Supplier switching costs and vertical integration in the automobile industry Kirk Monteverde & David J. Teece Eva Herbolzheimer University of Illinois at Urbana-Champaign

Research Objective Integration of the literature on Transaction Cost Theory and Industrial Know-How Analysis of efficiency incentives for backward vertical integration in the U.S. automobile industry (Ford and General Motors)  What motivates firms to take on parts production in-house? Supplier switching costs and vertical integration in the automobile industry

Factors influencing integration decisions Specialized, non-patentable know-how and skills  Difficulty of skill-transfer High switching costs Possibility of opportunistic re-contracting (“renegotiation of contract”) Know-how in the Automotive Industry: Development activities for new parts (heuristic development) First-mover advantage 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 (1982: 207).” Supplier switching costs and vertical integration in the automobile industry

Statistical Model Probit Analysis Dependent Variable (dichotomous): Extent of in-house production of 133 automotive components used by Ford and General Motors - 80% internal production rated as integrated Independent Variables: - Engineering - Chassis - Specific - Ventilation - Company - Electrical - Engine - Body Supplier switching costs and vertical integration in the automobile industry

Results (I) Supplier switching costs and vertical integration in the automobile industry

Results (II) “Engineering” variable (transaction-specific skills) is highly significant  development effort positively related to likelihood of vertical integration “Specific” is statistically significant  only components specific to a single assembler will be candidates for vertical integration “Company” is statistically significant  GM is more integrated than Ford Systems-effects hypothesis only mildly supported, however the set of five dummies taken together contributed to the explanatory power of the model Supplier switching costs and vertical integration in the automobile industry

Conclusion 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 when components are firm-specific and design must be coordinated with other parts Vertical integration decisions are based in part on efficiency considerations Supplier switching costs and vertical integration in the automobile industry