THE DYNAMICS OF MAKE OR BUY DECISIONS

Make or buy decisions are strategically important for business firms, particularly when production and marketing of components involves specialized technology and assets. Recent theories of make or buy decisions compare the cost of administering transactions inside a firm and across markets. In this paper, we extend these theories to a dynamic market in which profit from the use of specialized assets declines over time due to entry and substitution of technology. Using optimal control theory, we investigate the patterns of vertical integration under different parametric conditions. We also present empirical evidence from time series and cross-sectional data that lend support to the analytical results from the model.