Academic journal article Canadian Journal of Regional Science

Make or Buy: Internalization and Externalization of Producer Service Inputs in the Montreal Metropolitan Area

Academic journal article Canadian Journal of Regional Science

Make or Buy: Internalization and Externalization of Producer Service Inputs in the Montreal Metropolitan Area

Article excerpt

Producer or intermediate-demand services enhance the efficiency of operation and the value of output at various stages in the production process. All firms, whether specializing in the fabrication of goods or in the provision of services, employ a range of producer services as inputs into their production functions. The more advanced or modern the "value chain" (such as, the production process) of a firm, the more numerous and more complicated will be the links in the chain and the greater will be the importance of service inputs (Porter 1985; 1990). Indeed, a wide range of empirical evidence has demonstrated that producer services occupy a major and expanding role both within firms (Britton 1990; Quinn 1993) and within national, regional and metropolitan economies (Beyers 1989; Coffey 1994).

A fundamental decision that each firm (and, indeed, each establishment within a firm) must face concerns whether to "make" or to "buy" a specific producer service input; that is, whether to provide a given service internally by assigning its own personnel to the production of the service or, rather, to contract-out the provision of the service to experts in the employ of external (either affiliated or free-standing) specialized establishments. The decision to internalize or to externalize given service inputs is one of the most important strategic decisions that an establishment must make, as this choice ultimately affects the establishment's cost structure, its modes of operation and organization, and possibly its location (Coffey and Polese 1984; 1986).

The "make or buy" decision of individual establishments also has an impact upon the structure of an economy, as measured by official statistics on employment or output by sector of activity. For example, a lawyer hired in-house by a manufacturing establishment will increase the level of employment in the manufacturing sector, whereas the same lawyer working in a law firm, even though performing the same functions for the same manufacturing establishment, will augment employment in the producer services sector. (1)

In spite of its wide recognition as a fundamental aspect of "the service economy" and as an important element in both the organization and the functioning of enterprises, the propensity of establishments to make or to buy producer services has rarely been explored in a systematic manner. The purpose of the present study is to increase the understanding of this phenomenon by examining, from both conceptual and empirical perspectives, the make or buy behaviour of establishments across all sectors of activity. Our exploration of this issue begins in the next section with a review of the factors that can influence the decision to internalize or to externalize producer service inputs. After a brief section on definitions and methodology, we then examine empirical evidence drawn from a detailed survey of producer service consumption by establishments in the Montreal Census Metropolitan Area (CMA). We first present a descriptive analysis of internalization and externalization in the consumption of producer services, then attempt to identify some of the factors that underlie the make or buy decision. Our analysis concludes with some comments linking our empirical results to the producer services literature.

The Make or Buy Decision

Concern with the internalization and externalization of producer service inputs is by no means recent. This concern pre-dates the development of service industries research as an identifiable scholarly field. Stigler (1951) cited two major factors influencing the make or buy decision: complementarity and economies of scale. Complementarity refers to the extent to which service functions can be produced internally without raising a firm's cost of carrying out other functions. As Stanback et al. (1981) note, complementarity exists if services can be provided as a joint product, enabling better utilization of managerial or other scarce resources. …

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