An Empirical Examination of Transaction- and Firm-Level Influences on the Vertical Boundaries of the Firm Leiblein, Michael and Miller, Douglas Strategic Management Journal Ishva Minefee September 11, 2012

Overview of Presentation Study’s Motivation Literature Background Hypotheses and Conceptual Model Data Sample Findings Implications Discussion Questions

Study’s Motivation Foundational question: Why do firms vertically integrate? Transaction cost economics (TCE) accounts for significant amount of previous research, and suggests ‘that the optimal form of organization is primarily a function of the characteristics underlying a given exchange’ (p. 839) This research article however, maintains that TCE is limited in its explanation of vertical integration The literature typically does not account for firm-specific attributes as drivers of vertical integration

Literature Background Transaction Cost Economics Vertical boundary decisions are likely to be influenced by ‘characteristics associated with the efficiency of the chosen form of organization’ (Williamson, 1975; Klein et al., 1978) Neglects capabilities Resource-based view (RBV) Firm-specific governance decisions may arise from prior commitments, exchange relationships, and capability differentials Real options theory Explains trade-off between efficiency of competing forms of organization and the value to operate flexibly in an uncertain future

Hypotheses and Conceptual Model

Data Sample Sample Production activities of 117 global integrated circuit manufacturers (ICE, 1997) Non-random Unit of analysis: production decision (total of 469) 358 – internal production 111 – external production-sourcing relationships

Variables Dependent Variable Production decision (Make versus Buy) Independent Variables Asset specificity Demand uncertainty Fabrication experience Sourcing experiencing Diversification strategy Control Variables Ex Ante small numbers Firm size Firm tenure Geographic region Year

Findings The interaction of high asset specificity (measured by exchange involving analog, memory, or customized ASIC products), and high demand uncertainty (measured by the variance surrounding a time trend in the demand for similar products) increase the likelihood of vertical integration (TCE hypothesis 2b is corroborated). A firm’s past experiences (embodied in past production expertise using the relevant process technology) increase the likelihood of vertical integration (RBV hypothesis 3 is corroborated). A firm’s past experiences (measured by the number of prior outsourcing relationships over the past 5 years) reduce the likelihood of vertical integration (RBV hypothesis 4 is corroborated). Firms with higher levels of diversification across product-markets increase the likelihood of vertical integration (Real options hypothesis 5 is corroborated).

Research Limitations Model Specification Problems Are there any omitted variables based on: Transaction cost economics Resource-based view; and/or Real Options Measurement Problems Which measurement do you regard as the weakest in the paper? For example, is the asset specificity a good one? In theory, firm-level specificity would lead to small numbers by definition, and yet the correlation between these two variables is very slightly negative (in Table 1).

Research Limitations Endogeneity/Econometric Identification Concerns Potential for self-selection bias: Heckman (1978) correction Inverse Mills ratio used in two-stage Probit analysis Potential simultaneity problem between dependent and independent variables: Instrumental variables via a Hausman test Any other issues concerning alternative stories of causality?