Competition and relationship specific investments theory implications for strategy

competition and relationship specific investments theory implications for strategy

Selection and peer-review under responsibility of the International Strategic is based on the relational view of inter-organizational competitive advantage that to the transaction cost theory, relationship-specific investments increase the risk of On the basis of the above considerations, this study intends to explore the. Dec 2, will briefly discuss several other theories of vertical integration as well. existing market power problems or as a strategic move to create or enhance market power in . relationship-specific investments are investments which, once made term contracts) could be used strategically to soften competition in. Transaction Cost Economics (TCE) is one of the most established theories to many strategic actions taken by individual companies as anti-competitive. was to develop a theory of vertical integration that would have testable implications. Contract duration and relation-specific investments: Empirical evidence from .

The increase of human asset specificity creates value on the one side and increases the level of transaction costs on the other side. This is true inside the firm and outside the firm e. As asset specificity deepens, more complex governance structures are required to attenuate costly bargaining over created rent 5. For each level k of human asset specificity, corresponds a governance structure i that is maximizing the value created.

competition and relationship specific investments theory implications for strategy

If we note Nvik, the net value created with this level k of asset specificity using a governance structure i then: More precisely, the firm is described mainly as a coordination mechanism in which there exist low-powered incentives, extensive administrative controls and its own dispute settlement machinery courts will often refuse to hear intrafirm disputes, the effect of which is to make the firm its own court of ultimate appeal.

However, such control is at a cost of high transaction costs e. That is to say transaction costs coming from human asset specificity are reduced inside the firm compared to the market because of the distinctive capabilities of the firm we mentioned earlier.

Over a certain percentage of human asset specificity, the firm is the more adequate governance structure as it permits more value to be created by economizing on transaction costs. Knowledge and knowledge accumulation is the key issue which challenges the role given by TCT to opportunism and asset specificity in the decision to make or buy.

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The competence perspective — Evolutionary theory and RBV 8 Organizational actions and behaviors are based on rules and routines that have emerged through a pa This raises the following question: Firms are supposed to try What makes the firm better suited to develop knowledge is based on three arguments. First, knowledge is the result of learning and experience.

Second, since it is the result of learning, it is context- local and path-dependent historical. Finally, it is partly tacit and the organization is partly unaware of its existence because it is embedded in organizational routines and individual skills Nelson-Winter,Cohen et al. For this reason, knowledge can only be transferred to a third party who has some absorptive capacity, that is, who has already accumulated the required knowledge to understand and integrate the knowledge developed by this third party.

If it had not this absorptive capacity, the transfer would be too costly to be implemented Then, why should a firm buy knowledge on a market when it has the capacity to build it internally?

Knowledge is not developed in a vacuum, it is built as coordination and communication mechanisms emerge and become embedded in some shared identity Kogut-Zander, The consequence is that this common identity lowers the cost of communication for future search and learning.

Firms are therefore viewed as a governance structure that possesses advantages in generating firm-specific language and routines that yield valuable capabilities. When Knowledge is tacit and difficult to transfer, using independent contractor relationships for developing new knowledge may become very costly in terms of transactions and even impossible independently of any opportunistic behavior. Honest persons … may disagree about the best course of joint or even individual action, or the division of gains.

Because of irreducible individuals, adoption of the innovation may not be automatic. Whereas under the cover of the hierarchy, communication can be easier and disagreement can easily be settled through authority. TCT confines the role of organizations to one of restricting the scope for opportunism compared to the market. This is not the view defended by the competence perspective Moran-Goshal, And this is especially true as soon as you consider activities that are specific to the firm. Therefore, activities that need human specific investments are supposed to be internalized due to the enhanced governance efficiency when specific asset are needed, especially because firms have advantages and more capabilities than the market to develop these specific human assets.

In other words, transaction costs inside the firm are not increasing with human asset specificity, but decreasing with it. Hypothesis 1 is then not retained by the competence perspective CP. Hypotheses 2 remains common to both approaches.

The increase of human asset specificity creates value by decreasing production and transaction costs inside the firm. That is to say transaction costs driven by specific human assets reduce transaction cost inside the firm and increase transaction costs on the market Over a certain percentage of human asset specificity, the firm is the more adequate governance structure.

competition and relationship specific investments theory implications for strategy

We can note that this percentage threshold should be lower in the CP. Discussion 24Many questions and oppositions exist between alternative theories of the firm.

This is also true concerning the transaction cost perspective and the competence perspective. The critics addressed by each theory to the rival perspective stresses many limits that have to be considered. Why market should not be able to replicate what is supposed by CP to characterize firms over markets?

