Academic journal article Journal of Supply Chain Management

Firm and Individual Choice Drivers in Make-or-Buy Decisions: A Diminishing Role for Transaction Cost Economics?

Academic journal article Journal of Supply Chain Management

Firm and Individual Choice Drivers in Make-or-Buy Decisions: A Diminishing Role for Transaction Cost Economics?

Article excerpt

INTRODUCTION

The supply chain management literature has a long history of recognizing the strategic importance of make-or-buy decisions (Carter et al. 2000; Leenders and Nollett 1984). Make-or-buy decisions involve determining whether an organization will produce a good or service itself or procure it from another organization, and if from elsewhere, specifics of the terms of the exchange (Masten 1984). Make-or-buy decisions often are investigated via the theoretical framework of transaction cost economics (TCE) (e.g., Lonsdale 2001; van Hoek 2000). This theory examines transactions, the transference of a good or service across a technologically separable interface, comparing the costs associated with different ways of organizing transactions (Williamson 1996). Transaction costs are the costs associated with conducting an economic exchange, such as search, selection, bargaining, monitoring and enforcement (Madhok 2002). Because production costs are assumed to remain unchanged across the various ways of organizing exchanges (Williamson 1996), TCE predicts that managers will implement the organizational form that minimizes transaction costs (van Hoek 2000). Considerable empirical support for TCE predictions arises from both cross-industry and industry-specific studies (Rindfleisch and Heide 1997; Shelanski and Klein 1995). However, the explanation and prediction of supply chain design is not complete, leading some supply chain researchers to call for additional research employing TCE (van Hoek 2000).

Historically, research in TCE suggests that the economic factors of investments in specialized assets and uncertainty drive make-or-buy decision outcomes (Ellram 1991; Williamson 1996). That increasing levels of specialized investments and uncertainty lead increasingly to in-house manufacturing (the "make" decision) is supported empirically (Rindfleisch and Heide 1997; Shelanski and Klein 1995). Yet at the same time, TCE research has been criticized for focusing solely on firm-level economic determinants of decision outcomes without considering other factors that may impact organizational decision making (Granovetter 1985). In his case study of make-or-buy decisions, Venkatesan (1992) provided an example of the incompleteness of the TCE explanation: manufacturing managers prefer to "make" components to maintain high levels of equipment and personnel usage, while engineers prefer to "buy" components because external suppliers are more responsive to design changes. Venkatesan's (1992) case study identified a specific aspect of organizational life--functional group membership--that impacts decision making and is neglected by TCE researchers. This case study suggests that the choice of different alternatives among decision makers can be attributed to choice drivers at the level of the individual in the form of functional group reward systems that may suboptimize organizational decision making (Venkatesan 1992). The solution to this suboptimization problem is straightforward: ensure that individual reward systems and functional group goals are aligned with organizational goals (McQuiston and Dickson 1991; Pagell, Das, Curkovic and Easton 1996).

Another factor that also may impact make-or-buy decisions is the changes occurring in the supply management function as it evolves from an administrative function to a strategic activity (Giunipero and Pearcy 2000). One important driver of this evolution is e-commerce (Carter et al. 2000). In the past, completing transactions required considerable time and effort on the part of purchasing professionals. Now, the increasing use of e-commerce significantly reduces the amount and scope of these activities. Purchasing and supply executives are recognizing that, in order to accommodate the supply management evolution, purchasing professionals need to change their skill sets from completing transactions and expediting orders to managing the supply chain (Duffy 2000). By rewarding desired behavior, compensation systems impact supply managers' behavior (Pagell, Das, Curkovic and Easton 1996). …

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