1. Kirk Monteverde & David Teece - 1982
Supplier Switching Costs And Vertical Integration in the [US] Automobile Industry
Kirk Monteverde & David Teece

2. About the Paper Authored by: Published:
Kirk Monteverde (Stanford University)
David J. Teece (Stanford University)
Published:
Spring 1982 by ‘The Bell Journal of Economics’ (now ‘RAND Journal of Economics’)
1995 in The Legacy of Ronald Coase in Economic Analysis (S. Medema)
1995 in Transaction Cost Economics, Volume II: Policy and Applications (O. Williamson & S. Masten)
1996 in Case Studies in Contracting and Organization (S. Masten)
1998 in Economic Performance and the Theory of the Firm: The Selected Papers of David J. Teece, Volume One
2004 in Modes of Organization in the New Institutional Economics (C. Menard)
2005 in Strategic Management (J. Birkinshaw)

3. Article overview Transactions Cost Theory and Vertical Integration
Production is internally organized when external transaction costs exceed those of internal transaction costs (Coase)
Market Imperfection(s)
‘Know-how’ (more than a book of blue-prints)
Costs associated with transferring (production) ‘know-how’
Theories tested using data from U.S. automobile manufacturers General Motors Company and Ford Motor Company

4. Hypothesis
“Assemblers will vertically integrate when the production process… generates specialized, non-patentable know-how”
Why?
Ex post information sharing
Generation of high switching costs
Knowledge based rather than financial based
Possibility of opportunistic re-contracting (dependence on supplier)
Risk of economic rent appropriation due to transaction-specific know-how (dependence on supplier)

5. Testing Dependent Variable Independent Variables
113 automotive components coded in-house / contracted
Extent of vertical integration (looked for 80% in-house)
Independent Variables
Cost of component development (applications engineering)
Component specificity (GMC vs. FMC vs. generic)
Firm identity (GMC & FMC)
Systems effects (or ‘component effect on the system’)

6. Testing Engineering Specificity Company Engine (engine and emissions)
1-10 scale for engineering effort
Specificity
1 = firm specific component; 0 = otherwise
Company
1 = GMC; 0 = FMC
Engine (engine and emissions)
Chassis (chassis, transmission, steering)
Ventilation (ventilation)
Electrical (electrical)
Body (body, fuel tank, cap)

7. Findings
‘Engineering’ (component development effort) is positively related to vertical integration
‘Specificity’ is statistically significant
“Only components specific to a single assembler [firm] will be candidates for vertical integration”
Individually (except ‘Electrical’), no category indicated a significant relationship with vertical integration
All five, however, taken together showed significance in the Probit model

8. Conclusion
“GM and Ford are more likely to bring component design and manufacturing in-house if relying on suppliers for preproduction development service will provide suppliers with an exploitable advantage.”
HOWEVER – “[GM] and Ford also have a preference for backward vertical integration when the components are firm-specific and their design must be highly coordinated with other parts of the automobile system”
This shows an efficiency-driven vertical integration policy which may operate without regard to supplier opportunism
Findings do not apply in Japan, where “the relationship between the major auto firm and its satellite suppliers is one of total cooperation” (Ouchi, 1981)