INTEGRATION OF THE SALES FORCE: AN EMPIRICAL EXAMINATION Anderson, E., & Schmittlein D. C., Rand Journal of Economics, 1984 Youngsoo Kim, BADM 545 Fall 2013

Overview  When does vertical integration take place?  Conventional approach  Company size model  Focus on manufacturing – physical assets valuation oriented  What is new?  Human assets and vertical integration  Empirical verification of TCE approach  How?  Direct salesperson vs. Representative agency  Logistic regression analysis

Problem: “Rep” vs. “Direct”  Representative agency (“Rep”)  Independent of multiple manufacturers that it represents  market governance mode  Direct sales people  Employees of one manufacturer  hierarchical governance mode  Industry practices  Rep accounts for only 10% of U.S. dollar volume (as of 1977)

Proposition 1: Asset specificity  Fungible assets  Economies of scale, risk-pooling  Rep is preferable  Relationship specialized assets  Opportunism, inflexibility  Direct is more efficient  The greater the total value of company-specific assets, the greater the likelihood of vertical integration in the form of a direct sales force Fungible: able to replace or be replaced by another identical item; mutually interchangeable

Proposition 2: Uncertainty  Environmental uncertainty (Williamson, 1979)  Unforeseen environment shifts result to incomplete contracts  Direct is more suitable under high uncertainty because of easier adaptations, provided that assets are company specific  Difficulty of performance evaluation (Williamson, 1981)  Input measures and a subjective judgment are preferable to output measures when they are hard to assess  The likelihood of integration should increase with two forms of uncertainty

Proposition 3: Frequency  Tradeoff – overhead and opportunism  Specialized governance needs setup and maintenance costs  Market governance incurs opportunism and inflexibility  Transaction frequency  Measurability of transaction frequency  Can a firm break even on the fixed cost of integration?  Fixed costs / breakeven point estimation is not straightforward  Heuristic: geographic transaction density  As density increases, more use of a direct sales force is expected

Empirical model: data collection  Industry : Electronic components manufacturing  “… its variety makes it a microcosm of American business …”  Unit of analysis  Product line of a given company in a given (set of) territory  Survey respondents  Territory sales managers

Empirical model: logistic regression  Explanatory variables  Transaction specificity of assets (TSA)  Uncertainty as environmental unpredictability (UEU)  Uncertainty as difficulty of evaluating performance (UDEP)  Territory density (TD)  Company size (SIZE)  Asset specificity / unpredictability interaction (ZUEUTSA)  Asset specificity / measurement difficulty (ZUDEPTSA)  Regression model

Empirical results (1) 

Empirical results (2)  Coefficient of determination  To evaluate the contribution of the set of transaction-cost variables over SIZE alone  Both coefficient significance test and predictive effectiveness test indicate that TC variables significantly explain the likelihood of vertical integration

Conclusion  Some TC variables are crucial for vertical integration  Asset specificity  Performance immeasurability  Limitations  Specificity/uncertainty interactions were not found  Effect of density turns out to be insignificant  Findings are limited to one type of integration and industry