Asset Choice and Supplier Performance in Two Organizations–US and Japanese

Abstract

The problem of vertical integration is a venerable but increasingly important focus of attention in profit-seeking organizations. Over the past ten years, many industries have seen increased cooperation between buyers and suppliers to achieve more difficult goals caused by rising product market competition. In many firms, this cooperation is balanced against the putative advantages of diminishing but still substantial in-house operations. One way to compare the performance of cooperative suppliers with in-house operations is to focus on the buyer's choice of assets used to produce the inputs needed for the final product. For strategic reasons, some of these assets will be highly specialized and others standardized. The question this paper asks is whether this choice of specialized or standard assets influences the performance of the supplier, controlling for whether it is in the market or in-house. The hypothesis is that the choice of specialized assets, for strategic reasons, is associated with lower supplier conformance with the buyer's target price for the input. In other words, for these assets the supplier's price, which is higher than the buyer would have liked to pay, reflects some of the strategic value of the input to the buyer. The supplier is simply appropriating some of this value, since it can raise its price with a low threat of termination by the buyer. For standard assets, in contrast the threat of termination is omnipresent, so that the choice of assets is irrelevant for supplier price performance. The test is performed using data on both in-house operations and market suppliers from a quite large US manufacturing firm and on market suppliers to a very successful Japanese manufacturing firm. Interestingly, there is no difference between these firms in the applicability of the hypothesis. Also, in-house and market suppliers differ in price performance only for standard assets, market suppliers performing better. Organizations can therefore gain quite a bit from outsourcing the production of less specialized inputs but achieve roughly the same performance from in-house and market suppliers for more specialized inputs. This last result is controversial and should bc tested repeatedly using other micro-level data. This study therefore addresses three sides of the current debate surrounding modern questions of vertical integration. First, does the strategic value of the input make a difference in supplier performance? The answer is yes, but only for specialized inputs. Second, do in-house and market suppliers differ in their performance? The answer is yes, but only for standardized inputs. Third, do US and Japanese firms differ in the performance of their suppliers, given variation in asset specialization and strategic importance? The answer is no, at least for the two firms studied here. All caveats regarding the generalizability of results from small sample studies apply.