Asymmetric information and economies of scale in service contracting

We consider outsourcing in two important service settings: call center and order fulfillment operations. An important factor in both is the inherent economies of scale. Therefore, we advance a unifying model covering both applications and study the associated contracting problem under information asymmetry. At the time of contracting, the outsourcing firm, "the originator," faces uncertainty regarding the demand volume but has private information about its probability distribution. The true demand is quickly observed once the service commences. The service provider invests in capacity before the start of the operation and offers a menu of contracts to screen different types of the originator. Adopting a mechanism design approach, we prove that a menu of two-part tariffs achieves the full-information solution. Hence, it is optimal among all possible contracts (in both settings) because of economies of scale and contractibility of realized demand.