the marginal revenue of the integrated company for the sale of QB. When the marginal revenue equals the marginal cost, for the integrated company, where the output is QB * and the price is PB*, the profit π * is (PB * -(MCA+PO))QB *· If A does not integrate downstream, the market for QB will remain a competitive one. Then, the demand curve for A can be derived from the demand curve of B as the demand for A is in fact the highest price that A can charge B at any specific QA. As one of the competing companies, B can sell its products at a unit price of PB while paying PO for the second input factor QO to generate 1 unit of output. Thus, the maximum extra B is willing to pay for 1 unit QA is PB-PO. So, the demand of A is the demand of B minus Po. The demand curves are shown in figure 3. From above, we see that the demand curve P(QA) of A is acquired when the demand curve of B is moved downwards by PO. MRA is the marginal revenue of A. When the marginal revenue equals the marginal cost for A, where the output is QA * and the price is PA * , the profit π * is(PA * -MCA)QA * =(PB * - (MCA+PO))Qs* .Hence, profit is exactly the same with or without integration. To summarize, when the ratio between inputs is fixed for the downstream competitive company, profit will be the same whether the upstream dominant company integrates downstream or acts as an outsourced supplier of the downstream company, the reason being that an increase of 1 dollar in the service price of the upstream company will lead to 1 dollar increase in the marginal cost of the downstream company and in turn, 1 dollar increase in the selling price to clients. That is to say, the upstream company can fully control the final selling price to clients even without vertical integration. 3.3 On condition that the ratio between inputs is variable for the downstream company We assume that the ratio between the two inputs in B’s production is variable. If A does not integrate downstream, A will not have full control over B as B will replace part of A’s service with alternative QO when A increases price. We know that to achieve efficient production, the slope of the Isoquant Curve should be the same as the cost of input. In the above case, however, B employs too much QO and too little QA, and therefore, the replacement will lead to non-efficient production of B

and consequently,less profit for A.However, when A integrates downstream, it will have full control to ensure that the most efficientcombination of QA, and Q is used to increase profit.3.4Summaryofthis sectionOn condition that the input ratio is variable for the downstream company, the profit of thedominant upstream company will decrease if it does not integrate vertically because outsourcing bythedownstream company will lead toa non-efficient combination of the latter'production input.4Outsourcinganddoublemarkup4.1 Basic assumptions of the modelWe assume that the upstream logistics company is A while the downstream logistics company isB, i. e., A is the supplier of B. The only input required for B's production is QA purchased from A, 1unit of which produces 1 unit of QB. We further assume that both A and B are dominant in the market.Theproductionmarginal costofAisMCA.ThepriceofservicessoldtoBfromAisPA.Thepriceofservices sold to clients from. B is PB.4.2 On condition that the upstream the downstream are not vertically integratedAs illustrated in Figure 4, the demand of B is P (Q), the marginal revenue is MRg and themarginal cost is the service price of A, PA. For any PA, B will align its marginal revenue with PA.resulting in a marginal revenue curve for B the same as the demand curve P(QA).For A, the marginalrevenue is MRA and the marginal cost is MCA. The marginal revenue of A will be brought in linewith the marginal cost. So, When the Output is QA and the price is PA, the profit πA is (PA-MCA) QA*.When the service price of A is PA, 13 will align its marginal revenue with PA.Hence, Q-=QA*When price is P, the profit is (Pg -PA*)QB*From the above, we can see a clear double mark-up as both companies added mark-up on theirpaces.4.3 On Condition that the upstream and the downstream are vertically integrated.When a new company is formed through vertical integration of the upstream and the downstream,itsprofitstructureis explained infigure5.The demand curve is P(QB ).The marginal revenue is MRB. The marginal cost is MCA. Whenthe marginal revenue is the same as the marginal cost, for the company where the output is Q' and theprice is PA', the profit 元A is (PA-MCA) Q"AsQ'=2QA*=2QB’,元+-元A>TB,i.e.,元A*+元B*<元+

and consequently, less profit for A. However, when A integrates downstream, it will have full control to ensure that the most efficient combination of QA, and QB is used to increase profit. 3.4 Summary of this section On condition that the input ratio is variable for the downstream company, the profit of the dominant upstream company will decrease if it does not integrate vertically because outsourcing by the downstream company will lead to a non-efficient combination of the latter' production input. 4 Outsourcing and double mark up 4.1 Basic assumptions of the model We assume that the upstream logistics company is A while the downstream logistics company is B, i. e., A is the supplier of B. The only input required for B's production is QA purchased from A, 1 unit of which produces 1 unit of QB. We further assume that both A and B are dominant in the market. The production marginal cost of A is MCA. The price of services sold to B from A is PA. The price of services sold to clients from. B is PB. 4.2 On condition that the upstream the downstream are not vertically integrated As illustrated in Figure 4, the demand of B is P (QB), the marginal revenue is MRB and the marginal cost is the service price of A, PA. For any PA, B will align its marginal revenue with PA, resulting in a marginal revenue curve for B the same as the demand curve P ( QA).For A, the marginal revenue is MRA and the marginal cost is MCA. The marginal revenue of A will be brought in line with the marginal cost. So, When the Output is QA * and the price is PA, the profit πA is (PA-MCA) QA * . When the service price of A is PA * , 13 will align its marginal revenue with PA * .Hence, QB * ==QA *. When price is PB * , the profit is (PB * -PA * )QB * . From the above, we can see a clear double mark-up as both companies added mark-up on their paces. 4.3 On Condition that the upstream and the downstream are vertically integrated. When a new company is formed through vertical integration of the upstream and the downstream, its profit structure is explained in figure 5. The demand curve is P(QB ).The marginal revenue is MRB. The marginal cost is MCA. When the marginal revenue is the same as the marginal cost, for the company where the output is Q* and the price is PA * , the profit πA is (PA-MCA) Q*. As Q* =2QA * =2QB * , π*-πA>πB, i. e., πA*+πB*<π*

4.4Summaryof this chapterOn condition that both the upstream company and the downstream company dominate the market,profit of both companies will decrease when their integrated relationship is replaced by marketoutsourcingbecause of adoublingup inmarkup5ConclusionLogisticsoutsourcingwillleadtoreduction inprofit.Reasons as listedbelowA. Additional transaction cost;B. Lass from non-internalization of external economy,C.Non-efficient input combination of competitivedownstreamcompanywith variableinput ratiowhen the upstream company is dominant in market,D.Double markup for market dominant upstream company and downstream company

4.4 Summary of this chapter On condition that both the upstream company and the downstream company dominate the market, profit of both companies will decrease when their integrated relationship is replaced by market outsourcing because of a doubling up in markup. 5 Conclusion Logistics outsourcing will lead to reduction in profit. Reasons as listed below: A. Additional transaction cost; B. Lass from non-internalization of external economy; C. Non-efficient input combination of competitive downstream company with variable input ratio when the upstream company is dominant in market; D. Double markup for market dominant upstream company and downstream company