Why firms make when they can buy? Resource redeployability & firm vertical boundaries

Abstract

Why do firms establish inhouse capacity when transaction costs are low? We argue that insourcing is more attractive when the resources required for inhouse production can be redeployed to alternative uses within the firm. Resource redeployability creates option value and lowers the cost of simultaneously employing internal and external sourcing. We test this argument in U.S. patent prosecution, where firms choose between inhouse and external counsel, and where legal expertise can be redeployed across prosecution and enforcement. Leveraging the Supreme Court’s eBay v. MercExchange ruling, we show that firms with greater litigation exposure are more likely to establish inhouse capacity, particularly through hiring attorneys rather than agents. These findings extend research on plural sourcing, resource redeployability, and strategic human capital by linking redeployability to vertical boundary choices.