A Transaction Cost Approach to Make-or-Buy Decisions

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

2. Purpose of the paper • Transaction cost • Uncertainty • Asset specificity Make or buy decisions Production cost

3. Given moderate uncertainty Costs Governance cost when AS is low Internal organization > market Proxies for AS - Supplier competition - Buyer experience Asset specificity A Governance cost when AS is high Internal organization < market ΔTC Governance cost difference between internal organization and market

4. Given moderate uncertainty Production cost when AS is low Internal organization > market Costs Production cost when AS is high Internal organization > market BUT get close to each other ΔPC Asset specificity Proxies for PC Supplier production advantage

5. Given moderate uncertainty Proxies for uncertainty - Volume uncertainty - Technological uncertainty Costs Asset specificity A A’ Make or Buy decision ΔPC + ΔTC

7. Uncertainty Hypothesis 1, 2 Technological uncertainty negative Volume uncertainty Buy decision negative

8. production cost Hypothesis 3, 4 Supplier Competition Supplier Production advantage positive Positive Buy decision

9. Asset specificity Hypothesis 5, 6, 7, 8 Supplier Competition Supplier Production advantage Negative positive Technological uncertainty Buyer experience Negative positive Buy decision

10. Hypotheses

11. Full model Supplier Competition Supplier Production advantage positive Negative positive Technological uncertainty Buyer experience Negative Positive positive negative Volume uncertainty Buy decision Buy decision negative

13. Method and data The data consisted of 60 decisions made in a component division of a large U.S. automobile manufacturer over a period of three years The data were analyzed using the unweighted least squars (ULS) procedure

17. Results Supplier Competition (reverse scale) Supplier Production advantage -.315* -.198 .205* Technological uncertainty Buyer experience .862* -.316* .155 .034 Volume uncertainty Buy decision -.284*

18. Results (Mixed support for Williamson’s theory)

19. Discussion • Production costs were likely to be salient in the decision-making process • Transaction costs have small but significant effects • Limitations: -small sample size -data from a single corporate division -relative simplicity of the components