1. Testing Alternative Theories of The Firm:
Transaction Cost, Knowledge-Based, and Measurement Explanations for Make-or-Buy Decisions in Information Services
Poppo & Zenger (1998)
BADM 545 Foundations of Strategy Research
Presented by Der-Ting Huang

2. Main Purpose
Fills the void by developing and testing competing hypotheses from the TCE, knowledge-based, agency and measurement literature regarding:
Boundary Choice
Governance Performance

3. Introduction Transaction Cost Economics (TCE)
Asset specificity Boundary Choice
opportunistic behavior
Critiques of TCE
Knowledge-based theory
Asset specificity has a positive effect on internal efficiency, not a negative effect on the market (e.g. market failure)
Shared language, knowledge, routines equals more efficient coordination
Property rights and agency theory
Boundary choices turn on measurement issues influences
Continuous spectrum (markets and hierarchies)
Asset specificity, measurement accuracy hinder both market and hierarchical exchanges performances

4. Comparative Institutional Performance
Model
Pf = α x + e
Pm = β x + u
Firm Performance α𝑥
Exchange Attributes
Make-Buy Choice
Market Performance β𝑥

5. Comparative Institutional Performance
Determinants
Asset specificity: Transaction cost vs. knowledge-based predictions
Measurement difficulty
Technological uncertainty
Other: Production costs and economies of scale

6. Hypotheses

7. Hypotheses (Asset specificity)
Hypothesis 1a: Increases in the specificity of an activity may negatively affect the performance of governance through the market.
Hypothesis 1b: Increases in the specificity of an activity will positively affect the performance of governance through firm organization.
Hypothesis 1c: Increases in the specificity of an activity will have stronger positive effects on firm governance than market governance. Consequently, increases in the specificity of an activity encourage vertical integration.
Hypothesis 1d: Increases in the specificity of an activity will have similar effects on firm and market governance. Consequently, increases in the specificity of an activity will be unrelated to the choice of boundary.

8. Hypotheses (Measurement difficulty)
Hypothesis 2a: Increased difficulty in measuring the performance of an activity will negatively affect the performance of exchanges governed through the market.
Hypothesis 2b: Increased difficulty in measuring the performance of an activity will negatively affect the performance of exchanges governed through firm organization.
Hypothesis 2c: Increased difficulty in measuring the performance of an activity will have similar effects on market and firm performance. Consequently, changes in measurement accuracy will be unrelated to the choice of boundary.
Hypothesis 2d: Increases in the difficulty of measuring an activity will have a weaker negative effect on the performance of internally governed exchanges than on market-governed exchanges. Consequently, increases in measurement difficulty increase the likelihood of vertical integration.

9. Hypotheses (Technological uncertainty)
Hypothesis 3a: Increased technological uncertainty will negatively affect market performance.
Hypothesis 3b: Increased technological uncertainty will negatively affect firm performance.

10. Hypotheses (Other: Production costs and economies of scale)
Hypothesis 4: Increases in the scale of demand for an internally sourced activity will positively affect firm performance, but have no sizable effect on the performance of externally sourced activities. Consequently, an increase in the scale of internal demand for an activity increases the likelihood of vertical integration.

11. Method Data Directory of Top Computer Executives
Mail surveys: 3000 names (181 responses and 152 usable)
Telephone Surveys: 300 names (11% complete)
Nine IS functions across 152 companies for a total sample of information service exchanges

12. Method Measurement Dependent Measures Independent Measures
Exchange performance
Boundary choice
Independent Measures
Firm-specific assets
Measurement difficulty
Technological uncertainty
Skill set
Economies of scale
Firm size

13. Results (Performance)
Managers become less satisfied with the cost, quality, and responsiveness of outsourced activities as these activities become more firm-specific.
Internal demand for an activity had a strong positive effect on satisfaction with the performance of internalized activities.
Increases in skill set size had a significant positive effect on managers’ perceptions of cost, quality, and responsiveness performance for outsourced exchanges

14. Results (Boundary choice)
Firm-specific assets encourages internalization
Managers were less likely to reject the outsourcing alternative if the information services required extensive skills
Firms possessing internal scale were more likely to provide services in-house and were more likely to have rejected the outsourcing alternative

15. Conclusions Support boundary choice in TCE:
increasing asset specificity leads to the diminishing effectiveness of market governance
Support the agency theory and property rights literature:
the role of measurement difficulty as a determinant of governance performance in both markets and hierarchies
Clear support for the theoretical arguments that hierarchies and markets possess discretely different sets of governance tools.
Not informative on the role that technological uncertainty has on governance performance and optimal boundaries.