Supply Chain Strategy
Reading 1 – Transaction Cost Economics as a Theory of Supply Chain Efficiency
In this study, we use the label governance choice to refer collectively to all the options for
organizing the supply chain.
Research addressing governance choice in the supply chain falls into three main theoretical
categories:
1) Competence: Are production activities assigned to the technologically and
organizationally most capable (in terms of quality and cost) actors?
2) Power: Who controls various stages of the supply chain? To what extent is an actor in
the supply chain able to influence the actions of other actors?
3) Efficiency: What kind of a supply chain relationship enables the transfer of
components and intermediate products from one production stage to another in an
economically efficient way?
In the competence-based view of the firm, the identities of individual firms matter, and
research attention is focused on how the heterogeneity of firms’ competences influences
firm-level heterogeneity in economic performance.
Value creation
Comparative advantage
Competitive advantage
Persistent above-normal economic profits
In the power perspective, attention focuses on actors who can exert power on others in the
supply chain, effectively controlling assets without owning them. An example is a large final
assembler who can “squeeze” its small suppliers by unilaterally setting prices. The power
perspective also posits that actors in the supply chain seek ways to avoid dependence on any
individual actor or firm in the chain. Final assemblers rarely produce all components (let
alone raw materials) in-house and are thus dependent on suppliers.
Work on power
Bargaining power
Resource dependence
The starting point of a TCE analysis of an economic transaction is the assumption that the
transacting parties share the mutual interest of organizing the transaction in an economically
efficient manner to increase value creation.
Asset specificity = the degree to which an assets can be deployed to alternative uses and by
alternative users without sacrifice of productive value. Specifically, the higher the sacrifice in
productive value (due to non-redeployability), the higher the asset specificity.
Site specificity in which the buyer and the seller are geographically co-located in
successive supply chain stages, reflecting ex ante decisions to minimize inventory and
transportation costs.
Physical asset specificity in which one or both of the exchange parties to the
transaction make investments in equipment that involves design characteristics
specific to the transaction, and which have lower economic values in alternative uses.
Human capital specificity in which investments in relationship-specific human capital
often arise through various learning-by-doing processes.
, Temporal specificity links specificity to time. For example, perishable fruits and
vegetables must be handled in the supply chain in a timely manner, and may require
vertical integration as a safeguard.
Dedication assets are found in contexts where a supplier makes discrete investments
in production capacity for the prospect of selling a substantial volume of output to a
particular customer.
In the automotive supply chain, inter-firm exchange is ubiquitous: a common factor across
modern automakers is that they operate in the supply chain as final assemblers that
outsource the majority of components.
TCE suggests that exchange relationships are subject to three main types of uncertainty.
Technological uncertainty = the seats may require engineering effort, which means
that their exact price and quality may not be ex ante known.
Technological life cycles = when will current technology become obsolete?
Demand uncertainty = the demand for automobiles is significantly affected by factors
outside the control of the exchange parties – input prices, interest rates, and general
consumer confidence are but a few examples. Thus, the number of seats that GM will
require in any given month or year is variable and unpredictable, leading to potential
maladaptation problems such as order cancellations.
Behavioural uncertainty = it is generally impossible for one exchange party to predict
how the other party will behave in an unforeseen circumstance that the contract
does not cover.
A key assumption in TCE is that contracts are unavoidably incomplete due to bounded
rationality, which is described as behavior that is “intendedly rational, but only limitedly so”.
Limitations to rationality arise from the fact that “the capacity of the human mind for
formulating and solving complex problems is very small compared with the size of the
problem whose solution is required for objectively rational behavior in the real world.
Simple transactions – where asset specificity, uncertainty, and frequency are low – are more
effectively handled as discrete market transactions that rely on the price system. GM hardly
needs to pay as much attention to how it sources light bulbs or tires compared to seats or
steering columns. When transactions entail higher levels of asset specificity, trying to
manage the exchange relationship through relational (short- or long-term) contracts can
become cumbersome and involve high governance costs.
Operationally, a credible commitment can be thought of as “a contract in which a promise is
reliably compensated should the promisor prematurely terminate or otherwise alter the
agreement.”
“Clever institutional arrangements [that] are a functional substitute for [trust].”
Lecture 1 – Course Introduction, Theory of the Firm
Two core concepts of course design
1) Trade-offs
2) Strategic fit
,Strategy = as sustainable positioning, making trade-offs, and forging fit relationships among
activities.
SCM = strategic and organizational management that enables a focal firm to overcome
performance trade-offs and realize operational competitiveness through a fit among the
management elements within and across the firm to adapt to the external environment.
