A Transaction Cost Approach to MakeorBuy Decisions Gordon

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

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

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

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

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

Theory and Hypothesis H 1 Volume Uncertainty Transaction Cost make H 2 Technological Uncertainty Transaction Cost make H 3 Supplier cost advantage Production Cost buy H 4 Supplier market competition Transaction Cost buy Supplier Cost Advantage H 5 H 7 Buyer Experience Production Cost Transaction Cost buy H 6 Supplier Cost Advantage Production Cost make H 8 Technology Uncertainty Transaction buy

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)

Variables Supplier Competition Buyer Experience Volume Uncertainty Supplier Advantage Technological Uncertainty

SEM

Results

Results H 3 H 5 H 7 H 1 H 2

Results H 4

Results H 6 H 8

Result • H 1, H 3, H 4, H 5 and H 8 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

Result • H 1, H 3, H 4, H 5 and H 8 are corroborated • Transaction cost (TC) > Production Cost (PC) – Simplicity – Division outcomes > Functional outcomes

Result • H 1, H 3, H 4, H 5 and H 8 are corroborated • Transaction cost (TC) > Production Cost (PC) • Market Competition TC make/buy > PC make/buy – Method bias – Implicit Assumption: the cost of administrating interfunctional coordination within the firm were virtually independent of the transaction cost associated with contracting in the market

Result • H 1, H 3, H 4, H 5 and H 8 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

Result • H 1, H 3, H 4, H 5 and H 8 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

Result • H 1, H 3, H 4, H 5 and H 8 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 Poor communication within the division of • Buyer Experience make/buy important information contracting with • Technological Uncertainty make/buy for suppliers

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)