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

Model Firm Performance Exchange AttributesMake-Buy Choice Market Performance

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 IVsTCEKBVProperty rightsClassical agency Institutional agencyOther Asset specificity Markets perform poorly Firms perform well Markets=Firms Output measurement Markets perform poorlyMarkets=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 Ivs TCEKBVProperty rights Classical agency Institutional agencyOther Asset specificity Markets perform poorly Firms perform well Markets=Firms Output measurement Markets perform poorlyMarkets=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 IVsTCEKBV Property rights Classical agency Institutional agencyOther Asset specificityIntegrate Output measurement Boundary doesn't matterIntegrate Technological uncertaintyIntegrate Outsource Economies of scale Integrate Skill set Outsource

Results Theoretical Perspective IVsTCEKBV Property rights Classical agency Institutional agencyOther Asset specificityIntegrate Output measurement Boundary doesn't matterIntegrate Technological uncertaintyIntegrate 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.