Complexity, Flexibility, and the Make-or-Buy Decision

The transaction cost of haggling and friction due to ex post changes and adaptations when contracts are in complete is examined. The level of a transaction's complexity, which is associated with contractual incompleteness, will be the shifting parameter that determines both incentive schemes and integration costs. The present paper is a first attempt to extend the insights from the Bajari and Tadelis model (Bajari and Tadelis 2001) to address specifically the make-or-buy decision. It is found that more complex products are more likely to be procured internally (make) and have the upstream unit face low incentives, while the more simple products are more likely to be procured through the market (buy) and have the upstream supplier face high incentives.