Resource-based theory and vertical integration*

In a world of corporate refocusing, downsizing, and outsourcing, one of the most critical strategic decisions that senior managers must make is determining their firm’s boundary. Questions such as, ‘Which business activities should be brought within the boundary of the firm?’ and, ‘Which business activities should be outsourced and managed through some form of strategic alliance?’ and, ‘Which business activities should be outsourced and managed through some form of “arm’s-length” market process?’ are all essential in determining a firm’s boundary. Firms that bring the wrong business activities within their boundaries risk losing strategic focus and becoming bloated and bureaucratic. Firms that fail to bring the right business activities within their boundaries risk losing their competitive advantages and becoming ‘hallow corporations’ (Jones 1986; Postin 1988). Fortunately, there is a well-developed approach for determining a firm’s boundary in the field of strategic management and organizational economics. Called transactions cost economics, TCE, (Williamson 1975, 1985), this theory specifies, in some detail, the conditions under which firms will want to manage a particular economic exchange within their organizational boundary, the conditions under which firms will want to manage an exchange through some form of strategic alliance, and the conditions under which firms will want to manage an exchange through some form of market contracting. Moreover, not only is this theory well developed, it is also remarkably simple. Indeed, in its most popular version, this theory requires managers to consider only a single characteristic of an economic exchange—the, This chapter draws from Barney (1999).