Kirk Monteverde and David J. Teece Supplier switching costs and vertical integration in the automobile industry Kirk Monteverde and David J. Teece Bell Journal of Economics (1982) Weihao Li (Originally created by Eva Herbolzheimer ) University of Illinois at Urbana-Champaign

Research Objectives Refine existing Transaction Cost Theory to take into account Industrial Know-How and Cost of transferring this Know- how Analysis of efficiency incentives for backward vertical integration in the U.S. automobile industry (Ford and General Motors) What motivates automobile firms to produce parts in- house rather than depending on suppliers? Supplier switching costs and vertical integration in the automobile industry

The Concept: Know-how Know-how and skills in the Automobile Industry Specialized Non-patentable The existence of transaction-specific know-how and skills Are difficult to be transferred from supplier to supplier Induce high switching costs Expose the firm to the possibility of opportunistic re-contracting Give the supplier first-mover advantages if working in cooperation Supplier switching costs and vertical integration in the automobile industry

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.” A high proportion of know-how in an automobile part leads to high transaction cost, and therefore, leads to backward vertical integration. Assemblers (automobile firms) will vertically integrate when the production process generates specialized, non-patentable know-how. Supplier switching costs and vertical integration in the automobile industry

Analysis The Data 133 automotive components used by Ford and General Motors for U.S. production in 1976 The Dependent Variable (dichotomous) Each sample component is coded as being manufactured in-house (internal production >= 80%) by an external supplier The Focal Independent Variable Applications engineering effort (unable to gain) A surrogate measure: engineering cost rating (10-point scale) Supplier switching costs and vertical integration in the automobile industry

Analysis Control variables 1st group: Component Specificity 2nd group: Identity of the sample firms 3rd group: systems effect Supplier switching costs and vertical integration in the automobile industry

Results Development effort is positively related to the likelihood of vertical integration Only components specific to a single assembler will be candidates for vertical integration GM is more integrated into component production than is Ford Supplier switching costs and vertical integration in the automobile industry

Conclusions Transaction cost considerations concerning know-how and human skills have an effect on the choice of vertical integration in the automotive industry (support transaction cost paradigm by Williamson, 1975) GM and Ford are more likely to backwards integrate production if relying on suppliers will provide the later with a first-mover advantage (high switching costs) Backwards integration is preferred when components are firm- specific and design must be coordinated with other parts Vertical integration decisions are based in part on efficiency considerations—internal organization reduces suppliers opportunism Supplier switching costs and vertical integration in the automobile industry

Discussion The study provides empirical support to transaction cost theory (Williamson, 1975); however, instead of considering transaction cost, would there be any other (exogenous) factors that encourage firms in the automobile industry to (backward) vertically integrate? Supplier switching costs and vertical integration in the automobile industry