Endogenous Transaction Cost, Specialization, and Strategic Alliance

Abstract: In property rights theory, firm is an organizational response to reduce transaction cost associated with hold-up of using market mechanism. We claim that strategic alliance – without changing firm boundaries or asset ownership – is another type of organizational response. We construct a model to investigate individual firms’ strategic choice on specialization or diversification when producing intermediate products and their further choice of organizational form: autarchy or forming strategic alliance. We introduce fixed learning costs as an indicator of scales of economy and show that only if fixed learning costs are large enough, will firms have incentive to be specialization and form strategic alliance. We distinguish between asymmetric strategic alliance and symmetric strategic alliance and show that transaction cost is not monotonic with respect to fixed learning costs. In particular, for asymmetric strategic alliance, there exists overinvestment with un-utilized capacity. Further, asymmetric strategic alliance is always unstable, while symmetric strategic alliance is stable only if fixed learning costs are large enough. The firm who is entitled with higher learning cost gets higher payoff – rewards for the endeavor. If firms are more patient, they are less likely to form strategic alliance.