Supplier Switching Costs and Vertical Integration in the Automobile Industry

Kirk Monteverde & David Teece

Bell Journal of Economics (1982) Vol. 13, Issue No. 1: pp. 206-213

Presented by Christina L. Frye

Research Questions

• How does specialized know-how impact organizational design?

• What role does the development and deepening of human skills play in determining when firms decide to vertically integrate production processes ?

Theory & Hypothesis• Theory

– Transactions cost theory of vertical integration• When do we bring production in-house?• When are the switching costs high?

– Industrial “know-how”• Firm-specific production processes / transaction-

specific skills

• Hypothesis: The greater is the applications engineering effort associated with the development of any given automobile component, the higher are the expected appropriable quasi rents and, therefore, the greater is the likelihood of vertical integration of production for that component.

Methods• General Motors and Ford production (in U.S.)

in 1976• 133 automotive components (6

subsystems/categories)

• Dichotomous DV: ≥80% of parts manufactured in-house = vertically integrated

• “Know-How” = amount of engineering effort required to design part (rated by company officials)

• Controls: (1) specific vs. generic components, (2) firm identity, (3) “system” of parts (determined w/ replacement parts wholesaler)

• Logistic regression probit modeling

Results

• Assessed 70%, 80% and 90% thresholds – Vertically integrated = ≥80%

• Regardless of threshold, development effort associated with design of components (i.e. “know how”/ transaction-specific skills) is related to vertical integration

• Components specific to a single assembler are subject to vertical integration– Hypothesis is supported– GM’s component production is more integrated than

Ford’s– Mild support for systems-effects (electrical system)

Conclusion

• There are transaction costs associated with developing human skills– Holds implications for vertical integration of

firms• Why? There are high switching costs if

suppliers acquire transaction specific “know how” at the assembler’s expense.– Cannot be easily transferred to other suppliers– If switching costs are high, firms will vertically

integrate production processes• Supports transactions costs theory