a transaction cost approach to make-or-buy decisions

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A Transaction Cost Approach to Make-or-Buy Decisions

Gordon Walker and David WeberAdministrative Science Quarterly, 29 (1984): 373-391

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Purpose of the paper

Make or buydecisions

Transaction cost- Uncertainty- Asset specificity

Production cost

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Asset specificity

Cost

s

Governance cost when AS is lowInternal organization > market

Governance cost when AS is highInternal organization < market

Governance cost difference between internal organization and market

A

Given moderate uncertainty

ΔTC

Proxies for AS- Supplier competition- Buyer experience

4

Asset specificity

Cost

s Production cost when AS is lowInternal organization > market

Production cost when AS is highInternal organization > marketBUT get close to each other

ΔPC

Given moderate uncertainty

Proxies for PCSupplier production advantage

5

Asset specificity

Cost

s

A

ΔPC + ΔTC

A’

Given moderate uncertainty

Proxies for uncertainty- Volume uncertainty- Technological uncertainty

Make or Buy decision

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Buy decisionVolumeuncertainty

Technologicaluncertainty

negative

negative

UncertaintyHypothesis 1, 2

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SupplierCompetition

Buy decision

SupplierProductionadvantage

Positive

production cost

positive

Hypothesis 3, 4

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SupplierCompetition

Buy decision

Buyerexperience

positive

positive

Asset specificity

SupplierProductionadvantage

Technologicaluncertainty

Negative

Negative

Hypothesis 5, 6, 7, 8

HypothesesH1/β1 Volume uncertainty leads to making rather than buying a component.

H2/r1 Technological uncertainty increases the likelihood of a make rather than a buy decision.

H3/β2 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.

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SupplierCompetition

Buy decision

SupplierProductionadvantage

Positive

positive

Buy decisionVolumeuncertainty

Technologicaluncertainty

negative

negative

Buyerexperience

positive

positiveNegative

Negative

Full model

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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

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SupplierCompetition

(reverse scale)

Buy decision

SupplierProductionadvantage

Volumeuncertainty

TechnologicaluncertaintyBuyer

experience

-.284*

.034.155

-.198

-.315*

-.316*

.205*

.862*Results

Results (Mixed support for Williamson’s theory)

H1/r1 Volume uncertainty leads to making rather than buying a component. Significant effect

H2/β1 Technological uncertainty increases the likelihood of a make rather than a buy decision.

direction opposite to hypothesis; not significant

H3/β2 The higher the supplier production cost advantage, the more likely the firm is to buy rather than make a component.

Strongly supported

H4/r2 The competitiveness of the supplier market increases the production cost advantage of suppliers over buyers.

moderate

H5/r3 Greater supplier market competition should lead to buying the component.

Jackknife coefficient acceptable

H6/r4 The experience a buyer has in producing a component reduces the production cost advantage of the supplier over the buyer.

Jackknife coefficient not acceptable; variance explained low

H7/r5 Buyer experience in producing a component increases the likelihood of a buy decision.

Not significant; small effects

H8/r6 Buyer experience in component production reduces technological uncertainty associated with the component.

Moderate; variance explained low

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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