Make or Buy: Internalization and Externalization of Producer Service Inputs in the Montreal Metropolitan Area (1996)

Producer or intermediate-demand services enhance efficiency of operation and of output at various stages in production process. All firms, whether specializing in fabrication of goods or in provision of services, employ a range of producer services as inputs into their production functions. The more advanced or modern value (such as, production process) of a firm, more numerous and more complicated will be links in chain and greater will be importance of service inputs (Porter 1985; 1990). Indeed, a wide range of empirical evidence has demonstrated that producer services occupy a major and expanding role both within firms (Britton 1990; Quinn 1993) and within national, regional and metropolitan economies (Beyers 1989; Coffey 1994). A fundamental decision that each firm (and, indeed, each establishment within a firm) must face concerns whether to or to a specific producer service input; that is, whether to provide a given service internally by assigning its own personnel to production of service or, rather, to contract-out provision of service to experts in employ of external (either affiliated or free-standing) specialized establishments. The decision to internalize or to externalize given service inputs is one of most important strategic decisions that an establishment must make, as this choice ultimately affects establishment's cost structure, its modes of operation and organization, and possibly its location (Coffey and Polese 1984; 1986). The or decision of individual establishments also has an impact upon structure of an economy, as measured by official statistics on employment or output by sector of activity. For example, a lawyer hired in-house by a manufacturing establishment will increase level of employment in manufacturing sector, whereas same lawyer working in a law firm, even though performing same functions for same manufacturing establishment, will augment employment in producer services sector. (1) In spite of its wide recognition as a fundamental aspect of the service economy and as an important element in both organization and functioning of enterprises, propensity of establishments to make or to buy producer services has rarely been explored in a systematic manner. The purpose of present study is to increase understanding of this phenomenon by examining, from both conceptual and empirical perspectives, make or buy behaviour of establishments across all sectors of activity. Our exploration of this issue begins in next section with a review of factors that can influence decision to internalize or to externalize producer service inputs. After a brief section on definitions and methodology, we then examine empirical evidence drawn from a detailed survey of producer service consumption by establishments in Montreal Census Metropolitan Area (CMA). We first present a descriptive analysis of internalization and externalization in consumption of producer services, then attempt to identify some of factors that underlie make or buy decision. Our analysis concludes with some comments linking our empirical results to producer services literature. The Make or Buy Decision Concern with internalization and externalization of producer service inputs is by no means recent. This concern pre-dates development of service industries research as an identifiable scholarly field. Stigler (1951) cited two major factors influencing make or buy decision: complementarity and economies of scale. Complementarity refers to extent to which service functions can be produced internally without raising a firm's cost of carrying out other functions. As Stanback et al. (1981) note, complementarity exists if services can be provided as a joint product, enabling better utilization of managerial or other scarce resources. …