ISER Discussion Paper, Institute of Social and Economic Research, Osaka University 936
This paper examines the role of dual sourcing (e.g., outside options) in vertical and horizontal relations. In a bilateral monopoly market, if either the upstream or downstream firm has outside options, the other firm could lose from seemingly positive shocks, e.g., market expansion or technology improvements. We extend this setting to a bilateral duopoly market in which each downstream firm has outside options and upstream firms can engage in cost reducing investments and generate technological spillovers. We find that each upstream firm has an incentive to voluntarily generate technological spillovers to its upstream rival if the downstream firms have better outside options.