Profit Centers, Single-Source Suppliers and Transaction Costs

Abstract

This paper addresses criticisms of transaction-cost theory that it overstates the effect of asset specialization on vertical integration and understates the costs of managing interunit relationships within an organization, particularly for nonstandard organizations and markets. We apply the theory simultaneously to decentralized supply relationships in a manufacturing corporation and to the corporation's relationships with single-source suppliers. Our results support the core proposition of the theory-that specialized assets have lower transaction costs within the organization. However, the hybrid characteristics of these supply relationships challenge both the theory's basic assumptions and its predictive power. Corporate decentralization and relational contracting in the market diminish the role of asset specificity as a necessary condition for low transaction costs in-house and as a sufficient condition for high transaction costs in the market. Therefore, how the theory should be used as a predictor of shifts in the current boundaries of the corporation is unclear.