1. I NTEGRATION OF THE S ALES F ORCE : A N E MPIRICAL E XAMINATION Presented by: Sandra Corredor Erin Anderson Wharton – INSEAD Rand Journal of Economics (1984) David Schmittlein Wharton – MIT

2. Motivation  Few empirical tests of the uncertainty and behavioral [bounded rationality & opportunism] issues posed by TCE  E.g. Monteverde and Teece (1982) and Teece (1980) human assets  Further: studies human assets V.I.  When vertical integration takes place?  What determines whether to use direct selling or representative agency in the electronic components industry?  Reps: 50% manufacturing firms used them, only 10% of sales thru this channel.

3.  Problem: assets become specialized to a relationship, and the parties are locked into bilateral exchange… opportunism and maladaptation arise. Y OUR PAYOFFS  Specialized knowledge: particular operating procedures, sensitive formal+informal information. E.g. “key" accounts.  Specialized relationship: sales rep with the firm (production or design engineers). E.g. loyalty to the salesperson-not to the principal. Asset specificity P1 P1 The greater the total value of company-specific assets (on the company and customer sides), the greater the likelihood of V.I.

4.  Problem: assets become specialized to a relationship, and the parties are locked into bilateral exchange… opportunism and maladaptation arise. Y OUR PAYOFFS  Specialized knowledge: particular operating procedures, sensitive formal+informal information. E.g. “key" accounts.  Specialized relationship: sales rep with the firm (production or design engineers). E.g. loyalty to the salesperson-not to the principal. Asset specificity P1 P1 The greater the total value of company-specific assets (on the company and customer sides), the greater the likelihood of V.I.

5.  Environmental uncertainty: “mkt superiority is undisturbed - unless assets are specific to a nontrivial degree” (p.387)  Problem: incomplete contracts Uncertainty P2 P2 The likelihood of V.I. is expected to increase, given nontrivial asset specificity, with increasing uncertainty  Internal uncertainty: performance is difficult to evaluate.  Problem: imperfect input measures [manager's subjective judgment] and defective output measures [observables]. Integration is not essential (monitoring) P3 P3 The likelihood of integration should increase with the difficulty of monitoring performance

6.  Environmental uncertainty: “mkt superiority is undisturbed - unless assets are specific to a nontrivial degree” (p.387)  Problem: incomplete contracts Uncertainty P2 P2 The likelihood of V.I. is expected to increase, given nontrivial asset specificity, with increasing uncertainty  Internal uncertainty: performance is difficult to evaluate.  Problem: imperfect input measures [manager's subjective judgment] and defective output measures [observables]. Integration is not essential (monitoring) P3 P3 The likelihood of integration should increase with the difficulty of monitoring performance

7.  Problem: for infrequent transactions losses from opportunism and inflexibility are likely to be lower than the V.I. firm's incremental overhead Frequency P4 P4 The greater the total value of company-specific assets (on the company and customer sides), the greater the likelihood of V.I. t=1 t=2 t=3 t=4 t=5 Issue: whether a firm can at least break even on the fixed cost of an integrated function.

8.  Problem: for infrequent transactions losses from opportunism and inflexibility are likely to be lower than the V.I. firm's incremental overhead Frequency P4 P4 The greater the total value of company-specific assets (on the company and customer sides), the greater the likelihood of V.I. t=1 t=2 t=3 t=4 t=5 Issue: whether a firm can at least break even on the fixed cost of an integrated function.

9.  Problem: Large firms can achieve economies of scale in utilizing management skills, and the desirability of integration increases as density increases (though the breakeven point is unknown) Size P4 P4 As a firm size is large, V.I. becomes more desirable Issue: whether a firm can at least break even on the fixed cost of an integrated function.

10.  Problem: Large firms can achieve economies of scale in utilizing management skills, and the desirability of integration increases as density increases (though the breakeven point is unknown) Size P4 P4 As a firm size is large, V.I. becomes more desirable Issue: whether a firm can at least break even on the fixed cost of an integrated function.

11. Variables Transaction specificity of assets (TSA) Nature of the company (learning) Nature of product (learning) Confidential information Nature of the customer Importance of key account Customer loyalty Uncertainty as Environmental unpredictability (UEU) Expected deviation: forecast vs. actual sales (percentage) Uncertainty as difficulty of evaluating performance (UDEP) Difficulty of measuring the results of individual salesperson equitably Territory density (TD) Negative of: % of sales persons' time spent driving or flying Company size (SIZE) Total assets ZUEUTSA Specificity/unpredictability interaction ZUDEPTSA Specificity/ difficulty of evaluating performance interaction

12.  Conclusions about what determines the decision of V.I. does not mean that that decision was the best (eg. Performance impact as evaluated by Poppo & Zanger, 98)  Evaluating performance is the strongest predictor of V.I.: reasonable for human assets.  Given that all firms were from the electronic components, environmental uncertainty could have a lower variance.  This is a firm-centered analysis: no competitive dynamics (even geographic competition could vary). Some notes…

13.  Poppo & Zanger (1998) clarify the mechanism thru which size affect V.I. likelihood… not thru an impact on the performance of the external outsourced activities, but thru an impact on the performance of the internally sourced activity. frequency  Asset obsolescence idea on Balakishnan & Wernerfelt (1986) could also be a dimension of the frequency with which an asset is expected to be transacted. Connections