Transaction-Cost Economics and the Build-Borrow-Buy Choice: Why Platforms Acquire
When it pays to bring a capability inside the firm instead of contracting for it
The first note in this Notebook argued that buy-and-build advantage comes from accumulating and reconfiguring resources. It left a prior question unanswered. Granting that a platform needs certain resources, why acquire the companies that hold them at all? It could build the capability internally, or reach it through a supply contract or an alliance. Acquisition is the most expensive and least reversible of the three options, so its repeated use in buy-and-build needs an explanation that resource logic alone does not provide.
That explanation is transaction-cost economics, the branch of theory concerned with why some exchanges are organised through the market and others inside the firm. Where the resource-based view says which resources matter, transaction-cost economics says why a platform brings them inside through ownership rather than renting them. This note develops that complement, applies it to the build-borrow-buy choice, and tests it against the obvious objection that a long-term contract would be cheaper.
Why firms exist, and why they buy
The question is older than buy-and-build. Coase (1937) asked why firms exist at all, given that markets are supposed to coordinate production efficiently, and answered that using the market is itself costly: there are costs to discovering prices, negotiating, and enforcing contracts, and when those costs are high enough it is cheaper to organise the activity inside a firm under managerial direction. The boundary of the firm sits where the cost of one more internal transaction equals the cost of carrying it out through the market.
Williamson (1979) made that boundary operational. Three features push an exchange out of the market and inside the firm: asset specificity, when the parties must invest in assets specialised to the relationship; uncertainty, when contingencies cannot all be written into a contract; and the hazard of opportunism, when one party can exploit the other once both are committed. The greater these are, the more an arm’s-length contract leaves a firm exposed to hold-up, and the more attractive ownership becomes, because common ownership aligns incentives and lets disputes be settled by fiat rather than by renegotiation.
Build, borrow, or buy
For a growing platform this abstract make-or-buy choice takes a concrete form: build the capability internally, borrow it through a contract or alliance, or buy it through acquisition (Capron & Mitchell, 2012). Their argument is that firms default too readily to one mode, usually the one they know best, and that disciplined growth means matching the mode to the resource. Build when internal resources are close to what is needed; borrow when a capable partner exists and the relationship can be governed by contract; buy when the resource is deeply embedded in another organisation and cannot be cleanly separated from it.
In a platform the choice is recursive, which is what makes it interesting. Capabilities assembled through early add-ons change the calculus for later ones. A capability the platform once had to buy, because it had no foundation to build on, it may later be able to build, because earlier deals supplied the foundation. Conversely, a relationship the platform was happy to borrow through a contract can become specific enough, as volumes grow, that leaving it in the market becomes the riskier option.
Why platforms internalise
Transaction-cost reasoning explains several recurring buy-and-build patterns that a pure synergy story leaves vague. Vertical integration is the clearest. A platform that depends on a distributor or a specialist installer, and that has invested in assets specific to that relationship, faces hold-up risk: the partner can extract value precisely because the platform cannot easily switch. Acquiring the partner removes the hazard by bringing the transaction inside the firm. The same logic explains why platforms internalise scarce capabilities, such as a regional service network or a proprietary product line, rather than contracting for them, once those capabilities become specific to the platform’s strategy and too important to leave exposed to a counterparty’s incentives.
This is also where transaction-cost economics and the resource-based view fit together rather than compete. The resource-based view explains which capabilities are worth controlling, because they are valuable and hard to imitate (Barney, 1991; Dierickx & Cool, 1989); transaction-cost economics explains the governance form, ownership rather than contract, through which the platform secures them. Recent theory casts private equity itself as a specialised intermediary in the market for corporate assets, whose comparative advantage lies in reallocating and governing assets that markets price poorly (Nary & Kaul, 2023), which is a transaction-cost argument about the sponsor as much as about the platform.
A worked illustration: from supplier to subsidiary
Consider a building-products platform that for years has bought a specialised component from an independent regional manufacturer under an ordinary supply contract. Early on this is a textbook borrow: the component is available from several sources, the relationship is non-specific, and a contract governs it cheaply.
