8. Outsourcing Flashcards
make or buy?
- make: in house (staffing, incentives)
- buy: outsourcing
vertical integration
- do all steps in house - “make” → vertical integration
- occurs when a firm participates in more than one successive stages of the value chain
- can be forward integration or backward integration
why do firms exist?
- market imperfection may exist
- transaction cost may arise
market imperfection
- in perfect market, the market price contains all relevant information and guides all decisions
- perfect markets are markets with perfect competition
• large numbers of sellers and buyers
• complete information about products
• no participant with market power to set price
• no barrier to entry / exit
• no barrier to access to factors of production
• no externalities
• profit maximization
transaction cost (TAC)
cost of using market
- the cost of finding what to outsource
- the cost of inviting suppliers to bid
- the cost of comparing and evaluating supplies
- the cost of selecting suppliers and negotiating, writing and enforcing contracts
- the cost of monitoring a supplier’s output
- legal cost incurred in case of breach of contracts
→ market TAC can be avoided using organizations like firms
organizational cost
- organization cost = cost of using organizations
- internal cost may arise such as cost of staffing, cost of coping with coordination + incentive problems
make or buy?
comparing organizational cost (cost of internal coordination and cost of governance) to external costs when using the market
→ then decide whether to vertically integrate or not
→ optimal degree of integration
make or buy? (make)
the higher
- the frequency of the transactions
- the opportunism of the partners (risky when conflicting goals)
- the bounded rationality (makes other less predictable)
- the asset specificity (leading to problems of holdup)
→ the better it is to carry the transaction out without an organization
→ MAKE
make or buy? (buy)
if
- you buy things only occasionally
- you can calculate all problems
- no business secret is involved
- many sources exist
→ BUY
outsourcing: long-term vs. short-term
long-term contract vs. spot market
→ fixed market TAC vs. variable market TAC
→ inventory vs. just-in-time delivery
spot-market contracts
pros: keeps you flexible
cons:
- need to close a large number of contracts
- bear TAC each time (high TAC per unit purchased)
- face uncertainty whether you will find input factors in time
long-term contracts
- need to be fixed only once (in a while)
- makes deliveries more reliable
- may require high TAC for contract specification and adaption
