Management Papers

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Journal Article

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Strategic Management Journal





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This paper proposes that transaction costs and capabilities are fundamentally intertwined in the determination of vertical scope, and identifies the key mechanisms of their co-evolution. Specifically, we argue that capability differences are a necessary condition for vertical specialization; and that transaction cost reductions only lead to specialization when capabilities along the value chain are heterogeneous. Furthermore, we argue that there are four evolutionary mechanisms that shape vertical scope over time. First, the selection process, itself driven by capability differences, dynamically shapes vertical scope; second, transaction costs are endogenously changed by firms that try to reshape the transactional environment to increase their profit and market share; third, changes in vertical scope affect the nature of the capability development process, i.e., the way in which firms improve their operations over time; and finally, the changes in the capability development process reshape the capability pool in the industry, changing the roster of qualified participants. These dynamics of capability and transaction cost co-evolution are illustrated through two contrasting examples: the mortgage banking industry in the United States, which shows the shift from integrated to disintegrated production; and the Swiss watch-manufacturing industry, which went from disintegration to integration.

Copyright/Permission Statement

This is the peer reviewed version of the following article: Jacobides, M. G. and Winter, S. G. (2005), The co-evolution of capabilities and transaction costs: explaining the institutional structure of production. Strat. Mgmt. J., 26: 395–413., which has been published in final form at doi: 10.1002/smj.460. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving


capabilities, transaction costs, evolution, institutional structure of production



Date Posted: 27 November 2017

This document has been peer reviewed.