Why do firms set up permeable firm boundaries? A theoretical analysis integrating efficiency and capability perspectives

This paper presents a theoretical rationale for different boundary choices by firms. Beyond the traditional make versus buy dichotomy, we introduce concurrent sourcing and concurrent exploitation as independent and stable boundary choices. We propose that a firm’s design options in terms of its potential interfaces with suppliers and customers determine the type and extent of transaction costs that offset potential gains from trade and gains from specialization. This efficiency-centered argument is then integrated with capability arguments to present a (static) model of boundary choice. In addition, we develop a dynamic model that explains how firm boundaries evolve over time. Here we consider how learning may provide information about changes in either the capability distribution in the industry or the availability of new options regarding organizational design and may lead to a reassessment of the determinants of firm boundary choice. We also highlight how the industry architecture both constrains the boundary choices available, and how select firms’ boundary choices may alter the industry architecture. By integrating firm- and industry-level determinants in a dynamic model, we illustrate not only how firm boundary choices are made, but also how these choices affect the evolution of an industry architecture.