A Transaction Cost Approach to Make-or-Buy

Decisions

Gordon Walker and David Weber

Administrative Science Quarterly, 29 (1984): 373-

391

Focus of This Paper

• This paper focuses on the Make-or-Buy decision as a paradigmatic problem for analyzing transaction costs.

Structure of This Paper

• Reviewing existing theory;• Assumptions for the study in this paper;• Building models for testing the theory

Hypothesis; Data; Method; Results

• Discussion

Reviewing Existing Theory

• Ways of Managing the Buyer-Supplier relationship

1. Ouchi, Harrigan, Blois 2. This paper use “Prototypical choice”

• Anderson(1982) and Monteverde & Teece (1982a)

1. Asset specificity; uncertainty 2. Asset specificity on backward integration

Reviewing Existing Theory• Williamson’s Efficient boundaries

Framework (1981) 1. The administrative mechanisms whose efficiency is at issue 2. The dimensions of transactions that determine how efficiently a particular administrative mechanism performs 3.

Assumptions

• Assume sufficient uncertainty was inherent in all transactions – difficult for buyer to neutralize potential supplier opportunism effectively through contingent claims contracts

• Assume different types of uncertainty influenced transaction costs independent of the level of asset specificity

• Consider two types of uncertainty – volume (i.e., demand) and technological

Model in This Paper - Hypotheses

H1/r1 Volume uncertainty leads to making rather than buying a component

H2/β1 Technological uncertainty increases the likelihood of a make rather than a buy decision.

H3/β2 The higher the supplier production cost advantage, the more likely the firm is to buy rather than make a component.

H4/r2 The competitiveness of the supplier market increases the production cost advantage of suppliers over buyers.

H5/r3 Greater supplier market competition should lead to buying the component.

H6/r4 The experience a buyer has in producing a component reduces the production cost advantage of the supplier over the buyer.

H7/r5 Buyer experience in producing a component increases the likelihood of a buy decision.

H8/r6 Buyer experience in component production reduces technological uncertainty associated with the component.

Model in This Paper - Indicators

Number of suppliers

Suppilier proprietary technology

Buyer tools and equipment

Buyer manufacturing

technology

Uncertain Volume

Estimates

Changes in specifications

Technological improvements

Difference in Manufacturing

porcess

Difference in scale of

operations

Annual savings to make a component

Volume Uncertainty

Technological Uncertainty

Supplier Production Advantage

Competition among suppliers

Buyer Experience

Expected Volume

Fluctuations

competitive quotes

Model in This Paper – Data and Methods

• 60 decisions; one component division of a large U.S. automobile manufacturer; three years

• Un-weighted least squares (ULS)

Model in This Paper - Results

Model in This Paper - Results

11

SupplierCompetition

(reverse scale)

Make or Buy decision

SupplierProductionadvantage

Volumeuncertainty

Technologicaluncertainty

Buyerexperience

-.284*

.034.155

-.198

-.315*

-.316*

.205*

.86

2*

Discussion

Limitations of this paper• Small sample size; data from single corporation division – limit

the generalizability of findings• Relative simplicity of the components – failure of part of the

model

For managers’ use: when more information is needed?• Data were available as a base for judgments• Data must be related to more general experience• Manager’s judgment based on extensive general experience

rather than specific data

For Future Study• Implicit assumption – costs of administering inter-functional coordination

within the firm were virtually independent of the transaction costs associated with contracting in the market – Is it valid?

Other Discussions

Thank You！