Transaction Cost Approach to Make-or-Buy Decisions in Business

A Transaction Cost Approach to A Transaction Cost Approach to Make Make- -or or- -Buy Buy Decisions Decisions Gordon Walker and David Weber Gordon Walker and David Weber Administrative Science Quarterly, 29 (1984): 373 Administrative Science Quarterly, 29 (1984): 373- -391 391

Focus of This Paper Focus of This Paper This paper focuses on the Make-or-Buy decision as a paradigmatic problem for analyzing transaction costs.

Structure of This Paper Structure of This Paper Reviewing existing theory; Reviewing existing theory; Assumptions for the study in this paper; Assumptions for the study in this paper; Building models for testing the theory Building models for testing the theory Hypothesis; Data; Method; Results Hypothesis; Data; Method; Results Discussion Discussion

Reviewing Existing Theory Ways of Managing the Buyer Ways of Managing the Buyer- -Supplier relationship 1. Ouchi Ouchi, , Harrigan Harrigan, Blois , Blois 2. This paper use Prototypical choice 2. This paper use Prototypical choice Supplier relationship Anderson(1982) and Anderson(1982) and Monteverde 1. Asset specificity; uncertainty 2. Asset specificity on backward integration Monteverde & & Teece Teece (1982a) (1982a)

Reviewing Existing Theory Williamson s Efficient boundaries Framework (1981) 1. The administrative mechanisms whose efficiency is at issue 1. The administrative mechanisms whose efficiency is at issue 2. The dimensions of transactions that determine how efficiently a particular 2. The dimensions of transactions that determine how efficiently a particular administrative mechanism performs administrative mechanism performs 3. 3.

Assumptions Assume sufficient uncertainty was inherent in all transactions Assume sufficient uncertainty was inherent in all transactions difficult for buyer to neutralize potential supplier opportunism difficult for buyer to neutralize potential supplier opportunism effectively through contingent claims contracts effectively through contingent claims contracts Assume Assume different types of uncertainty influenced transaction different types of uncertainty influenced transaction costs independent of the level of asset specificity costs independent of the level of asset specificity Consider two types of uncertainty Consider two types of uncertainty volume (i.e., demand) and technological technological volume (i.e., demand) and

Model in This Paper Model in This Paper - - Hypotheses Hypotheses H1/r1 Volume uncertainty leads to making rather than buying a component H2/ 1 Technological uncertainty increases the likelihood of a make rather than a buy decision. H3/ 2 The higher the supplier production cost advantage, the more likely the firm is to buy rather than make a component. H4/r2 The competitiveness of the supplier market increases the production cost advantage of suppliers over buyers. H5/r3 Greater supplier market competition should lead to buying the component. H6/r4 The experience a buyer has in producing a component reduces the production cost advantage of the supplier over the buyer. H7/r5 Buyer experience in producing a component increases the likelihood of a buy decision. H8/r6 Buyer experience in component production reduces technological uncertainty associated with the component.

Model in This Paper Model in This Paper - - Indicators Indicators Volume Uncertainty Technological Uncertainty Supplier Production Advantage Competition among suppliers Buyer Experience Changes in specifications competitive quotes Buyer tools and equipment Expected Volume Fluctuations Difference in Manufacturing porcess Difference in scale of operations Buyer Technological improvements Number of suppliers Uncertain Volume Estimates manufacturing technology Suppilier proprietary technology Annual savings to make a component

Model in This Paper Data and Methods 60 decisions; one component division of a large U.S. automobile manufacturer; three years Un-weighted least squares (ULS)

Model in This Paper Model in This Paper - - Results Results

Model in This Paper Model in This Paper - - Results Results Supplier Competition (reverse scale) -.315* Supplier Production advantage .862* -.316* Buyer experience Technological uncertainty .155 .034 -.284* Volume uncertainty Make or Buy decision 11

Discussion Discussion Limitations of this paper Limitations of this paper Small sample size; data from single corporation division limit the generalizability of findings Relative simplicity of the components failure of part of the model For managers use: when more information is needed? For managers use: when more information is needed? Data were available as a base for judgments Data must be related to more general experience Manager s judgment based on extensive general experience rather than specific data For Future Study For Future Study Implicit assumption costs of administering inter-functional coordination within the firm were virtually independent of the transaction costs associated with contracting in the market Is it valid? Other Discussions Other Discussions