Malone et al. (1987) analyzed the effect of information
technology on outsourcing decisions, focusing
on transaction costs incurred in the dealings
between a buyer and his suppliers. They found that
the increased use of ITT decreases buyer search costs
and leads to a reduction in vertical integration and
to an increase in the reliance on markets for the supply
of parts in manufacturing. Using similar analysis
of transaction cost, Bakos (1991) found that the
increased use of ITT leads to reduced cost of coordination
of buyer-supplier activities, which would
tend to increase the number of suppliers the buyer
chooses to do business with. Although these transaction
cost–based results have found some empirical
support in that information technology investments
lead to smaller firms (Brynjolfsson et al. 1994), there
is also evidence from the automobile industry that
there is a general tendency toward a reduction in the
number of suppliers with whom the buyers are doing
business (Helper 1991, Cusumano and Takeishi 1991).
The analysis in this paper builds on the transaction
cost literature and augments it by considering how
increased use of ITT has an impact simultaneously on
the breadth of enforceable terms included in contracts
and the optimal number of suppliers.