Sourcing parts of complex products: evidence on transactions costs, high-powered incentives and ex-post opportunism

This paper revisits evidence on the correlates of sourcing decisions in the US auto industry to see whether adoption of new contracting terms and early involvement of suppliers in design activities (e.g. “relational contracting”) yields different results as compared to previous findings. Previous studies find that US auto firms insource complex parts that require investments in specific assets. Absent large differences in production costs, the results suggest that transactions costs associated with external suppliers exceed transactions costs associated with internal suppliers (e.g. loss of high powered incentives). Using data on 156 sourcing decisions for process tooling (dies) of a new car program we find that under the new relational contracting regime, transaction cost theory continues to have explanatory power for sourcing decisions; however, attributes that favored insourcing in previous studies favor outsourcing in this setting. Moreover, more complex subassemblies are associated with fewer distinct suppliers than expected — evidence of a tendency to co-locate decision rights to reduce transactions costs related to system interactions. After controlling for transaction characteristics that are associated with the sourcing decision, we find no evidence that outsourcing is associated with increased ex post opportunism by the firm (e.g. agreement about contract completion); however, outsourced parts are submitted by suppliers for evaluation significantly later than insourced parts (e.g. delivery holdup).