As the platform grows, the relationship changes character. The platform redesigns its installed product around this manufacturer’s specification, trains its branch staff on it, and markets it to customers, investments that are specific to this supplier and worth little if the relationship ends. The manufacturer, aware of this, presses for better terms at each renewal. The platform now faces classic hold-up: it is committed, the asset is specific, and the contract cannot anticipate every future contingency. Transaction-cost logic predicts what happens next. The platform acquires the manufacturer, not because the manufacturer is a wonderful standalone business but because internalising the transaction removes a hazard that had become too costly to manage through the market. The borrow became a buy when specificity and uncertainty crossed a threshold.
The objection: wouldn’t a contract be cheaper?
The natural objection is that acquisition is an expensive and clumsy way to solve a contracting problem. Long-term agreements, exclusivity clauses, and well-designed incentives can manage most supplier relationships without the cost and integration burden of ownership, and often they should. Transaction-cost economics agrees: where specificity and uncertainty are low, the market is the right governance form, and a platform that acquires everything it transacts with will overpay and overload its integration capacity.
The objection fails only at the margin transaction-cost economics actually identifies. When assets are highly specific, contingencies cannot be fully specified, and opportunism is a live risk, contracts become incomplete in ways no clause fully closes, and the cost of repeated renegotiation and the exposure to hold-up exceed the cost of ownership. There is also a resource-based limit the contract cannot reach: some of what the platform wants, the tacit know-how and routines embedded in the target, cannot be transferred by contract at all, only by acquiring the organisation that holds them. The discipline cuts both ways, and the failure case proves it. When bidders lack the keystone resources needed to unlock a target’s value, the right move is not to own it; firms that announce deals and then find they cannot create the value divest the target-related resources rather than absorb them (Gibbs et al., 2026). Transaction-cost economics is not an argument for buying; it is an argument for buying only when the market is the costlier option.
Four propositions
Stated plainly, so they can be argued with and tested against cases:
Governance, not just resources. The resource-based view says which capabilities to control; transaction-cost economics says when to control them through ownership rather than contract or alliance.
Specificity drives internalisation. Platforms acquire, rather than contract, when asset specificity, uncertainty, and the hazard of opportunism make the market exchange too costly to govern.
The mode choice is recursive. Capabilities accumulated through early add-ons shift later build-borrow-buy decisions, converting some buys into builds and some borrows into buys.
Buy is not the default. Where specificity and uncertainty are low the market is the right form; acquiring everything overloads capacity and destroys value, and the failure case is divestiture.
Why this matters
Read alongside the resource-based view, transaction-cost economics turns buy-and-build from a series of opportunistic purchases into a governed sequence of make-or-buy decisions. It explains why platforms internalise distribution, why a comfortable supplier relationship suddenly becomes an acquisition target, and why the discipline is knowing when not to buy. The companion question, once the platform has decided to acquire, of which target to choose, is the subject of the target-selection note; and the constraint that every internalisation quietly draws down is the absorptive capacity examined later in the Notebook. Ownership solves a governance problem, but it spends the one resource a platform cannot easily replace.
References
Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17(1), 99–120.
Capron, L., & Mitchell, W. (2012). Build, borrow, or buy: Solving the growth dilemma. Harvard Business Review Press.
Coase, R. H. (1937). The nature of the firm. Economica, 4(16), 386–405.
Dierickx, I., & Cool, K. (1989). Asset stock accumulation and sustainability of competitive advantage. Management Science, 35(12), 1504–1511.
Gibbs, A., Byun, H., & Lim, K. (2026). Build, borrow, buy… or bail: Divestiture following merger and acquisition deal termination. Strategy Science. Advance online publication.
Nary, P., & Kaul, A. (2023). Private equity as an intermediary in the market for corporate assets. Academy of Management Review, 48(4), 719–748.
Williamson, O. E. (1979).Transaction-cost economics: The governance of contractual relations. The Journal of Law and Economics, 22(2), 233–261.