Testing Altermative Theories of The Firm:

TRANSACTION COST, KNOWLEDGE-BASED, AND MEASUREMENT EXPLANATIONS FOR MAKE-OR-

BUY DECISIONS IN INFORMATION SERVICES.

Laura Poppo and Todd Zenger, 1998

TCE—Boundary Choice

• TCE argues and empirically finds that boundary choices are driven largely by the specificity of assets involved in an exchange. (Shelanski and Klein, 1995)

Criticisms

• Knowledge-based theory

• Property right and agency theory

• Others

Knowledge-based theory of the firm

• The link between asset specificity and boundary choices has little to do with opportunistic behavior and failed market.

• Specificity of activity will enhance the efficiency but not trigger the market failure.

Property rights and agency theory

• Internalizing an activity avoids costly measurement and contracting cost.

Others

•Markets and hierarchies are points on a continuous spectrum and that the same exchange conditions which hinder market performance also hinder the performance of hierarchical exchanges.

Contribution• Fill the void by developing and testing competing hypotheses from the transaction-cost, agency and measurement literature.

•Methodology

• Sample Selection

ModelFirm

Performance

Exchange Attributes

Make-Buy Choice

Market Performance

α 𝑥

β 𝑥=αx+e

=βx+µ

Hypotheses

Data Collection

• Key informants

• Director of Top Computer Executives

• Response rates are particularly low

Data Collection•Mail surveys: 3000 names

• 181 responses and 152 usable

• Telephone Surveys: 300 names

• 11% complete

Core Sample

•Nine IS functions across 152 companies for a total sample of 1368 information service exchanges.

Test Bias

• Compared the industries and the geographic locations represented in the sample to the population.

• Early-returned, Late-returned, and Non-respondents

Dependent measures

• Exchange performance

• Boundary choice

Independent measures• Firm-specific assets

•Measurement difficulty

• Technological uncertainty

• Skill set

• Economies of scale

• Firm size

Results--performance

•Maximum likelihood estimates of the effects of asset specificity, measurement difficulty, technological uncertainty, scale, skill set, and firm size on the performance of both internal and out sourced services.

Results-performance• Managers become less satisfied with the cost, quality and

responsiveness of outsourced activities as these activities become more firm-specific.

• When IS managers could not easily measure the performance of an outsourced activity, they were less satisfied with its cost.

• There is no support that managers were less satisfied with the performance of activities characterized by higher levels of technological chance for either outsourced or internal activities.

• Internal demand for an activity had a strong positive effect on satisfaction with the performance of internalized activities.

• Increases in skill set size had a significant positive effect on managers’ perceptions of cost, quality, and responsiveness performance for outsourced exchanges.

Predictions on governance performance

  Theoretical Perspective

 IVs TCE KBV Property rights Classical agencyInstitutional agency Other

Asset specificityMarkets perform poorly

Firms perform well   Markets=Firms    

Output measurement    

Markets perform poorly Markets=Firms

Firms perform  poorly   

Technological uncertainty

Markets perform poorly        

Firms perform poorly

Economies of scale          

Firms perform well

Skill set          Markets outperform firms

Results  Theoretical Perspective

 IvsTCE KBV Property rights

Classical agency

Institutional agency Other

Asset specificity

Markets perform poorly

Firms perform well   Markets=Firms    

Output measurement    

Markets perform poorly Markets=Firms

Firms perform  poorly   

Technological uncertainty

Markets perform poorly        

Firms perform poorly

Economies of scale          

Firms perform well

Skill set          

Markets outperform firms

Results—Boundary choice• The presence of firm-specific assets encourages

internalization.

• Increases in measurement difficulty consistently discouraged outsourcing for only one dependent measure, the percentage of the activity which was outsourced.

• Managers were less likely to reject the outsourcing alternative if the information services required extensive skills.

• Technological chance did not appear to affect outsourcing decisions.

• Firms possessing internal scale sufficient to enjoy economies of scale were more likely to provide services in-house and were more likely to have rejected the outsourcing alternative.

Predictions on governance choice

  Theoretical Perspective

 IVs TCE KBVProperty rights

Classical agency

Institutional agency Other

Asset specificity Integrate Integrate        

Output measurement      

Boundary doesn't matter Integrate  

Technological uncertainty Integrate         Outsource

Economies of scale           Integrate

Skill set           Outsource

Results

  Theoretical Perspective

 IVs TCE KBVProperty rights

Classical agency

Institutional agency Other

Asset specificity Integrate Integrate        

Output measurement      

Boundary doesn't matter Integrate  

Technological uncertainty Integrate         Outsource

Economies of scale           Integrate

Skill set           Outsource

Discussion• Increasing asset specificity leads to the diminishing

effectiveness of market governance.

• Knowledge-based explanation of boundary choice requires contingent reasoning.

• Corroborates the role of measurement difficulty as a determinant of governance performance in both markets and hierarchies.

• Clear support for the theoretical arguments that hierarchies and markets possess discretely different sets of governance tools.

• Not informative on the role that technological uncertainty has on governance performance and optimal boundaries.