Chapter 3 Flashcards
What is the make-or-buy decision
A firm’s decision to perform an activity itself or to purchase it from independent firm
What does make mean
Make means that the firm performs the activity itself
What does buy mean
Buy means it relies on an independent firm to perform the activity, perhaps under contract
What are make or buy the extremes of
Vertical integration
Explain the Make-or-buy continuum
Arm’s length market transactions - Less integrated
Long-term contracts
Strategic alliances and joint ventures
Parent/subsidiary relationships
Perform activity internally - More integrated
Benefits of using the market
Markets firms can achieve economies of scale that in-house departments producing only for their own needs cannot
Market firms are subject to the discipline of the market and must be efficient and innovative to survive
Costs of using the market
Coordination of production flows through the vertical chain may be compromised when an activity is purchased from an independent market
Private information may be leaked
There may be costs of transacting
Reasons to buy
Market firms enjoy two distinct types of efficiencies:
1. They exploit economies of scale and the learning curve
2. They eliminate bureacracy
What are agency costs
Agency costs are the costs associated with shirking and the administrative controls deter it.
What is shirking
Managers and workers who knowingly do not act in the best interests of their firm are shirking.
What are influence costs
losses caused by individuals in the firm attempting to influence company decisions for their own private benefit, and the costs the firm incurs trying to prevent this
What is Organizational design
Organizational design defines the lines of reporting and authority in the firm
What happens to the organizational design of firms when they integrate
They usually unify
What do contracts define
The conditions of exchange
Why are contracts are valuable?
because they list the set of tasks that each contracting party expects the other to perform
What does the effectiveness of a contract depends on?
The completeness of the contract
The available body of contract law
What does a complete contract do
it eliminates the opportunities for shirking
What are all real-world contracts:
They are incomplete
What are the three factors that prevent complete contracting
- Bounded rationality
- Difficulties specifying or measuring performance
- Asymmetric information
What is bounded rationality
Bounded rationality refers to limits on the capacity of individuals to process information, deal with complexity, and pursue rational aims.
What is Difficulties specifying or measuring performance
When the performance under a contract is complex or subtle, not even the most accomplished wordsmiths may be able to spell out each party’s rights and responsibilities.
What is Asymmetric Information
Even if the parties can foresee all contingencies and specify and measure relevant performance dimensions, a contract may still be still incomplete because the parties do not have equal access to all contract-relevant information. If one party knows something that the other does not, then information is asymmetric.
How do you coordinate production flows through the vertical chain
Timing fit
Sequence fit
Technical specification fit
Color fit
What are design attributes
Attributes that need to relate to eachother in a precise fashion; otherwise they lose a significant portion of their economic value
Three reasons to make
Coordination of production flows
leakage of private information
Transaction costs
Are patents foolproof
no, because of bounded rationality
What are three concepts from transaction costs economics:
Relationship specific assets
quasi-rents
Hold-up problem
Forms of asset specificity
there are 4
Site specificity
Physical asset specificity
Dedicated assets
Human asset specificity
What is site specificity
Site specificity refers to assets that are located side by side to economize on transportation or inventory costs.
What is physical asset specificity
Physical asset specificity refers to assets whose physical or engineering properties are specifically tailored to a particular transaction. For example glass molds for custom tailored containers shapes
What is dedicated assets
A dedicated asset is an investment in plant and equipment made to satisfy a particular buyer.
What is human asset specificity
Human asset specificity refers to cases in which a worker, or group of workers, has acquired skill, know-how, and information that are more valuable inside a particular relationship than outside it.
What is the fundamental transformation
Once the parties invest in relationship-specific assets, the relationship changes from a “large numbers” bargaining situation to a “small numbers” bargaining situation. This because before they invest in the assets they have alternative trading partners.
What is rent
Your rent is simply the profit you expect to get when you build the plant, assuming all goes as planned.
What is quasi-rent
Your quasi-rent is the extra profit that you get if the deal goes ahead as planned, versus the profit you would get if you had to turn to your next-best alternative.
What is the holdup problem
A firm holds up its trading partner by attempting to renegotiate the terms of a deal.
How does the hold up problem raise the cost of transacting arm’s length.
- more difficult contract negotiations and more frequent renegotiations
- investments to improve ex post bargaining positions
- distrust
- reduced ex ante investment in relationship-specific investments
