Integrating modularity theory with vertical integration theories

Vertical integration level of firms define which activities of the firm's value chain are conducted by the firm and which of them are provided by external parties. Several terms about vertical integration level of firma are used in researches including market or hierarchy, firm boundaries, make or buy, outsourcing, alliance, etc. We use the term firm boundaries in our research which is the most common one used in literature. Firm boundaries play strategic role in the success of firms. Successful firms determine their boundaries in harmony with their organizational structure, external environment and business strategy. The effect of operating activities within the firm, using outsourcing, joint ventures, strategic partnerships, merger&acquisitions on firm performance has been studied for a long time. When the firms do not include important activities within firm, they face with the risk of losing competitive advantage. On the other hand, when firms operate insignificant activities within the firm boundaries, they face with the risk of becoming clumsy. Strategy scholars deal with the organization and performance of firms in a detailed way. Despite decades of research on theories of the firm, academicians still struggle with the basic question of how firms determine their boundaries. Beginning with Adam Smith, efforts to explain the firm boundaries have examined the relative advantages of alternative production arrangements and exchange methodologies. In these studies, dilemma between internalizing and externalizing activities within firm structure was examined. Great progress about understanding the firm vertical boundaries and which factors impact these boundaries has been recorded in recent. Firms that do business in same industry may take different decision about firm. We see firms have different motivations related to firm boundaries problem. According to some scholars firms choose to outsource resources according to business performance goals in case supplier's resources are superior to firms' from quality or product performance perspectives. However flexibility needs affect firm boundary decisions under some circumstances in case capacity utilization is important from business performance perspective. Some scholars see outsourcing as a knowledge transfer where exploiting resources approach in place, and learning and improvement is approached where exploring opportunities approach in place. The basic dilemma is about root of learning & innovation; by doing itself or from suppliers. When the firm is seen as an open-system and part of a network in a dynamic environment, learning from suppliers is very crucial for competitive success. What should be the firms' boundaries is still a matter of debate. Even though, there are lots of researches about it, any theory is not helpful in understanding firms' boundaries alone. Each theory explains certain parts of the problem but do not answer the entire issue. There are two important approaches that are resource-based and economic view in the area of firm boundaries. Primary theories from those approaches which are neo-classical economics, transaction costs, real option and resource- based view do not foresee same things in any case. While one theory supports including activities within firm boundaries, other theory support opposite by saying activities should be outsourced. The main reason of this contradiction lies within firms' different points of views to firmm boundaries issue. According to neo-classical economics theory, firms' boundary decisions are determined by technological factors such as economics of scale or scope. Neo-classical economics theory focus on the production function and its associated costs as the driver for a firms' boundaries decision. The greater the scale or scope economics of the firm, the less the marginal cost of the production of a particular good, since producing this good in concert with usual internal or external sourcing decision reduces the firms' total cost. There are two leading approaches (economics and resource-based view) about studies that observe the factors for firm boundaries decision as internal or external. Economics and resource-based view differs from each other and in some cases they may provide contradictory vertical boundary results for a specific case. Economics approach has evolved under the influence of transaction costs and real option theory. According to transaction costs theory assets that will cause suppliers to show opportunistic behavior in the future should be internalized in firm scope in order to minimize cost of production. While transaction costs theory only deals with cost of production, issues of new product development and success of products in the market is considered as part of real options theory. According to real options theory that supports, internalizing flexible assets in firm scope or outsourcing will be the strategies that increase economic value. Even though transaction costs theory approaches were supported in the first years of researches, later research has shown that transaction costs theory is not completely valid in high-tech industries. While transaction costs theory experts initially thought that firms' resources and competences have very little effect in determining the firms' boundaries, anymore they accepted that without considering the resources and capabilities firms cannot determine firm's boundaries. The resource-based view of the firm provides one means to analyze the effect of firm-level capabilities on firm boundary decisions. Although transaction costs theory describes effect of internalizing an activity, it is silent on the relative influence of firm-specific capabilities. Resource-based view suggests that a firm that owns valuable and difficult-to-imitate capabilities will be more likely to integrate than its competitors. Firms' boundaries are also be affected by the sector that operates in and firms' unique features. The issues about being old or new sector, distribution of resources and abilities homogeneously or not lead to differences in firm boundaries approaches in sectors. Firms' market power, the level of information technologies, experience about technology, risk taking potential by managers are researched for the effect of firms unique features on firm boundaries and those researches assist in understanding different results that are foreseen by different theories. One of the factors that is unique to firms and has important impact on firms' boundaries is modularity level of business processes. It is analyzed how modularity level of firms' processes affect making activities outsourced by using holistic model that is created in the scope of this thesis. It is foreseen that modularity will affect firms' decison to use outsources, and this impact will assist to explain why having different results than firm boundary levels that is defined in the scope of theories. It is needed to deal with theories by a holistic view rather than considering special features of firms separately in order to fully understand firms' boundaries. In the scope of this view, theories will be taken into consideration as complement of each other rather than alternatives to each other. There is very few researches in literature for the subject of developing integrated model that includes different theories. The main aim of this study is to deal with the theories that have crucial role in determining firm boundaries with opportunity and cost perspective in a holistic model. In the scope of this thesis, it is researched that how the information technology processes are outsourced and how modularity level of these processes influence the decision of using outsources that plays crucial role in firm success in service and data intense sectors. A survey is held via an independent researh company, including 274 surveys about information technology processes of 30 firms from banking, insurance, media, telecommunication, logistics, retail and airway industries participated to research. According to research about determining firms' boundaries, it is seen that having flexibility in the situation of operating within firm or using outsources more crucial factor than opportunistic behaviour cost by outsourced firm. According to this, real option theory is more valid than transaction cost theory in the area of information technology processes. When we look at from the view of resourced-based view and neo-classical economics theory that are other theories of research, firms should be experienced about using outsources and there should be firms in the market that can make activities outsourced in order to provide flexibility by making activities outsourced. Otherwise, there is no possibility making use of this flexibility. When there is increase in modularity level, using outsources are getting easy as well as answering market demand becomes flexibly. When considering moderator impact of modularity, firms less need making processes outsourced in the situation of demand uncertainty and when there is potential outsourced firms in the market it is easy to work with these firms. As a result, when there are firms that can provide high quality and relevant cost in the area of information technologies, processes are outsourced. On the other hand, when there is uncertainty in demand and increase in modularity level of processes firms less need using outsources.