A Transaction Cost Approach to Make-or-Buy Decisions

1. A Transaction Cost Approach to Make-or-Buy Decisions Gordon Walker and David Weber Presenter: Wen ZHENG

2. Research Question • Apply transaction cost framework to investigate make-or-buy decisions for relative simple components in a manufacturing division of a large U.S. automobile company. • Transaction cost • Production Cost

3. Theory and Hypothesis • Williamson (1981) • Production cost (ΔPC) • Buyers’ production Cost -Supplier’s production cost • Transaction cost • Transaction cost of buy -Transaction cost of make

4. Theory and Hypothesis • Williamson (1981) • Make or buy=f(asset specificity * uncertainty) • Walker and Weber (1984) • Make or buy= f(asset specificity, uncertainty)

5. Theory and Hypothesis • Williamson (1981) • Make or buy=f(asset specificity * uncertainty) • Walker and Weber (1984) • Make or buy= f(asset specificity, uncertainty) Supplier Market Competition Volume uncertainty Technological Uncertainty

6. Theory and Hypothesis H1 H2 H3 H4 H5 H7 H6 H8

7. Empirical Test • Sample • 60 decisions made in a component division of a large U.S. automobile manufacture over a period of three years • Method • Structure Equation Model (SEM) • Unweighted Least Squares (ULS)

8. Variables Supplier Competition Buyer Experience Volume Uncertainty Supplier Advantage Technological Uncertainty

9. SEM

10. Results

11. Results H3 H5 H7 H2 H1

12. Results H4

13. Results H6 H8

14. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy >  PC make/buy • Volume Uncertainty TC > Technological Uncertainty TC • Buyer Experience  PC • Buyer Experience  make/buy • Technological Uncertainty make/buy

15. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Simplicity • Division outcomes > Functional outcomes

16. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy >  PC make/buy • Method bias • Implicit Assumption: the cost of administrating interfunctionalcoordination within the firm were virtually independent of the transaction cost associated with contracting in the market

17. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy >  PC make/buy • Volume Uncertainty TC > Technological Uncertainty TC • Simplicity • Buyer pay retooling and both parties pay the changes in volume • Scale economies may be crucial for suppliers

18. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy >  PC make/buy • Volume Uncertainty TC > Technological Uncertainty TC • Buyer Experience  PC • Simplicity

19. Result • H1, H3, H4, H5 and H8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy >  PC make/buy • Volume Uncertainty TC > Technological Uncertainty TC • Buyer Experience  PC • Buyer Experience  make/buy • Technological Uncertainty make/buy Poor communication within the division of important information for contracting with suppliers

20. Discussion • Weakness • Small sample size drawn from a single corporate division limit the generalizability of the empirical findings • Relative simplicity of the components studied may explain to some extent the failure of part of the model • Method Bias: The component manager answers questions about both supplier market competition and supplier production cost advantage • Future Research • Other forms of buyer-supplier relationships (e.g. tapered integration, joint venture, and the type of coordination and dedicated supply called “kanban” by the Japanese)