The Make-or-Buy Decision: Lessons from Empirical Studies

Should a firm make its own inputs, buy them on the spot market, or maintain an ongo- ing relationship with a particular supplier? The emergence of the transaction cost approach to vertical integration in the 1970s and 1980s generated a substantial body of empirical research on vertical firm boundaries and related issues in contracting and organizational design. This chapter reviews the empirical literature on the make-or-buy decision, focusing on the transaction cost approach. After reviewing the Coasian or "contractual" approach to vertical integration I summa- rize the most common empirical strategies, highlighting current controversies over data and methods, sample selection, and related issues. I next provide a sampler of evidence on compo- nent procurement, forward integration into marketing and distribution, contractual design, and the use of informal agreements. Finally, I discuss outstanding challenges and directions for fu- ture research, focusing on the measurement and definition of key variables, the role of asset specificity, the comparison of rival explanations, causality, and the effects of the legal and regu- latory environment.