Supplier switching costs and vertical integration in the automobile industry

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Supplier switching costs andvertical
integrationin the automobile industry

• Monteverde, Kirk and David J. Teece (1982).
• Bell Journal of Economics, 13 (1) 206-213.
• Prepared by He Soung AHN
• Sept 9, 2009

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Hypothesis

• Why do U.S. automobile companies take parts
  production in-house?
• Main hypothesis
• Assemblers will vertically integrate when the
  production process generates specialized and
  non-patentable know-how

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An assembler will chose to vertically integrate
component production when
Transaction-specific know-how and skills
Costly to switch to an alternative supplier (high
supplier switching costs)
Expose the assembler to opportunistic
recontracting

• development activities for new automotive parts

• Testable hypothesis
• The greater is the applications engineering
  effort associated with the development of any
  given automobile component, the higher are the
  expected appropriable quasi rents, therefore, the
  greater is the likelihood of vertical integration
  of production for that component.

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Methodology

• Dependent variable
• The extent of vertical integration by General
  Motors and Ford for U.S. production in 1976 for
  133 automotive components
• Manufactured either in-house or by an external
  supplier --- Probit model binary choice
• Independent variable
• Interested primarily in the influence of
  applications engineering on vertical integration
  choices
• Here, an engineering cost rating was used

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• 3 control variables
• Distinguishes components that are specific to a
  company from those that are generic
• A dummy variable to control for systematic
  differences between General Motors and Ford
• A set of dummy variables related to systems
  effect
• In the vehicle system, the relationships
  between individual components must be considered
  because its design and implementation are tightly
  coordinated
• Vertical integration is predicted for components
  with large systems effects.

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Results
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Results

• The development effort associated with the design
  of any given automotive component is shown to be
  positively related to the likelihood of
  vertically integrated production of that
  component
• Only components specific to a single assembler
  will be candidates for vertical integration
• General Motors is more integrated into component
  production than Ford
• Only a mild relationship between vertical
  integration and components with large systems
  effects exists

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Conclusion

• Transaction cost considerations surrounding the
  development and deepening of human skills appear
  to have important ramifications for vertical
  integration in the automobile industry, thereby
  supporting the transaction cost paradigm