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Supplier switching costs and
vertical integration in the
automobile industry
Kirk Monteverde &
David J. Teece
Eva Herbolzheimer
University of Illinois at Urbana-Champaign
Research Objective
 Integration of the literature on Transaction Cost Theory
and Industrial Know-How
 Analysis of efficiency incentives for backward vertical
integration in the U.S. automobile industry
(Ford and General Motors)
 What motivates firms to take on parts
production in-house?
Supplier switching costs and vertical integration in the automobile industry
Factors influencing integration decisions
 Specialized, non-patentable know-how and skills
 Difficulty of skill-transfer
 High switching costs
 Possibility of opportunistic re-contracting (“renegotiation
of contract”)
 Know-how in the Automotive Industry:
- Development activities for new parts (heuristic development)
- First-mover advantage
Supplier switching costs and vertical integration in the automobile industry
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 and, therefore,
the greater is the likelihood of vertical integration
of production for that component (1982: 207).”
Supplier switching costs and vertical integration in the automobile industry
Statistical Model
Probit Analysis
Dependent Variable (dichotomous): Extent of in-house
production of 133 automotive components used by Ford and
General Motors
- 80% internal production rated as integrated
Independent Variables:
- Engineering
- Chassis
- Specific
- Ventilation
- Company
- Electrical
- Engine
- Body
Supplier switching costs and vertical integration in the automobile industry
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Results (I)
Supplier switching costs and vertical integration in the automobile industry
Results (II)
 “Engineering” variable (transaction-specific skills) is highly
significant
 development effort positively related to likelihood of vertical
integration
 “Specific” is statistically significant
 only components specific to a single assembler will be
candidates for vertical integration
 “Company” is statistically significant
 GM is more integrated than Ford
 Systems-effects hypothesis only mildly supported, however the
set of five dummies taken together contributed to the
explanatory power of the model
Supplier switching costs and vertical integration in the automobile industry
Conclusion
 Transaction cost considerations concerning know-how and
human skills have an effect on the choice of vertical
integration in the automotive industry (support
transaction cost paradigm by Williamson, 1975)
 GM and Ford are more likely to backwards integrate
production if relying on suppliers will provide the later
with a first-mover advantage (high switching costs)
 Backwards integration when components are firm-specific
and design must be coordinated with other parts
 Vertical integration decisions are based in part on
efficiency considerations
Supplier switching costs and vertical integration in the automobile industry