Kirk Monteverde & David Teece

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SUPPLIER SWITCHING

COSTS AND VERTICAL

INTEGRATION IN THE [US]

AUTOMOBILE INDUSTRY

Kirk

Monteverde &

David Teece -

1982

ABOUT THE PAPER

Authored by:

Kirk Monteverde (Stanford University)

David J. Teece (Stanford University)

Published:

Spring 1982 by ‘The Bell Journal of Economics’ (now ‘RAND Journal of

Economics’)

1995 in

The Legacy of Ronald Coase in Economic Analysis

(S. Medema)

1995 in

Transaction Cost Economics, Volume II: Policy and Applications

(O. Williamson & S. Masten)

1996 in

Case Studies in Contracting and Organization

(S. Masten)

1998 in

Economic Performance and the Theory of the Firm: The Selected

Papers of David J. Teece, Volume One

2004 in

Modes of Organization in the New Institutional Economics

(C. Menard)

2005 in

Strategic Management

(J. Birkinshaw)

ARTICLE OVERVIEW

Transactions Cost Theory and Vertical Integration

 Production is internally organized when external transaction costs exceed those of internal transaction costs (Coase)

Market Imperfection(s)

‘Know-how’ (more than a book of blue-prints)

Costs associated with transferring (production) ‘know -how’

Theories tested using data from U.S. automobile manufacturers General Motors Company and Ford Motor

Company

HYPOTHESIS

“Assemblers will vertically integrate when the production process… generates specialized, non -patentable know -how”

Why?

Ex post

information sharing

Generation of high switching costs

 Knowledge based rather than financial based

Possibility of opportunistic re-contracting (dependence on supplier)

Risk of economic rent appropriation due to transaction -specific know-how (dependence on supplier)

TESTING

Dependent Variable

113 automotive components coded in-house / contracted

Extent of vertical integration (looked for 80% in-house)

Independent Variables

Cost of component development (applications engineering)

Component specificity (GMC vs. FMC vs. generic)

Firm identity (GMC & FMC)

Systems effects (or ‘component effect on the system’)

TESTING

Engineering

 1-10 scale for engineering effort

Specificity

 1 = firm specific component; 0 = otherwise

Company

 1 = GMC; 0 = FMC

Engine (engine and emissions)

Chassis (chassis, transmission, steering)

Ventilation (ventilation)

Electrical (electrical)

Body (body, fuel tank, cap)

FINDINGS

‘Engineering’ (component development effort) is positively related to vertical integration

‘Specificity’ is statistically significant

“Only components specific to a single assembler [firm] will be candidates for vertical integration”

Individually (except ‘Electrical’), no category indicated a significant relationship with vertical integration

 All five, however, taken together showed significance in the Probit model

CONCLUSION

“GM and Ford are more likely to bring component design and manufacturing in-house if relying on suppliers for preproduction development service will provide suppliers with an exploitable advantage.”

HOWEVER – “[GM] and Ford also have a preference for backward vertical integration when the components are firm -specific and their design must be highly coordinated with other parts of the automobile system”

 This shows an efficiency-driven vertical integration policy which may operate without regard to supplier opportunism

Findings do not apply in Japan, where “the relationship between the major auto firm and its satellite suppliers is one of total cooperation” ( Ouchi,

1981)

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