The Co-evolution of Capabilities and Transaction Costs: Explaining the Institutional Structure of Production

Strategic Management Journal, Forthcoming

38 Pages Posted: 21 May 2005

See all articles by Michael G. Jacobides

Michael G. Jacobides

London Business School

Sidney G. Winter

University of Pennsylvania - Management Department

Abstract

This paper proposes that transaction costs and capabilities are fundamentally intertwined in the determination of vertical scope, and identifies the key mechanisms of their co-evolution. Specifically, we argue that capability differences are a necessary condition for vertical specialization; and that transaction cost reductions only lead to specialization when capabilities along the value chain are heterogeneous. Furthermore, we argue that there are four evolutionary mechanisms that shape vertical scope over time. First, the selection process, itself driven by capability differences, dynamically shapes vertical scope; second, transaction costs are endogenously changed by firms that try to re-shape the transactional environment to increase their profit and market share; third, changes in vertical scope affect the nature of the capability development process, i.e., the way in which firms improve their operations over time; and finally, the changes in the capability development process re-shape the capability pool in the industry, changing the roster of qualified participants. These dynamics of capability and transaction cost co-evolution are illustrated through two contrasting examples: The mortgage banking industry in the US, which shows the shift from integrated to dis-integrated production; and the Swiss watch manufacturing industry, which went from dis-integration to integration.

Keywords: Capabilities, transaction costs, evolution, institutional structure of production

JEL Classification: L23,L14,L22,D20,D21,D22,D51,D52,D92,K1,M2,O33

Suggested Citation

Jacobides, Michael G. and Winter, Sidney G., The Co-evolution of Capabilities and Transaction Costs: Explaining the Institutional Structure of Production. Strategic Management Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=670361

Michael G. Jacobides (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7706 6725 (Phone)
+44 20 7724 7875 (Fax)

HOME PAGE: http://faculty.london.edu/mjacobides/

Sidney G. Winter

University of Pennsylvania - Management Department ( email )

The Wharton School
Philadelphia, PA 19104-6370
United States

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