Real options theory in the context of SCM
Managerial decisions revolve around creating and then exercising or not exercising
certain options.
Having the flexibility provided by options is beneficial when facing uncertainty (i.e.
unpredictability of environment or organizational variables).
To decide to what extent to exercise certain option requires through trade-offs (e.g.
flexibility/responsiveness versus efficiency/cost; efficiency versus resilience).
For example, Benetton’s supply chain redesign by implementing postponement on its
garment dyeing.
Strategy = as sustainable positioning, making trade-offs, and forging fit relationships among
activities.
SCM = strategic and organizational management that enables a focal firm to overcome
performance trade-offs and realize operational competitiveness through a fit among the
management elements within and across the firm to adapt to the external environment.
Strategic fit/Supply chain fit
Alignment/consistency of functional strategies, including sales.
When a firm designs a strategy that leverages its internal capable environment in
which it operates.
o External environment: supply and demand uncertainty, market competition.
o Internal capabilities: what resources a firm possesses and how effective.
Strategic fit is an ideal state that firms continually strive for but with alignment at a
specific point in time, the dynamic nature of … moving target.
Who make those laptops and smartphones?
o What parties are involved in making these devices?
, Why are there so many companies involved in the supply chain?
o Why do you think these companies operate in such ways?
The machines that changed the world
In 1930s Ford produced steel and wood products used for car bodies. Ford managed the
plantations that produced rubber for making tires. Ford owned barges and ships for
transportation. Ford attempted to integrate every stage of production and sales into his
operation. Nowadays, significant part of manufacturing is outsourced.
Why do firms exist?
Why can’t everything be contracted for?
Why not just one big firm for the whole economy?
What determines the boundary of the firm?
Why does Apple design/develop its OS but outsource production and assembly? Why
does Dell outsource almost everything? Why does TSMC focus solely on manufacturing
chips, while Nvidia only designs chips?
What are predictor variables?
Make-or-buy-or-ally decision
Two theoretical perspectives
1) Economic perspective = led by transaction cost economics (and other theories such
as agency theory).
2) Strategic perspective = led by resource-based view (and other theories such as
knowledge-based view, dynamic capabilities.
Economic perspective (Ronald Coase)
Reading 1 – Transaction Cost Economics as a Theory of Supply Chain Efficiency
In this study, we use the label governance choice to refer collectively to all the options for
organizing the supply chain.
Research addressing governance choice in the supply chain falls into three main theoretical
categories:
1) Competence: Are production activities assigned to the technologically and
organizationally most capable (in terms of quality and cost) actors?
2) Power: Who controls various stages of the supply chain? To what extent is an actor in
the supply chain able to influence the actions of other actors?
3) Efficiency: What kind of a supply chain relationship enables the transfer of
components and intermediate products from one production stage to another in an
economically efficient way?
In the competence-based view of the firm, the identities of individual firms matter, and
research attention is focused on how the heterogeneity of firms’ competences influences
firm-level heterogeneity in economic performance.
Value creation
Comparative advantage
Competitive advantage
Persistent above-normal economic profits
In the power perspective, attention focuses on actors who can exert power on others in the
supply chain, effectively controlling assets without owning them. An example is a large final
assembler who can “squeeze” its small suppliers by unilaterally setting prices. The power
perspective also posits that actors in the supply chain seek ways to avoid dependence on any
individual actor or firm in the chain. Final assemblers rarely produce all components (let
alone raw materials) in-house and are thus dependent on suppliers.
Work on power
Bargaining power
Resource dependence
The starting point of a TCE analysis of an economic transaction is the assumption that the
transacting parties share the mutual interest of organizing the transaction in an economically
efficient manner to increase value creation.
Asset specificity = the degree to which an assets can be deployed to alternative uses and by
alternative users without sacrifice of productive value. Specifically, the higher the sacrifice in
productive value (due to non-redeployability), the higher the asset specificity.
Site specificity in which the buyer and the seller are geographically co-located in
successive supply chain stages, reflecting ex ante decisions to minimize inventory and
transportation costs.
Physical asset specificity in which one or both of the exchange parties to the
transaction make investments in equipment that involves design characteristics
specific to the transaction, and which have lower economic values in alternative uses.
Human capital specificity in which investments in relationship-specific human capital
often arise through various learning-by-doing processes.
, Temporal specificity links specificity to time. For example, perishable fruits and
vegetables must be handled in the supply chain in a timely manner, and may require
vertical integration as a safeguard.
