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UGF Lecture 7
Management
> Global Firm >
Basis for I >
Internalisation > Decision process 1
Decision process - example 1
Two examples are given to illustrate the internalisation decision
process.
1. Engineering consultancy services
A manufacturing firm has a complex layout and machinery. It calls in
consultants from a particular engineering firm when things go wrong, as
they do not have expert engineers themselves. Do they persist with this
external market arrangement ("borrowing" the consultancy's OAs) or
replace it with an internalised alternative (buy the consultancy, hire
their own experts, train their employees)?
There are several factors which would influence this choice:
- The number and length of visits the consultants currently make
- The transaction costs of the visits. If the consultant knows the
firm well, the transaction costs will be lower. This avoids
switching costs of transferring to another consultant. However,
this may also bring the bargaining costs of small number
conditions, meaning that when the two sides know that the other
really wants to do the deal, they will get tougher in negotiations.
This will raise transaction costs. The higher the transaction costs,
the more likely it is that the manufacturing company will
internalise, as the in-house experts will be immediately available
with no negotiations needed.
- Dishonesty, opportunism is another factor, as the consultancy
could be taking advantage of the fact that the manufacturing company
cannot accurately assess how good a job the consultants are doing.
They can exploit information asymmetry to do a good enough, rather
than an excellent job. An in-house engineering unit would be
motivated to do the best possible job in an honest manner.
- Appropriability, where the consultants can take what they have
learned from the manufacturing plant and take it to competitors,
while the plant is unaware of the gained benefits and cannot employ
them to its own company. These "learning-by-doing" benefits would be
applied if they were gained by an in-house unit.
Decision process 2
Decision 2 continued
Negative LAs
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