1. The costs of organization
UIUC BA545_Fall 2019
Scott E. Masten
Professor of Business Economics and Public Policy
University of Michigan
James W. Meehan
Professor of Economics (Retired)
Colby College
Edward A. Snyder
Professor of Economics and Management
Yale School of Management
Masten, S.E., J.W. Meehan, and E.A. Snyder (1991). The costs of organization. Journal of Law, Economics and Organization, 7(1): 1-25.
The costs of organization
Professor Joseph T. Mahoney
Presented by: Fang-Yi Lo

2. 01 · Based on previous limitation, propose test model
Content
01 · Based on previous limitation, propose test model
02 · Specific Hypotheses: Naval shipbuilding
03 · Survey: 74 (43 Make; 31 Buy)
04 · Result: Probit model; Organization-Cost Estimates
05 · Conclusion

3. Provide dollar estimates of those costs
Main Idea
Previous studies focused on examining factors that aggravate the hazards of market exchange (or transaction costs)
Internal organization cost as a limitation to be treated as a barrier to overcome prior to integration
Why?
Difficult to observe and measure transaction costs
Indirect test
The one not chosen unable to measure
Therefore, it is impossible to distinguish whether observed patterns of organization are resulted from the market transaction costs or from costs incurred organizing production internally
Explicitly examines the role of internal organization costs in integration decisions
Provide dollar estimates of those costs

4. 02 1) A tautological formulation 2. Conceptual issues
I: Institution chosen
Io: Internal Organization
Im: Market Exchange
Go: Cost of Organization
Gm: Cost of Market
Limitation
Difficult to observe and measure
Selection problem

5. 02 2) Reduced-form analysis 2. Conceptual issues
Estimate organizational form as a function of observable characteristics (e.g. asset specificity, level of uncertainty).
The resulting model is qualitative choice estimation techniques such as probit and logit (stage 1)
Hypotheses regarding organizational form can be based on the signs and relative magnitudes of the coefficients.
2. Conceptual issues
Limitation
β – α > 0  Integrate
However, this finding can’t refute the underlying hypotheses that both coefficients are non-negative. Integration might be caused from the high cost of organization cost.

6. 02 3) Direct tests – stronger test of the theory! 2. Conceptual issues
Only cost data for one of the institutions is required.
Estimates of the coefficients
could be obtained using either maximum likelihood or two- stage methods.
2. Conceptual issues
Advantages
Censored regression techniques yield dollar estimates of the costs of organization.
Can identify the magnitude of individual coefficients in the cost equations and therefore permits tests of hypotheses regarding the costs of organizing under each institution.

7. 2. Comparative assessment
Whether and to what extent variations in internal rather than market organization costs are responsible for observed variations in organizational form? 02
Cost of Market
Cost of Organize
2. Comparative assessment
All those three variables, favor organize

8. 03 Determinants of organization costs in naval shipbuilding
Physical assets are less relationship specific – tend to be mobile
High degrees of human asset specificity (specialized design of military vessels)
Timing and coordination are critical (temporal specificity) – The unique design and location aspects of construction projects, limit the ability to hold inventories of work in progress. 03
3. Naval Shipbuilding:
favor organize

9. 03 3. Specific Hypotheses Complexity task Unique/non-standardized
favor organize
3. Specific Hypotheses
favor organize
favor market
Complexity task
Unique/non-standardized
Produced in limited quantities
Construction project on a unique site
High technical activities rely outside of a shipbuilder’s main area of expertise

10. 4. Evidence on the Structure and Costs of Organization in Shipbuilding
1) Data 04
Survey : sample of tasks and components from the make-or-buy program of a large, naval shipbuilder
Number of observations= 74 (43 Make; 31 Buy)
10-point scale
Data collected on organization costs to permit estimation of structural cost equation.
Costs of internal organization: the number of hours devoted by management to planning, directing, and supervising a particular component or process times the average hourly management wage rate.
4. Evidence on the Structure and Costs of Organization in Shipbuilding

11. 4. Evidence on the Structure and Costs of Organization in Shipbuilding
2) Measurement 04
4. Evidence on the Structure and Costs of Organization in Shipbuilding

12. 04 1st stage 2nd stage 4. Model Two-stage procedure Probit model
The selection decision regarding whether to organize the process internally or to subcontract the work.
Structural cost equations of the model
Estimate internal organization costs to correct for selectivity using an index constructed from the first-stage results.
Estimates of the coefficients in the (unobserved) external organization-cost equation are inferred from the parameters of the probit and internal organization cost estimates.
4. Model
Two-stage procedure

13. Probit Estimates of Make-or-buy decisions
Y: Probability of Make 04
Supported
Supported
4. Results
Probit Estimates of Make-or-buy decisions
Nonmonotonic relationship, U
Supported
Supported

14. Organization-Cost Estimates
Y: Cost of Organization
Linear
Log specifications 04
4. Results
Organization-Cost Estimates
Nonmonotonic relationship, U
Supported
Supported

15. Supported (only at Probability of Make)
Result Summary 05
Result Summary
Hypotheses
Result
Transaction Specificities
Physical asset
(+) Organize
Not Supported
Human asset
+ Organize
Supported (only at Probability of Make)
Temporal
Uncertainty/Complexity
Complexity
Non-linear
Similarity of transactions
Labor intensity
- Market
Supported
Engineering intensity
Conclusion

16. Questions
Only one data of the institutions
Previous literatures’ limitation?
Here, legitimacy of one data model
Easier data collect and empirical test
But, right or wrong?
10-point scale?
Single item, measurement reliability & validity?
Why add complex2 as non-linear relationship?
Comments