Optimal contract design for outsourcing: pricing and quality decisions

Outsourcing is currently being used as an important strategy for many companies in the USA to focus on the core competency, reduce cost and increase profit. We consider a company (buyer) outsourcing a part of her service. One of the main concerns of outsourcing is the quality of service. We use a game theoretic model to design optimal contracts between the buyer and the service supplier under the full information and the asymmetric information. In both cases, we find the optimum outsourcing quantity, quality, price and a cut-off point that will make the contract unsuitable.