The Make-and-Buy Decision

15 September 2006 at 2:27 pm 1 comment

| Peter Klein |

Two new papers address bi-sourcing: Why do some firms simultaneously produce their own inputs and purchase the same inputs from external suppliers? Julan Du, Yi Lu, and Zhigang Tao’s “Why Do Firms Conduct Bi-Sourcing?” (Economics Letters, August 2006) uses bargaining theory to show how simultaneously making and buying can mitigate the holdup problem associated with exclusive reliance on an external supplier. Daifeng He and Jackson Nickerson’s “Why Do Firms Make and Buy? Efficiency, Appropriability, and Competition in the Trucking Industry” (Strategic Organization, February 2006) tells a more nuanced story in which “the interaction of efficiency, appropriability and competition concerns” explains simultaneous bi-sourcing. He and Nickerson provide empirical analysis inconsisent with market-power, capacity-constraint, agency-theoretic, and property-rights explanations for the results.

Both papers contribute to a growing understanding that vertical relationships are frequently more subtle and complex than what can be captured by simple “make-or-buy” models. (Even our canonical examples deserve further scrutiny.)

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

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1 Comment Add your own

  • 1. Matt Elliott  |  18 September 2006 at 3:48 pm

    Dr. Klein, if you’re interested in an Agriculture application of this phenomenon, you should look at seed use of farmers. Particularly wheat seed, which I’m a little more familiar with. Every year our farm uses both seed we raised from the previous crop and seed we purchase from seed suppliers. There are different reasons for this; variety selections, obtaining cleaner seed, and of course cost. One of the motivations of seed companies and probably for the greater good of wheat producers, if everybody followed the rules (no free riders), is to reduce the amount of in house seed use. Less in house seed use would decrease the number of diseases and weeds that are put in the environment by continually reusing your own seed and also maintaining the integrity of various disease and herbicide genetic tolerances. If you look at the seed business industry wide, this is a major issue, in my opinion causing mechanisms and genetic design to increase asset specificity so you can’t reuse seed. Anyways just thought I would throw it out there after we discussed it in class.

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