Organizational Limits to Firm Scope: An Overview

1
Organizational Limits to Firm Scope An Overview

• Main Issue
• Unit of Analysis Transaction
• Transaction Cost Economics (TCE)
• Transactional Governance Structures
• Bias to the Market
• The Market Benefits Costs
• Hierarchy Benefits Costs
• Choice of Governance Structure

2
Transaction Cost Economics

• TCE issue
• Transaction Costs
• Direct Costs
• Indirect Costs
• Potential Benefits of Transactional Structure
• Choice of Transactional Structure

3
Limit to Firm Scope
Cost of the Hierarchy
A

Market Cost
B
Benefit
Increasing Firm Scope
Org. Boundary Independent of Market
Org. Boundary Given Market Costs
4
The Market Costs, Benefits Causes

• Benefits
• Efficient Information Processing
• High-Powered Incentives

• Costs
• High Transaction Costs due to Market Failure
• Conditions for Market Failure
• Opportunistic Behavior
• Asset Specificity
• Uncertainty
• High Transaction Frequency
• Inseparability of RCs
• Information Assymetries
• Market Power

5
Hierarchy Costs, Benefits Causes

• Benefits
• Authority over Activity
• Coordination
• Tax Benefits
• Quality Control
• Information Access
• Leverage RCs

• Costs
• Increased Bureaucracy
• Agency Costs
• Loss of Flexibility
• Potential Overcapacity
• Attractiveness of Buyer Supplier Markets

6
Choice of Governance Structure

• 1. Disaggregate Industry Value Chain
• Structural Attractiveness
• Possession of RCs
• 2. Competitive Advantage?
• 3. Market Failure?
• Assess Conditions
• Cospecialized Assets
• 4. Need for Coordination?
• Conditions for Internalization
• Incentive Problems?
• See Next Slide

7
Incentive Problems Governance Structures
8
Integration/Market-Exchange Decision Process
Competitive Advantage?
Coordination Need?
Market Failure?
No
No
No
Market Exchange
Yes
Yes
Yes
Firm Hierarchy
Incentive Problem?
No
Yes
Trade-off
9
Governance Structures
Spot Market
Alliances
L-T Contracts
Joint Ventures
Integration
Most Common Swollen Middle