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The Demand for Tailored Goods and the Theory of the Firm

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  • Thiele, Veikko

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 elaborates on a firm's make-or-buy decision in a context with relational contracts in order to investigate 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 (i) impose lower costs 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/2471/
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File URL: http://mpra.ub.uni-muenchen.de/8372/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2471.

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Date of creation: 12 Mar 2007
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Handle: RePEc:pra:mprapa:2471

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

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