Strategic Sourcing, Vertical Integration, and Transaction Costs

In managing strategic risk in sourcing relationships, an organization is assumed to order inputs and operations in terms of their value to accomplishing the firm's product market performance goals. Supplier relationships involving higher value inputs and operations have higher levels of strategic risk, since failure by the supplier leads to greater decline in the performance of the firm. Three types of risk are appropriation, technology diffusion, and end product degradation, which occur under different conditions. Vertical integration (or deintegration) may be undertaken as the level of strategic risk varies and the firm is more or less qualified to perform the operation relative to the best outside supplier.