Dedication assets are found in contexts where a supplier makes discrete investments
in production capacity for the prospect of selling a substantial volume of output to a
particular customer.
In the automotive supply chain, inter-firm exchange is ubiquitous: a common factor across
modern automakers is that they operate in the supply chain as final assemblers that
outsource the majority of components.
TCE suggests that exchange relationships are subject to three main types of uncertainty.
Technological uncertainty = the seats may require engineering effort, which means
that their exact price and quality may not be ex ante known.
Technological life cycles = when will current technology become obsolete?
Demand uncertainty = the demand for automobiles is significantly affected by factors
outside the control of the exchange parties – input prices, interest rates, and general
consumer confidence are but a few examples. Thus, the number of seats that GM will
require in any given month or year is variable and unpredictable, leading to potential
maladaptation problems such as order cancellations.
Behavioural uncertainty = it is generally impossible for one exchange party to predict
how the other party will behave in an unforeseen circumstance that the contract
does not cover.
A key assumption in TCE is that contracts are unavoidably incomplete due to bounded
rationality, which is described as behavior that is “intendedly rational, but only limitedly so”.
Limitations to rationality arise from the fact that “the capacity of the human mind for
formulating and solving complex problems is very small compared with the size of the
problem whose solution is required for objectively rational behavior in the real world.
Simple transactions – where asset specificity, uncertainty, and frequency are low – are more
effectively handled as discrete market transactions that rely on the price system. GM hardly
needs to pay as much attention to how it sources light bulbs or tires compared to seats or
steering columns. When transactions entail higher levels of asset specificity, trying to
manage the exchange relationship through relational (short- or long-term) contracts can
become cumbersome and involve high governance costs.
Operationally, a credible commitment can be thought of as “a contract in which a promise is
reliably compensated should the promisor prematurely terminate or otherwise alter the
agreement.”
“Clever institutional arrangements [that] are a functional substitute for [trust].”
Lecture 1 – Course Introduction, Theory of the Firm
Two core concepts of course design
1) Trade-offs
2) Strategic fit
,Strategy = as sustainable positioning, making trade-offs, and forging fit relationships among
activities.
SCM = strategic and organizational management that enables a focal firm to overcome
performance trade-offs and realize operational competitiveness through a fit among the
management elements within and across the firm to adapt to the external environment.
Real options theory in the context of SCM
Managerial decisions revolve around creating and then exercising or not exercising
certain options.
Having the flexibility provided by options is beneficial when facing uncertainty (i.e.
unpredictability of environment or organizational variables).
To decide to what extent to exercise certain option requires through trade-offs (e.g.
flexibility/responsiveness versus efficiency/cost; efficiency versus resilience).
For example, Benetton’s supply chain redesign by implementing postponement on its
garment dyeing.
Strategy = as sustainable positioning, making trade-offs, and forging fit relationships among
activities.
SCM = strategic and organizational management that enables a focal firm to overcome
performance trade-offs and realize operational competitiveness through a fit among the
management elements within and across the firm to adapt to the external environment.
Strategic fit/Supply chain fit
Alignment/consistency of functional strategies, including sales.
When a firm designs a strategy that leverages its internal capable environment in
which it operates.
o External environment: supply and demand uncertainty, market competition.
o Internal capabilities: what resources a firm possesses and how effective.
Strategic fit is an ideal state that firms continually strive for but with alignment at a
specific point in time, the dynamic nature of … moving target.
Who make those laptops and smartphones?
o What parties are involved in making these devices?
, Why are there so many companies involved in the supply chain?
o Why do you think these companies operate in such ways?
The machines that changed the world
In 1930s Ford produced steel and wood products used for car bodies. Ford managed the
plantations that produced rubber for making tires. Ford owned barges and ships for
transportation. Ford attempted to integrate every stage of production and sales into his
operation. Nowadays, significant part of manufacturing is outsourced.
Why do firms exist?
Why can’t everything be contracted for?
Why not just one big firm for the whole economy?
What determines the boundary of the firm?
Why does Apple design/develop its OS but outsource production and assembly? Why
does Dell outsource almost everything? Why does TSMC focus solely on manufacturing
chips, while Nvidia only designs chips?
What are predictor variables?
Make-or-buy-or-ally decision
Two theoretical perspectives
1) Economic perspective = led by transaction cost economics (and other theories such
as agency theory).
2) Strategic perspective = led by resource-based view (and other theories such as
knowledge-based view, dynamic capabilities.
Economic perspective (Ronald Coase)