That is especially a problem in a framework without any opportunistic behavior that is the framework retained by CP! The argument from TCT would be that because hierarchy can more successfully control opportunism, higher order organizing principles would emerge. Consequently it seems to us that the CP does not address convincingly the question of the limit to the firm size, that is a unavoidable question for a theory of the firm.

Markets and hierarchies are supposed to have no identical access to fiat, firms enjoy the advantage over markets with respect to cooperative adaptation but not with respect to autonomous adaptation. Considerations of differential probity have been examined in the context of transactions where failures of loyalty and real time responsiveness could undermine integrity.

Unforeseen Consequences: A Half-Life Documentary

The importance of cognitive specialization has also been featured. Nevertheless, it is only fair to say that cognitive specialization and the understanding of bureaucracy is underdeveloped in the TCT framework. Assumption that what is being coordinated i. Whereas the competence perspective sees organizations as being first of all responsible for designing and putting to work solutions to productive problems and that specific organizational arrangements are essential parts of such as design process, actually determining which solutions can be generated and tested.

Consequently, what is mainly reproached to TCT is its static view of the firm. Such a vision is reinforced by empirical tests in the CP framework that generally do not address the make or buy question to focus on differential of performances between firms. We would expect the theory to incorporate such issues, but to take into account other issues such as resolving agency problems and knowledge transfers. The real question is to find how such a theory of the firm could incorporate all those elements together, putting good weight on each element.

The up-shot is that we believe the majority of empirical works to be irrelevant to rule out competing views of the firm. As we will argue below, traditional empirical specifications of make or buy models are unable to comparatively test among alternative theories. We urge for more sophisticated models of comparative institutional performance to rule out alternative views. Recent surveys concerning empirical research using transaction cost analysis as theoretical framework exhibit more than articles that empirically test some aspects of TCE theory Boerner-Macher On the other hand, progresses are still to be made in order to conclude that TCE is a real empirical success story Masten-SaussierSaussier Especially when we consider econometrical tests looking at the question of the make-or-buy.

Does hierarchy arise as a response to the increased hazards of market contracting? Or does internalization of those transactions lower their costs beyond what market governance can achieve, even without the threat of opportunism? In other words, the majority of econometrical tests of the make or buy decision might corroborate the transaction cost view of the firm as well as the resource based view of the firm.

It is quiet embarrassing as empirical research, and more especially econometric works should be shaped in order to help us to determine probable explanations for the existence and boundaries of the firms. A need to assess the impact of organizational choices on performances 36To go a step further towards testing in order to disentangle alternative views of the firm, it would be useful to connect organizational choices and performances directly instead of limiting the analysis to the reduced-forms.

One, we know how much a carton of milk is supposed to be priced at retail, and those who do not can find out at a negligible cost. Two, at least in the United States, we are assured that the quality of dairy products is intact. Both federal and state governments have established safety regulations for dairy products, and violations are heavily sanctioned e.

Symmetrically, the seller benefits, because the buyer is confident enough to make the purchase. Even if upon arriving at home you realize the milk you bought is past its expiration date, the transaction is easily reversible and the problem thus remediable. There is nothing transactionally complex about buying a carton of milk. The dairy product transaction looks simple to us because it is supported by the price system and the system of institutions. Those who live in the developing countries, or travel in them, know that simplicity is in fact only ostensible.

Specifically, absent the proper system of institutions, buying even dairy products becomes so complex and risky that many will refrain from using them. Consider in contrast a situation where the exchanging parties cannot fully rely on the price system or the system of institutions.

Let us briefly put ourselves in the position of a purchasing manager of an automobile manufacturer, seeking a supplier for ten thousand make-and-model-specific automatic transmission assemblies, priced at a thousand dollars per unit e. These assemblies are engineered to model specifications, which means their quality probably cannot fully be ascertained ex ante; even the precise price may be unknown.

Further, the purchasing manager may or may not have prior experience with the pool of candidate suppliers. It is easy to see how in this situation, both the buyer and the supplier expose themselves to considerable risk. What if some unforeseen development brings about disagreement? Consider the worst-case scenario: How much will it cost to determine who is at fault?

Use of poor-quality inputs is of course always cause for concern; however, what is relevant from the point of view of TCE and the costs of transacting is that in situations where the supplier and the buyer are separate firms, addressing the consequences of quality problems can be much more costly.

If Delphi were a part of GM, the situation would be comparatively simpler. In complex settings, transactions can still occur, and we are clearly all better off for the fact that they do occur.

If in addition to the final assembly, automakers made all parts and sub-assemblies in-house, cars would be much more expensive than they are now. The higher prices would result from lack of economies of specialization, which is known to give rise to immense productivity benefits.

