A Transaction Cost Approach to Make-or-Buy Decisions

Gordon Walker and David Weber

Presenter: Wen ZHENG

Research Question• Apply transaction cost framework to investigate

make-or-buy decisions for relative simple components in a manufacturing division of a large U.S. automobile company.

– Transaction cost

– Production Cost

Theory and Hypothesis

• Williamson (1981)

– Production cost (ΔPC) • Buyers’ production Cost-Supplier’s production cost

– Transaction cost• Transaction cost of buy-Transaction cost of make

Theory and Hypothesis

• Williamson (1981)– Make or buy=f(asset specificity * uncertainty)

• Walker and Weber (1984)– Make or buy= f(asset specificity, uncertainty)

Theory and Hypothesis

• Williamson (1981)– Make or buy=f(asset specificity * uncertainty)

• Walker and Weber (1984)– Make or buy= f(asset specificity, uncertainty)

Supplier Market Competition

Volume uncertainty Technological Uncertainty

Theory and HypothesisVolume Uncertainty Transaction Cost make

Technological Uncertainty Transaction Cost make

Supplier cost advantage Production Cost buy

Supplier market competition Transaction Cost buy

Buyer Experience Transaction Cost buy

Supplier Cost Advantage

Production Cost buy

Supplier Cost Advantage

Production Cost make

Technology Uncertainty Transaction buy

H1

H2

H3

H4

H5

H7

H6

H8

Empirical Test• Sample– 60 decisions made in a component division of a large

U.S. automobile manufacture over a period of three years

• Method– Structure Equation Model (SEM)– Unweighted Least Squares (ULS)

Variables

Volume Uncertainty

Technological Uncertainty

Supplier Competition

Buyer Experience

Supplier Advantage

SEM

Results

Results

H1

H5

H3

H7H2

Results

H4

Results

H6

H8

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)• Market Competition TC make/buy >

PC make/buy• Volume Uncertainty TC > Technological Uncertainty TC• Buyer Experience PC• Buyer Experience make/buy• Technological Uncertainty make/buy

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)– Simplicity– Division outcomes > Functional outcomes

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)• Market Competition TC make/buy > PC make/buy– Method bias– Implicit Assumption: the cost of administrating

interfunctional coordination within the firm were virtually independent of the transaction cost associated with contracting in the market

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)• Market Competition TC make/buy >

PC make/buy• Volume Uncertainty TC > Technological Uncertainty TC– Simplicity– Buyer pay retooling and both parties pay the changes in

volume– Scale economies may be crucial for suppliers

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)• Market Competition TC make/buy >

PC make/buy• Volume Uncertainty TC > Technological Uncertainty TC• Buyer Experience PC– Simplicity

Result• H1, H3, H4, H5 and H8 are corroborated• Transaction cost (TC) > Production Cost (PC)• Market Competition TC make/buy >

PC make/buy• Volume Uncertainty TC > Technological Uncertainty TC• Buyer Experience PC• Buyer Experience make/buy• Technological Uncertainty make/buy

Poor communication within the division of important information for contracting with suppliers

Discussion• Weakness– Small sample size drawn from a single corporate division

limit the generalizability of the empirical findings– Relative simplicity of the components studied may

explain to some extent the failure of part of the model– Method Bias: The component manager answers

questions about both supplier market competition and supplier production cost advantage

• Future Research– Other forms of buyer-supplier relationships (e.g. tapered

integration, joint venture, and the type of coordination and dedicated supply called “kanban” by the Japanese)