Transaction cost economics proposes that vertical integration is more efficient than contracting
for goods and services in the marketplace when the transaction costs of buying goods
on the open market become too great. When highly vertically integrated firms become excessively
large and bureaucratic, however, the costs of managing the internal transactions may become
greater than simply purchasing the needed goods externally—thus justifying
outsourcing over vertical integration. This is why vertical integration and outsourcing are situation
specific. Neither approach is best for all companies in all situations.13 See the Strategy
Highlight 7.1 feature on how transaction cost economics helps explain why firms vertically
integrate or outsource important activities. Research thus far provides mixed support for the
predictions of transaction cost economics.