A Transaction Cost Approach
to Make-or-Buy Decisions.
Gordon Walker and David Weber,
Administrative Science Quarterly.
September, 1984
A Paper Summary
By – Amit Darekar
Problem at hand….
• Make-or-Buy decisions as a paradigmatic
problem for analyzing transaction costs
• Focus on the prototypical choice between
making a component within the firm or buying
the component in a market partly regulated by
competitive forces.
Hypotheses
1.
Volume uncertainty leads to making rather than buying a component.
2.
Technological uncertainty increases the likelihood of a make rather
than a buy decision
3.
The higher the supplier production cost advantage, the more likely the
firm is to buy rather than make a component
4.
The competitiveness of the supplier market increases the production
cost advantage of suppliers over buyers
5.
Greater supplier market competition should lead to buying the
component.
6.
The experience a buyer has in producing a component reduces the
production cost advantage of the supplier over the buyer.
7.
Buyer experience in producing a component increases the likelihood
of a buy decision.
8.
Buyer experience in component production reduces technological
uncertainty associated with the component.
Assumptions
1. Asset Specificity and uncertainty are allowed to
influence make-or-buy decisions independently
2. Sufficient uncertainty was inherent in all transactions
included in the study, therefore any increase in asset
specificity would tend to increase transaction costs
3. Types of uncertainty influenced transaction costs
independent of the level of asset specificity.
4. Types of uncertainty:
1.
2.
Volume uncertainty
Technological changes
5. The costs of administering inter functional
coordination within the firm were virtually
independent of the transaction costs associated
with contracting in the market
Model Developed…
• The model constructed was a structural equation
system with observed and unobserved variables.
• All constructs, except the make-or-buy decision
itself, were indicated by more than one observed
variable.
• These constructs were measured using following
indicators
–
–
–
–
–
Volume uncertainty
Technological uncertainty
Supplier production advantage
Competition among suppliers
Buyer experience
Full model
Supplier
Competition
Negative
Supplier
Production
advantage
Technological
uncertainty
Positive
Buyer
experience
positive
negative
Volume
uncertainty
negative
Buy decision
7
Data and Methods…
• Sample in this study consisted of relatively
simple parts associated with the initial assembly
stage
• The data consisted of 60 decisions made in a
component division of a large U.S. automobile
manufacturer over a period of three years
• Structure Equation Model (SEM)
• The data were analyzed using the unweighted
least squares (ULS) procedure of Joreskog and
Sorbom (1982)
9
Results
Supplier
Competition
(reverse scale)
Technological
uncertainty
-.316*
.155
Volume
uncertainty
-.284*
.862*
Buyer
experience
-.315*
Supplier
Production
advantage
.034
Buy decision
11
Results
• The hypothesis about the effect of the production
advantage of the supplier on make-or-buy decisions
was strongly supported
• The effect of supplier competition on production
advantage was moderate and had an acceptable
critical ratio
• The direction of the effect of buyer experience on
comparative production costs is negative, as
hypothesized
• The results show that the effects of competition and
buyer experience were relatively small and that only
market competition had an acceptable critical ratio
for the jackknife coefficient. Both effects indicated a
buy decision as hypothesized.
• Of the two types of uncertainty studied here, only
volume uncertainty had a significant effect in the
predicted direction
Results (Mixed support for Williamson’s theory)
H1/r1
Volume uncertainty leads to making rather than buying a component.
Significant effect
H2/β1
Technological uncertainty increases the likelihood of a make rather
than a buy decision.
direction opposite to
hypothesis; not
significant
H3/β2
The higher the supplier production cost advantage, the more likely
the firm is to buy rather than make a component.
Strongly supported
H4/r2
The competitiveness of the supplier market increases the production
cost advantage of suppliers over buyers.
moderate
H5/r3
Greater supplier market competition should lead to buying the
component.
Jackknife coefficient
acceptable
H6/r4
The experience a buyer has in producing a component reduces the
production cost advantage of the supplier over the buyer.
Jackknife coefficient
not acceptable;
variance explained
low
H7/r5
Buyer experience in producing a component increases the likelihood
of a buy decision.
Not significant; small
effects
H8/r6
Buyer experience in component production reduces technological
uncertainty associated with the component.
Moderate; variance
explained low
Discussion
• The results show mixed support for Williamson's (1975) theory.
• The effect of transaction costs on make-or-buy decisions
was substantially overshadowed by comparative
production costs
• The extent to which market competition affects make-orbuy decisions may reflect the ability of the component
purchasing manager to indicate how low competition leads
to contracting difficulties
• A reasonably confident inference can be drawn that the
supplier production advantage construct is relatively
uncontaminated by transaction costs associated with the
buyer-supplier relationship.
• Small sample size (not a random sample)
• Simple components
• “Common method bias”