Vertical Scope Revisited: Transaction Costs vs Capabilities & Profit Opportunities in Mortgage Banking

What determines vertical scope? Transactions cost economics (TCE) has been the dominant paradigm for understanding "make" vs. "buy" choices. However, the traditional focus on empirically validating or refuting TCE has taken attention away from other possible drivers of scope, and it has rarely allowed us to understand the explanatory power of TCE versus other competing theories. This paper, using a particularly rich panel dataset from the Mortgage Banking industry, explores both the extent to which TCE predictions hold, and their ability to explain the variance in scope, when compared to all other possible drivers of integration. Using some direct measures of transaction costs, we observe that integration does mitigate risks; yet such risks and transaction costs do not seem to drive firm-level decisions of integration in retail production of loans. Rather, capability-driven and capacity- (or limit to growth-) driven considerations explain a significant amount of variance in our sample, under a variety of specifications and tests. We thus conclude that while TCE explanations of vertical scope are important, their impact is dwarfed by capability differences and by the desire of firms to leverage their capabilities and productive capacity by using the market.Mortgage Banking; Transaction Costs; Integration; Capabilities; Capacity Constraints; Limits to Growth

Regulating platforms and ecosystems: an introduction

Digital technologies and modular production methods have led to the emergence of a new generation of global leaders which cement their market position by orchestrating digital platforms and ecosystems of complementors, which offer them new ways to create and capture value that often transcend the boundaries of existing sectors. Their business models, built on intangibles such as software code and access to data, support expansion that is both breathtakingly rapid and effectively costless. With capital markets all too willing to invest in these firms’ growth, and regulators unable to rein them in, these firms have been able to accumulate unprecedented power and wealth, with profound implications for competition, the economy, and society itself. This special issue confronts the challenge of regulating platforms and ecosystems head-on, revisiting the economic, strategic, and legal foundations that enable us to detect and redress issues of dominance and competition and address questions of the appropriate conception of and limits of the law. The papers included cover topics including the true nature of competition with an emphasis on dynamics and innovation, new approaches for legal and economic analysis including the alternatives for the “welfare criterion” and the protection of sunk investments, the approaches to take on tech mergers and acquisitions, the virtues and limits of self-regulation, the potential for radical breakups of Big Tech, and the issues of data, when privacy protection and competition steer us in different directions. Contributors also weigh up the case for regulatory intervention, the practical challenges involved, and the future state that we hope such actions will bring about

Ecosystems and competition law in theory and practice

One of the most profound changes in the industrial landscape in the last decade has been the growth of business ecosystems—groups of connected firms, drawing on (digital) platforms that leverage their complementors and lock in their customers, exploiting the “bottlenecks” that emerge in new industry architectures. This has created new asymmetries of power, where the “field” of competition is not the relevant product market, as is usually the case in competition law, but rather the ecosystem of various complementary products and associated complementor firms. These dynamics raise novel concerns over competition. After examining the foundational elements of the ecosystem concept, we review how ecosystems are addressed within the current scope of competition law and identify the gap in the existing framework of conventional competition law. We then move to a critical review of current efforts and proposals in the European Union for providing regulatory remedies for ex ante and ex post resolution of problems, focusing on the current (2020) proposals of the Digital Market Act on ex ante regulation, with its particular focus on “gatekeepers.” We also review recent regulatory initiatives in European countries that focus on ex post regulation and on the role of business models and ecosystem architectures in regulation before providing a deep dive into proposed Greek legislation that explicitly focuses on ecosystem regulation. We conclude with our observations on the challenges in instituting and implementing a regulatory framework for ecosystems, drawing on research and our own engagement in the regulatory process

Vertical Scope Revisited: Transaction Costs vs Capabilities & Profit Opportunities in Mortgage Banking

