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Firms' Procurement Decisions: Is Input Specificity Always an Argument for Vertical Integration?

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Thiele, Veikko

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Abstract

The transaction cost theory predicts that firms are inclined to vertically integrate transactions in response to the specificity of their required inputs. Yet, reality proves that some firms engage in repeated transactions with external suppliers aimed at procuring highly specific inputs. To explain this phenomenon, this paper investigates a firm's make-or-buy decision in a context with relational (i.e. non-enforceable) contracts, and exposes how this decision is affected by the required input specificity. This paper demonstrates that a high degree of input specificity can lead to repeated market transactions being favored over vertical integration because demanding more specific inputs is shown to (i) impose lower costs on firms to maintain repeated market transactions founded on relational contracts; and (ii), facilitate the self-enforcement of these relational contracts.

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File URL: http://mpra.ub.uni-muenchen.de/8372/
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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2471.

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Date of creation: 21 Apr 2008
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Handle: RePEc:pra:mprapa:2471

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Related research
Keywords: Input specificity; vertical integration; market transactions; relational contracts; transaction cost theory;

Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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References listed on IDEAS
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    Other versions:
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    Other versions:
  20. Joskow, Paul L, 1988. "Asset Specificity and the Structure of Vertical Relationships: Empirical Evidence," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 95-117, Spring.
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