Kirk Monteverde & David J. Teece (1982) The Bell Journal of Economics BADM 545, Fall 2019 Session 3. Transaction Costs Empirical Application: Vertical Integration Supplier Switching Costs and Vertical Integration in Automobile Industry Kirk Monteverde & David J. Teece (1982) The Bell Journal of Economics Presented by. Hyewon Ma

Introduction Specialized know-how’s ramifications for organizational design have been commonly ignored in economic theory Theoretical development of transaction costs economies (Williamson, 1975, 1979) Objective of this paper: to draw together the literatures on transactions cost and industrial know-how and bring them to bear on analysis of efficiency incentives for backward vertical integration in the U.S. automobile industry

Know-how and Vertical Integration Theoretical Reasoning Know-how: knowledge acquired during development as preproduction heuristic When production process generates specialized nonpatentable know-how High switching costs incur from dependence upon supplier and buyer is exposed to opportunistic re-contracting or to the loss of transaction specific know-how 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.

Model Specification Sample: component production of Ford and General Motor U.S. in 1976 (133 components) Dependent variable: dichotomous variable which measures whether a component is manufactured in house or by an external supplier (in-house production of 80% or more of a component’s output was operationalized as vertical integration) Independent variable: Engineering cost rating: relative engineering cost ratings (10-point scale) with each component by industry-level data

Model Specification Control variables Component specificity: whether a component is specific to a company or generic (specially designed for a single automaker). It was measured based on wholesaler company officials’ response on “whether a component’s information on manufacturer, make, and model of automobile is identified” Identity of the sample firm: Ford or General Motor

Model Specification Control variables System effects (degree of technical interrelatedness among the components): nine categories of components  aggregate into six subsystems based on expert evaluation

Empirical Strategy Probit model Alternative measurements of dependent variable: cutoffs of 70% and 90% for the dependent variable

Results Transaction-specific skills are significantly associated with the likelihood of in- house production.

Conclusion and Discussion Transaction cost considerations concerning know-how and human skill have an effect on the choice of vertical integration in automobile industry. GM and Ford are more likely to backward integrate production if relying on suppliers will provide first-mover advantage from high switching costs. Contribution of this paper As one of the earliest empirical applications of transaction costs theory, the paper provides empirical support for the theory and potential for future empirical study development

Conclusion and Discussion How do you evaluate the measurement of asset specificity in this paper compared to those from other papers in today’s session? Can you come up with any omitted variables in this paper’s model? If there are, how would those omitted variables influence the results?