What determines vertical scope? Transactions cost economics (TCE) has been the dominant paradigm for understanding “make” vs. “buy” choices. However, the traditional focus on empirically validating or refuting TCE has taken attention away from other possible drivers of scope, and it has rarely allowed us to understand the explanatory power of TCE versus other competing theories. This paper, using a particularly rich panel dataset from the Mortgage Banking industry, explores both the extent to which TCE predictions hold, and their ability to explain the variance in scope, when compared to all other possible drivers of integration. Using some direct measures of transaction costs, we observe that integration does mitigate risks; yet such risks and transaction costs do not seem to drive firm-level decisions of integration in retail production of loans. Rather, capability-driven and capacity- (or limit to growth-) driven considerations explain a significant amount of variance in our sample, under a variety of specifications and tests. We thus conclude that while TCE explanations of vertical scope are important, their impact is dwarfed by capability differences and by the desire of firms to leverage their capabilities and productive capacity by using the market

The dynamics of wealth, profit and sustainable advantage

This paper shows how idiosyncratic resources can be the basis of sustained profitability and persistent heterogeneity under competitive conditions: Generic inputs purchased in the market become idiosyncratic resources by investments in customization. Analytically, we show how heterogeneous firms co-exist in equilibrium. Computationally, we show that sustainable profits can emerge without monopolistic imperfections. We consider how capability heterogeneity, resource customization cost and ease of expansion interact to drive short-run and sustainable profits. Results illustrate that, in an industry evolution context, sustainable profits may represent a small part of total wealth creation, and that changes in factors shaping a sectors' evolutionary trajectory may be more important than changes in factors that determine profits' ultimate sustainability, thus calling into question the familiar emphasis on sustainable advantage

Agency, Structure, and the Dominance of OEMs: Change and Stability in the Automotive Sector

Research summary: This article reviews structural change in the automotive sector from 1997 to 2007. We find that, following internal framing contests, Original Equipment Manufacturers (OEMs) led efforts to change their sector\u27s architecture, starting from both strong and weak competitive positions and working with suppliers to advocate a new vision based on modularity and outsourcing. As the risks and costs of this vision became apparent, OEMs were able to reverse course and reaffirm their hierarchical control on the sector, taking advantage of structural features that weren\u27t salient ex ante. We consider why certain OEMs initiated this status-quo challenging change, and identify how sector structure mediated their (and suppliers\u27) efforts to implement it. We document the complex change process, driven by agency, structure, and heterogeneity in firms\u27 understanding of their sector\u27s architecture. Managerial summary: We study the “industry architecture” (i.e., division of labor and profit) of the automotive sector. During the late 1990s, Original Equipment Manufacturers (OEMs) embraced a new vision, based on “Modularity + Outsourcing,” inspired by an analogy with Personal Computers (PCs). This seems puzzling since such a change was hard to implement and could have led to OEMs relinquishing strategic control of the sector. The misstep was caused by internal framing contests and the agendas and influence of suppliers, consultants, and academics. We also consider why OEMs were able to partially reverse these changes, and document the role of structural features that let them control their sector and retain value: managing the customer experience, acting as guarantors of quality, and preserving hierarchical supply chains in which they functioned as system integrators

Fending Off Commoditization and Softening Competition Through Strategic Boundary Design

Designing a firm’s boundaries can lead to substantial strategic regeneration. But the question is, how? Moving beyond transaction-level analysis, we consider how the design of the firm’s overall boundaries (rather than individual make-vs-buy choices) yield strategic advantages in addition to organizational benefits. We do so through in-depth analysis of a European textile manufacturer that disaggregated its vertical structure without changing its overall scope. We discuss how the change in value proposition from integrated final good provider, to outsourcee delivering a series of intermediate goods and services, yielded real benefit in a saturated market. We highlight the major strategic benefits of this vertical disaggregation, and consider how it changed both strategic prospects and industry dynamics. We show that this new structure allowed the firm to transform its monolithic structure into a vertically agile layout, enabling it to reconfigure the scope of its offerings to customers and, ultimately, to use reconfigurability as a strategic tool to fend off commoditization and segregate markets to soften the effects of competition. We identify the critical role of IT as a factor enabling the new flexible structure. We show that, in contrast to our expectations and the literature, it is architectural technologies such as ERP systems, rather than the technologies linking firms (such as EDI systems), that enable reconfigurable modular structures. We examine the conditions under which such flexible vertical structures may be effective, identifying high maturity and low appropriability in our setting. We conclude with implications for theory and practice