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 -Suppliers 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 Volume UncertaintyTransaction Costmake Technological Uncertainty Transaction Costmake Supplier cost advantageProduction Costbuy Supplier market competition Transaction Costbuy Buyer ExperienceTransaction Costbuy Supplier Cost Advantage Production Cost buy Supplier Cost Advantage Production Cost make Technology Uncertainty Transactionbuy H1 H2 H3 H4 H5 H7 H6 H8

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 Volume Uncertainty Technological Uncertainty Supplier Competition Buyer Experience Supplier Advantage

SEM

Results

H1 H5 H3 H7 H2

Results H4

Results H6 H8

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

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

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 interfunctional coordination within the firm were virtually independent of the transaction cost associated with contracting in the market

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

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

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

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)