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Boeing 787 production network. Titanium forgings (Russia). Landing gear (Messier, France). Wings (MHI, Japan). Final Assembly Boeing Everett,WA. Horiz. Stabil. (Alenia, Italy). Fuselage (Spirit AS, Kansas). Tail fins (Boeing, Frederickson, WA). Flaps (Boeing Australia).

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boeing 787 production network
Boeing 787 production network

Titanium forgings

(Russia)

Landing gear

(Messier, France)

Wings

(MHI, Japan)

Final

Assembly

Boeing

Everett,WA

Horiz. Stabil.

(Alenia, Italy)

Fuselage

(Spirit AS, Kansas)

Tail fins

(Boeing, Frederickson, WA)

Flaps

(Boeing Australia)

chapter 8 internalization

Chapter 8: Internalization

Keith Head

Sauder School of Business

the take away for chapter 8
The “take-away” for chapter 8
  • Firms must decide what things they will do themselves, and what they will “outsource” to/from other firms
  • Business can be carried out through
    • Short-term (arm’s length, “spot”) transactions
    • Long-term contractual arrangements
    • Internalization through ownership
  • Each option has its own problems so there is no “one-size-fits all” solution.
internalization decision tree
Internalization decision tree

Equity

Ownership

(in)Corporation

Foreign

Direct Investment

Control

Visible Hand

Network

Long-term

Contracts

Licensing, Franchising,

Sub-contracting=“outsourcing”

Markets

Spot Transactions

Invisible Hand

the case for markets
The Case for Markets
  • Range of choice (variety of options)
  • Speed of choice (no up-front costs)
  • Flexibility of choice (option to change)
  • Adam Smith’s (1776) invisible hand:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest”

where spot markets can fail
Where spot markets can fail
  • Relationship-specific investment (RSI),
    • ex post bilateral monopoly
    • The hold-up problem.
  • Vertical incentive conflict (CC in France)
    • Over-pricing
    • Under-promotion
  • Information-transfer transactions
  • Reputation-transfer transactions
contractual solutions
Contractual solutions
  • Long-term, contractually-specified prices
  • Two-part tariffs (e.g. $175K franchise fee to operate a McDonalds restaurant)
  • Intellectual property law (patents & trademarks)
  • Non-compete clauses
  • Franchising agreements (McDonald’s 400-page operating manual)
when contracts fail
When contracts fail
  • Lack of enforcement
    • Punishing firms that breach contracts
  • Problems in “Verifiability”
    • Courts must decide if breach has occurred
  • Unforeseen contingencies
    • Contracts must cover all the important things that might happen
examples of contract based international business
Examples of Contract-based International Business
  • Labatt & Anheuser-Busch
  • IKEA
  • Benetton
  • Boeing & Rolls-Royce
  • Nike and its “sub-contractors”
  • Coca-Cola and its’ bottler-distributors
  • McDonalds and its restaurant franchises
  • OEMs/EMS (e.g. Flextronics) and VARs
why not just internalize
Why not just internalize?
  • Financing costs of ownership
  • Risks of ownership
  • Inflexibility
  • Firm-level comparative advantage
    • “Spanning” costs (diluted attention)
    • “Incompetence” costs