Technological change and the make-or-buy decision

An issue commonly raised by critics of the mainstream approach to the theory of the firm involves the fact that the differences in productive capabilities of firms have been suppressed in the modern theory. While the neoclassical approach of seeing the firm as a production function is inadequate so is the idea that technology can be ignored altogether. The critics emphasise that firms have differential productive capabilities and that this may influence economic organisation. In short, the contemporary theory of the firm ignores technology.

In a new paper in the Journal of Law, Economics, and Organization Ann P. Bartel, Saul Lach, and Nachum Sicherman look at Technological Change and the Make-or-Buy Decision

A central decision faced by firms is whether to make intermediate components internally or to buy them from specialized producers. We argue that firms producing products for which rapid technological change is characteristic will benefit from outsourcing to avoid the risk of not recouping their sunk cost investments when new production technologies appear. This risk is exacerbated when firms produce for low volume internal use, and is mitigated for those firms that sell to larger markets. Hence, products characterized by higher rates of technological change will be more likely to be produced by mass specialized firms to which other firms outsource production. Using a 1990–2002 panel data set on Spanish firms and an exogenous proxy for technological change, we provide causal evidence that technological change increases the likelihood of outsourcing.

So we see one way in which technology can affect the boundaries of the firm.