How A Firm’s Capabilities Affect Boundary Decisions

Traditional Transactions Cost Analysis>>Boundary decisions Within the organization

 Specify conditions under which firms business activities should be taking place.
 Factors affecting boundary decisions: The cost of governance can often be offset by outsourcing
1. Cost of governance mechanism its ability in mitigating opportunism.

2. Threat of opportunism
Governance Opportunism
- mechanism through which firms manages an economic exchange - exists when a party of an exchange takes unfair
- the more elaborate, the more costly advantage of the other party that makes large
- costs: market<intermediate<hierarchical transaction-specific investment
 Market (outside boundary) >> rely on market determined prices - transaction-specific investment: investment being
 Intermediate (outside boundary) >> use of complex contracts and significantly more valuable in a particular exchange
other forms of strategic alliances (joint venture) than in alternative exchanges
 Hierarchical (within boundary) >> possess and operate own stores, - the more elaborate, the higher chance of reducing
sales & distribution networks or factory supplying the products it sells opportunism
etc.
Capability Considerations
 Costliness of obtaining capabilities with hierarchical governance.
 Reasons for high costs of creating capabilities:
1. Historical context -create capability in cost-effective way depend on unique historical conditions that no longer exits.

2. Path Dependence -capability developed based on a long, difficult learning process

3. Social Complexity -capabilities that only evolve over time (culture, reputation etc.) are unlikely to be developed in the
short term （e.g. “visionary” firms such as Sony, Wal-Mart, Disney）
4. Causal Ambiguity -actions may not lead to intended results
-“invisible assets”

 Reasons for high costs of gaining capabilities through acquisition:

1. Legal Constraints -efforts foiled by antitrust laws to ensure fair competition and local ownership restrictions prevent
foreign ownership of domestic firms
- e.g. Microsoft’s plan to purchase Intuit
2. Effect On The Value of -value of capability reduced with acquisition
Capabilities
3. Strategic Flexibility and -under conditions of high uncertainty, acquisition is less flexible and incurs higher cost in reselling
Uncertainty newly acquired firm than withdrawing from non-hierarchical governance
-instead, firms prefer strategic alliances (immediate governance)
4. Unwanted “Baggage” & -firm is a bundle of capabilities and desired ones are often spread across globally, thus difficult to
Diffused Capabilities be extracted，acquiring unwanted capabilities add to the total cost of acquisition
5. Leveraging Acquired -acquiring firms unable to take full advantage of newly acquired capabilities
Capabilities -integration difficulties -- difference in culture, systems, approach increases overall cost
 Non-hierarchical choices are preferred when the cost of using hierarchical governance is too high
 Opportunism is simply part of the cost of gaining access to the special capabilities controlled by another firm that cannot be
developed internally or accessed through acquisition in a cost-effective way.
 These exchange conditions are prevalent in rapidly evolving high-technology industries, including biotechnology,
microelectronics, and certain sectors of computer software.