At the same time, in complex settings there are many costs to transacting that were absent in the grocery store example. Contracting parties must seek information that may be costly to obtain; they must agree upon and enforce a potentially complex buyer-supplier contract; potential disputes may require renegotiation, arbitration, sometimes even litigation; et cetera. These are examples of transaction costs, which may be significant enough to have far-reaching consequences.

Fundamentally, TCE is a theory that emphasizes the importance of understanding these consequences, which in turn, helps us direct attention to the relevant antecedents in an informed way. Schwinn had, among other things, restricted the sale of its bicycles to certain distributors. The Supreme Court ruled United States v. But is market power the primary reason for why firms seek vertical restrictions, or in the extreme case, vertical integration?

Are there no alternative plausible explanations and motivations behind such vertical actions? How was this alleged motivation demonstrated?

Are they all examples of anti-competitive abuse? Are firms guilty unless they prove themselves innocent? It was specifically the Schwinn case, and a number of others, that prompted Oliver Williamson, a pioneer of TCE, to ask: To Williamson, formulating policy based on a lack of understanding was a great cause for concern.

Or as Coasep. And as in this field we are very ignorant, the number of un-understandable practices tends to be very large, and the reliance on a monopoly explanation, frequent. Williamsonp. It ignored possible differences among customers and their marketing ramifications.

Further, it was specifically this critique that sparked the formal development of TCE, the early formulations of which can be described as a search for an alternative explanation of vertical integration Williamson, Vertical integration here means changes in financial ownership in the value chain e.

This is in contrast with horizontal integration, where a firm buys the assets of a similar company, such as one of its competitors. Yes, vertical integration may spell trouble, but it may also spell efficiency that benefits all the stakeholders involved.

Above all else, Williamson claimed, the field needed a theory of vertical integration that could provide empirically testable predictions: TCE has had a fundamental impact on how we view vertical integration in particular. As Shapirop. In the case of Schwinn, the Supreme Court was effectively denying Schwinn a competitive strategy based on product differentiation: As a more general point, we may not realize that many of the business practices and strategies we now consider strictly competitive were—only 40 years ago—indeed considered largely anti-competitive.

Just imagine what our strategy textbooks would look like if the courts continued to restrict strategic firm actions, such as vertical coordination. Indeed, the fact that the label of vertical restrictions was applied implied an immediate value judgment that such actions are dubious.

But even continuing with the antitrust language, we ask: Why would a firm want to build a competitive advantage on the idea of offering high-quality products if it could not decide how, where, and by whom these products are sold? What would happen to product innovation? Much of the early TCE was developed in the context of the special case of examining the empirically salient vertical integration decision. Further, the aim was to develop a theory of vertical integration that would have testable implications.

But this exercise was merely the first step in a journey that has now spanned several decades: The General Case of the Governance Decision The more general question underpinning the make-or-buy decision pertains to governance of contractual relationships. It thereupon applies this hypothesis to a wide range of phenomena—vertical integration, vertical restrictions, labor organization, corporate governance, finance, regulation and deregulationconglomerate organization, technology transfer, and, more generally, to any issue that can be posed directly or indirectly as a contracting problem.

As it turns out, large numbers of problems that on first examination do not appear to be of a contracting kind turn out to have an underlying contracting structure. Let us return to the general premise that TCE starts at trying to specify how transactions differ.

Theories of the firm: How to rule out competing views?

According to TCE, the three dimensions that merit attention are frequency, uncertainty, and specificity Williamson,p. All three should be thought of as characteristics of a contractual exchange relationship between two exchange parties; the principal unit of analysis in TCE is indeed the individual transaction. Contractual relationships are always associated with a cost, and with larger volumes i.

The two exchange parties always have interests that are only partially overlapping, and disagreements are a source of cost. In complex exchange relationships, it is simply impossible to write a complete contract that covers all possible contingencies.

TCE works out of the assumption that contracts are incomplete. Of the three dimensions, specificity deserves closer attention. The economic value this sub-assembly plant generates would suffer greatly should the exchange relationship terminate. More generally, specificity takes many different forms Williamson, Importantly, specificity gives rise to dependency, which may be either unilateral or bilateral. In many situations, even though the actual investment may appear on the balance sheet of just one of the transacting parties e.

If the customer were to terminate the contract with the supplier who made the specific investment, it would either have to make the same investment itself, or alternatively, convince another supplier to do so. Of course, a dependency relationship is always at least somewhat asymmetric, and purely unilateral dependency tends to be rare in situations that involve specificity.