Relying on at least two frameworks discuss those factors which influence an organisation's decision whether to "make or buy" goods or services.


Essay, 2003
9 Pages, Grade: 2

Excerpt

Introduction

Operating in domestic markets and expanding into global market offers new opportunities. These opportunities necessitate changes relating to the strategy, operational planning and the organisation itself. Growth can be planned. To operate effectively in a global market it is necessary to identify global drivers and to compete with rivals. Therefore costs should be reduced and the competitive advantage should be extended. One issue relating to the reduction of costs could be a “make or buy (m/b)” decision, in other words, vertical integration or vertical de-integration, so-called outsourcing. Cost savings are achieved through more effective co-operation. Vertical integration includes merging and acquiring and its direction is backward or forwards due to its related activities respectively its supply chain. Outsourcing, or de-integration, contains to concentrate on the specialisation of competences by sub-contracting all other activities and it subcontracts activities (Grant, 2002: 393-4). There are three forms of outsourcing: Co-sourcing that keeps the clients responsibility for management and strategic aspects of the activity while an expert provides the outsourced activity (Brown, 1997: 60). Secondly, removing an activity out of the company as an indepented company and demand its products. Thirdly, outsourcing as used in the following: An activity is in the responsibility of another organisation (Brown, 1997: 60).

While talking about a m/b decision it is necessary to define and to present the point of view of the transaction cost approach in contrast to the resource-based approach. Firstly, an introduction in transaction costs approach is given, after a discussion of its point of view relating to the make and buy decision. Afterwards the resource-based approach is added. Because of limits of space, the network approach is not discussed[1].

Transactions costs (TC) Approach

The underlying assumption of the TC approach is that there is an economic system that works by itself without being centrally controlled. Its automatic co-ordination is guaranteed through the interaction of demand and supply, the so-called price-mechanism.[2] Participants of the markets choose rationally between alternatives, hence, optimal allocation of resources is given (Coase, 1937: 387). Also firms try to maximize their profits by working along the production function. (Williamson, 1996: 131). Within firm, activities are coordinated through the hierarchy, which includes, for example rules and directives, routines, mutual adjustment as well as internal prices and competition. Activities between firms’ are co-ordinated by contracts and the price- mechanism (Grant, 2002: 194; 390).

To summarise, there are two different “places” where co-ordination takes place: Within the organisation and between organisations. Within the organisation co-ordination is guided by hierarchies (“visible hand”), or in other words, by the administrative-mechanism. Between organisations, the market coordinates decisions through the price-mechanism (“invisible hand”) (Grant, 2002: 388). However, these mechanisms of co-ordination do not work perfectly: there are several imperfections in markets that should be mentioned briefly: market failure due to imperfect competition, market failure due to inadequate information and governmental failures.[3] Contracts exist in order to reduce imperfections in the market. Despite the existence of these contracts, imperfections are reduced, but not deleted, in terms of co-ordination. Moreover, every activity, within firms or on markets, includes transactions, and produces costs, the so-called TC (Whittington, 1994: 92): Whenever an exchange between two parties takes place, it is necessary to communicate, to command and obey the on hand, also to search and collect information, to negotiate, to reach satisfying agreements, to draw up the contract and its enforcement (Frances, 1991: 13; Grant, 2002: 390). Sometimes TC are mentioned as costs of co-ordination or costs of making a transaction (Lorenz, 1991: 186). It is obvious, that the underlying agreement process of signing contract produces a high amount of costs. The more complex a contract the higher are the TC. Furthermore, there is yet another type of imperfection, which is caused by human boundaries and relates to information processing, knowledge about the future and its characteristics TC represents the restrictions that have an impact on institutions (Frances et al, 1991: 13). “These TC are raised by the bounded rationality and self-seeking opportunism inherent in human nature” (Whittington, 1994: 92). Because of opportunism and bounded rationality of human behaviour, the level of contracts´ complexity, that increases TC, is depended on the frequency of transactions, on uncertainty or the level of complexity and on specific assets of contracts matter. Bounded rationality can be described exemplarily as the physical limit of not having a never-ending storage of information, knowledge etc. Williamson suggests that in a sufficiently simple environment, the constraints of bounded rationality are never reached, but in times of uncertainty and complexity, such constraints come to the fore (Williamson, 1975: 21-3). However, it is more convincing that, uncertainty always exists, as nobody knows what the future holds, thus such constraints are always evident. However it is obvious that wherever TC are low, the market is almost perfect: Competitive supply, conditions, and information are readily available, switching costs for buyers and suppliers are low. Wherever market imperfection are high and disable the market-mechanism TC are high: The situation of monopolies is associated with a highly imperfect market because prises of goods are generated through the monopolistic bargaining power. Also the high degree of dependency on monopolistic suppliers set an incentive to their opportunism. Moreover if there is a transaction-specific investment necessary to fulfil a contract: Risk of wasting this investment increases because it is future-orientated. Uncertainty and risk for the supplier increase due to strengthen buyers bargaining power, which gives confidence to buyers’ self-opportunism. Additionally imperfections are more likely when this specific investment is infrequent (Grant, 2002: 394-5). Furthermore, opportunistic behaviour involves making false threats and promises in order to achieve self-advantage at the expense of the transaction partner (Williamson, 1975: 26-7). The more specific investments have to be undertaken, the higher the uncertainty and the less the frequency of activities, the higher the level of self- opportunism and bounded rationality. The higher the level of opportunism and bounded rationality the higher are the TC. That is why there is an incentive to integrate activities under direct ownership where it is cheaper to prevent errors and cheating by the administrative mechanism (Whittington, 1994: 92). There are several influences that have an effect on the “places” where activities are advantageous or in other words if activities should coordinated through market or hierarchy:

[...]


[1] For further reading: Lynch, R. (2000), Corporate strategy, 2nd ed.

[2] Adam Smiths approach of the invisible hand should just mentioned briefly. For further reading: Smith, A. (1776), An inquiry into nature and causes of the wealth of nations, in: Campell, R. H./ Skinner A. S./ Todd, W. B. (eds.).

[3] For further reading relating to market imperfections: Levacic, R. (1991), Markets and government: an overview, in. Thompson, G. et al (eds.), Markets, hierarchies & networks, pp.35-47.

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Details

Title
Relying on at least two frameworks discuss those factors which influence an organisation's decision whether to "make or buy" goods or services.
College
University of Kent
Course
Strategic Management
Grade
2
Author
Year
2003
Pages
9
Catalog Number
V53644
ISBN (eBook)
9783638490382
File size
456 KB
Language
English
Notes
To decide whether to outsource or to rely on their activities is one of the questions organisations have to deal with. Due to globalisation business becomes too complex to be successful in activities that are necessary for producing goods. This essay deals with the question of vertical intergration and outsourcing by discussing the resource based approach in contrast to the transaction cost approach.
Tags
Relying, Strategic, Management
Quote paper
Susanne Jung (Author), 2003, Relying on at least two frameworks discuss those factors which influence an organisation's decision whether to "make or buy" goods or services., Munich, GRIN Verlag, https://www.grin.com/document/53644

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