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
Volume
Uncertainty
Expected
Volume
Fluctuations
Uncertain
Volume
Estimates
Technological
Uncertainty
Supplier Production Competition among
Buyer Experience
Advantage
suppliers
Changes in Difference in
specifications Manufacturing
competitive
quotes
Buyer tools and
equipment
Difference in
scale of
operations
Number of
suppliers
Buyer
manufacturing
technology
Annual savings to
make a component
Suppilier
proprietary
technology
porcess
Technological
improvements
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
Supplier
Competition
(reverse scale)
-.316*
Technological
uncertainty
.155
Volume
uncertainty
Supplier
Production
advantage
.862*
Buyer
experience
-.315*
.034
-.284*
Make or
Buy decision
11
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