Outsourcing a Two-Level Service Process

  • Authors:

  • Hsiao-Hui Lee;Edieal J. Pinker;Robert A. Shumsky

  • Affiliations:

  • School of Business, University of Hong Kong, Pok Fu Lam, Hong Kong;Simon School of Business, University of Rochester, Rochester, New York 14627;Tuck School of Business, Dartmouth College, Hanover, New Hampshire 03755

  • Venue:
  • Management Science
  • Year:
  • 2012

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Abstract

This paper studies outsourcing decisions for a two-level service process in which the first level serves as a gatekeeper for a second level of experts. The objective of the system operator (the client) is to minimize the sum of staffing costs, customer waiting costs, and mistreatment costs due to unsuccessful attempts by a gatekeeper to solve the customer's problem. The client may outsource all or part of the process to a vendor, and first-best contracts exist when the client outsources only gatekeepers or experts. When the client outsources the entire system as a two-level process, a client-optimal contract may not exist unless the exogenous system parameters satisfy a particular (and unlikely) coordination condition. In addition, optimal incentive-compatible contracts exist when the vendor's structure choice (one level or two levels) can deviate from the client's preference. Finally, we numerically examine how vendor structure choice and labor cost advantages influence the client's optimal outsourcing option. This paper was accepted by Martin Lariviere, operations management.