Essay: Japanese Auto Firms
There are pros and cons of choosing to vertically integrate or buy from outside suppliers. From the perspective of Japanese auto firms, leaving manufacturing to outside suppliers may work best for them because of core competency since it is a family business to most of the Japanese families. Secondly, it increases the incentive for them to produce better facilities given chance of awarding high bonus and profit.
However, there are two problems encountered by the auto firms. First is the hold-up problem. How can it innovate and invest to better facilities without short-term gains? Unless it is an obvious credibility by firms, otherwise, it is impossible to trust the auto firms natively. Additionally, buyers can beat the price down below the average total cost given it is a hold-up problem and only one buyer in this case. Secondly, what is the incentive that driving suppliers to keep improving their skills, labors and organizational management? In reality, American’s Big Three have not successfully found a solution to handle this problem. As a result, it rely on integrated vertically and buy a few parts under short-term competitive market. Two bold points that make them so successful is trust that governed between the relationship and price was determined by the historic situation by comparing with one or at most two firms. Firstly, both of the parties sought to create a win-win environment by forgoing short term but emphasis on the long-term gain. If one party was tempted by the immediate gain, such relationship cannot be maintained. As a result, this is a non-credible assurance. Auto firms employ a few techniques to increase incentives (Smitka 1991, page 5):
- The gradual expansion of a purchasing relationship-ensure transaction was made after trust was established between each other.
- Both sides invested in the transaction-make sure no one free ride on the other one.
- The establishment of clear norms for business behavior-such as price, quality and delivery ordering