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The First Rule of Strategy

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									Testing Alternative Theories of the Firm: Transaction Cost,
  Knowledge-Based, and Measurement Explanations for
      Make-or-Buy Decisions in Information Systems
                Laura Poppo (Virginia Tech)
             Todd Zenger (Washington University)
          (1998) Strategic Management Journal

                         Group 3:

                        Jason Franken
                      Prasanna Karhade
                       Hsiao-Ching Lee
                        Jennifer Shen
                       Marko Madunic
                                                        1
       GOALS AND OBJECTIVES
Strategic management seeks to explain how and why
there are differences in firms’ economic performances

Poppo and Zenger’s paper represents transaction-cost
economics explanation of firm boundaries
   TCE – not an exhaustive tool for analyzing boundary choices

Compare transaction cost, knowledge-based, and
measurement cost explanations of make-or-buy choices
   TCE has been a popular framework for analyzing the efficiency
   of inter-organizational boundary decisions


                                                                 2
Then, why should a firm buy knowledge on a market
when it has the capacity to build it internally?

 Knowledge is built as coordination and communication
 mechanisms emerge and become embedded in some
 shared identity (Kogut and Zander, 1996)

 This common identity lowers the cost of communication
 for future search
     “As an activity becomes more specific to the firm, it
    increasingly accesses and develops a common
    organizational communication code which both codifies
    knowledge and facilitates its efficient dissemination
    and protection ”

                                                             3
Then, why should a firm buy knowledge on a market
when it has the capacity to build it internally?

   Knowledge-based reasoning suggests that firms with superior
   capabilities tend to have more efficient production
      Efficiencies are sensitive to scale, firms with greater production
      volume tend to internalize functions through vertical
      integration

    STRATEGIC IMPORTANCE OF KNOWLEDGE WITHIN FIRM
      (RBV and knowledge based view) – firms will control particular
      knowledge source when strategic importance is high
      Firms adopt the knowledge acquisition mode of
      internalization


                                                                    4
Asset specificity
 TCE: Assumption that efficient production necessitates
 investments in physical and human assets that are
 transaction specific (Williamson, 1979)
 TCE logic assumes that firm specific assets reduce costs,
 these assets are also hypothesized to damage the
 performance of simple market governance as a result of
 costly contractual safeguards to protect from opportunist
 behavior (Williamson, 1981, 1985)
Resources and capabilities
 The resource-based perspective is similar to TCE theory
 because asset specificity is related to the nature of firm
 resources
 RBV focuses on the firm’s competencies and capabilities of
 coordinating productive resources that are not transaction
 specific
                                                              5
          SAMPLE AND METHODS
 Authors study the governance of nine information services
 at 152 companies, resulting in a sample 1,368 observations
 Survey data were gathered using a key informant
 technique from chief information service officer or the
 manager of information technology

DEPENDENT VARIABLE
 Information technology support services that require
 specialized skills were used as a dependent variable
 The dependent variable has been defined as dichotomous,
 reflecting a yes/no decision toward outsourcing
    Information systems – highly specific functions,
    involving tacit knowledge were less likely to be
    outsourced
                                                        6
     Results and findings:
Authors found that contrary to the RBV hypothesis (hypothesis
2) managers do not become more satisfied with performance as
internal activities become more firm specific (page 867).

Firm specificity has a strong negative effect on market
performance and no clear effect on firm-level performance

TCE view is corroborated as empirical test clearly shows that
asset specificity triggers governance choices because hierarchies
more effectively cope with asset specificity than markets

Routines, language and embedded forms of knowledge are thus
rigid mechanisms that hamper performance

                                                             7
      Results and findings:
Decision to vertically integrate when information
services are firm specific are more determined by
performance dissatisfaction with using market
governance (outsourcing) rather than performance
satisfaction with using internal governance (internal
sourcing)

Therefore, boundary choices should be a function
of the possession and composition of rare and
inimitable resources that are a source of competitive
advantage

Risk of obsolescence is better managed by external
suppliers
                                                        8
         Results and findings:
Firm size
  Contrary to the scale economies hypothesis, larger
  firms are inclined to outsource their IT activities more

Increasing management costs, linked to more
complex organizational structure, are major
determinant of the outsourcing of non-core activities
  IT: Information systems are generally viewed as non-
  core activities, and difficult to manage internally

Firms will outsource IS functions, the more
comprehensive the demands for personnel with
extensive knowledge and skills
                                                        9
                 TCE LIMITATIONS

The dynamics of rapidly evolving information technology
exposed theoretical shortcomings of TCE research

Authors question overemphasis in TCE on asset
specificity, without sufficient consideration of the firm’s
competencies and capability of coordinating productive
resources that are not transaction specific

If competitive advantage emanates from valuable and
inimitable resources (Barney, 1991) then boundary
choices should be explained by the possession and
composition of resources that are a source of competitive
advantage


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