Lecture 2 - Make or Buy Decision Flashcards
What is the make or buy decision?
Deciding which items to product in house and which to purchase externally.
What are the theories of supply?
Economic
Strategy
Behavioural
What are the advantages of vertical integration? (MAKE)
- Greater supply control
- Greater access
- No/low transaction costs
- Protection from external environment
- Knowledge transfer
- Enables innovation
- Exploit economies of scale
- Diversifies business
- Greater quality
What are the disadvantages of vertical integration? (MAKE)
- Does not allow for specialisation
- High R&D costs
- Delays affect the whole supply chain
- May not be financially feasible
- High degree of responsibility
What are the advantages of outsourcing? (BUY)
- Allows business to focus on core activities
- Cost efficiency/lower acquisition costs
- Access economies of scale
- Product and service improvements
- Access IP protected innovation
- Overcome capacity constraints
- Avoid capital investment
- Access best practise and fresh ideas
- Risk allocation
What are the disadvantages of outsourcing? (BUY)
- Missed target costs
- Quality failure
- Dependence on suppliers
- Different objectives
- Skills to manage contracts are lacking
- Loss of core competencies
- Supplier collusion
- Cultural, economic and geographic distance
- Employees may feel threatened
- May need to manage relationships that have gone wrong
What is transaction cost economics?
Theory of efficiency.
An attempt to explain the existence of firms and more recently the formation of alliance structures. Boundaries are set by the aim to minimise transaction costs which are determined by behavioural and transaction characteristics.
Coase (1937) The existence of firms was predicated on the costs of using the market mechanism (transaction costs)
What is the process of transaction costs?
Transaction and behavioural characteristics lead to transaction costs.
Transaction costs lead us to decide whether to make or buy
What are transaction costs?
The cost of planning, adapting, coordinating and safeguarding exchange. They vary across different natures of transactions.
Examples of transaction costs
Cost of ongoing business Cost of supplier training for systems Cost of exiting relationship Cost of scheduling orders Search and information costs Cost during tender process Bargaining and policing costs Cost of adaptation Cost of logistics
What did Williamson (1985, 2004) theorise?
Transaction costs arise due to bounded rationality and opportunism.
What is frequency regarding the make or buy decision?
How frequent a transaction is
What is asset specificity?
What are the 4 main areas of asset specificity?
Transferability of an asset within a buyer/supplier relationship.
We can ask how specialised the asset is to the relationship:
1) Human
2) Site
3) Physical
4) Dedicated
What is uncertainty?
Uncertainty of future states of the market (environmental or behavioural)
What is bounded rationality?
Human are intendedly rational but only limitedly (Simon, 1957)
ie incomplete contracts and information assymetry
What is opportunism?
Self interest seeking with guile (Williamson, 1975)
ie take advantage of situations for self gain
What are the 3 transaction characteristics?
Frequency
Asset specificity
Economic uncertainty
What is economic uncertainty?
Arises because of uncertainty of future states of the market
eg: actions of trading partners, prices, availability
High environmental uncertainty = high ex ante costs
High behavioural uncertainty = high ex post costs
Examples of products or services with high frequency, asset specificity and uncertainty
Countries with political/economic uncertainty
- People less willing to trade with you in times of economic uncertainty
Products with an important focus
When frequency, asset specificity and uncertainty rise, what happens to the cost of using the market?
Cost of using the market increases
In what situation should you BUY?
Low asset specificity
Low frequency
In what situation should you MAKE?
High asset specificity
High frequency
When the level of dedicated resources is high we want maximum safeguards, which level has the highest level of control?
MAKE
Has safeguards and asset specificity larger than 0
What happens when transaction costs are high?
When costs are high, transaction cost economics predicts it is more efficient to coordinate activity within the boundaries of the firm (make)
