Assets versus Activities

27 July 2006 at 1:46 pm 3 comments

| Richard Langlois |

At the risk of injecting some substance into my posts, let me raise an issue in the economics of organization that I have been thinking about recently.

There has been much discussion in the literature about the differences between the transaction-cost and capabilities views of organization, something that Nicolai and I, among many others, have written about. But another division might be between asset theories and activity theories. Asset theories are of course the province of the mainstream economics of organization. In this literature, one typically defines vertical integration as joint ownership of productive assets, and integration typically arises because of hazards from cooperating without joint ownership. Activity theories come from the literatures on product design and modularity. Here the issue is how tasks (or activities) ought to be designed given the structure of the production process. In this literature, the logic of integrality versus modularity provides clues to which activities out to be “outsourced.” Perhaps the best example of this kind of thinking is by Baldwin and Clark. I have also tried to think about the issues in a paper that will be coming out in Organization Studies. In many ways, this approach harkens back to Adam Smith.

But how do the two approaches fit together? This is a good question, and one that need more research. In an interesting paper given at the 2005 DRUID summer conference, Mari Sako confronted the two approaches by looking at the organization of automobile supplier parks around the world. What she found is that the two accounts of integration seem to be orthogonal to one another. In her case studies, “modular product architecture is indeed associated with greater outsourcing of tasks, but task outsourcing is not necessarily associated with the disintegration of asset ownership. If anything, a high degree of task outsourcing goes hand-in-hand with integrated asset ownership in modular consortia.”

This result would seem to be consistent with a sophisticated (indeed, rather daunting) analysis by Sharon Novak and Birger Wernerfelt. They use data from the automobile industry to test the idea that outsourcing of tasks is driven by the minimization of adjustment costs within and between firms. Not surprisingly, perhaps, they find that tasks are more likely to be undertaken within the same firm the more frequently adjustments are needed between the tasks. As they put it, the firm is a low variable-cost but high fixed-cost way to govern adjustments. So, as in Sako, you might want to integrate assets when you’re governing tasks needing frequent adjustment; but what you outsource depends on the modular structure of production, that is, on which tasks don’t need to be adjusted frequently.

Entry filed under: - Langlois -, Papers, Strategic Management, Theory of the Firm.

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3 Comments Add your own

  • 1. Peter Klein  |  28 July 2006 at 9:16 am

    Dick, any thoughts on how this relates to Williamson’s concepts of “autonomous” and “coordinated” adaptation? WIlliamson’s focus, of course, is not on modularity but on asset specificity. But modularity and asset specificity perform a similar function; that is, when tasks are highly modular, or when asset specificity is low, contracting parties can make adjustments individually, without tight vertical coordination, and vice versa.

    In his more recent writings Williamson emphasizes adaptation as the “central problem of economic activity.” In other words, the function of asset ownership is to facilitate adaptation. Even Oliver Hart, as I noted in a recent post, seems to recognize the need for a temporal explanation for integration. Do you think any of these approaches provide a useful link between asset and activity explanations?

  • 2. rlanglois  |  28 July 2006 at 1:16 pm

    Peter — I don’t think I’m familiar with that distinction. You’ll have to enlighten me.

    It’s interesting that Williamson is now stressing adaptation. I always thought that was a hallmark of the early Williamson (which was an important influence on me). But somewhere around 1979-81 he began making the claim that asset specificity is the most important variable in explaining organization. If the focus on adaptation is a return to the earlier emphasis, I am glad of it.

    But the question is: what exactly does joint ownership of assets help you adapt? Arguably, asset integration helps you apapt (adjust) matters that have to do with divergences of interest (or maybe also divergences of opinion, though that gets less emphasis). If we merge our specific assets into a single firm of which we are both residual claimants, our incentives are basically aligned, and we have some (usually unspecified) governance structure to help sort out problems of private interest that arise later. But this is a far cry from adaptation in the pure production sense. There the issue is changing aspects of the production process in real time in response to endogenous and exogenous variation. (This is the kind of adjustment that Novak and Wernerfelt are talking about.) It isn’t obvious that adaptation in production typcially has much to do with rent seeking issues, although it certainly could on occasion. In general both of us as shareholders want production adaptation to take place efficiently. That’s why I suggested that the two kinds of adaptation are orthogonal. In Monteverde and Teece, stamping out car bodies is a separable task (though activities within the task need to be adapted), so body stamping can be outsourced to body firms. But the dies created are highly specific assets, so the car companies own the dies, even though the body makers fabricate and use the dies.

  • 3. Dick Langlois  |  8 September 2006 at 3:19 pm

    Just ran across this paper, in which someone explicitly models the asset and activity problem simultaneously. I haven’t read it carefully enough yet to know if it makes sense.

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