How firm strategies influence the architecture of transaction networks

n the context of business ecosystems, hierarchy is an architectural property that refers to the degree to which transactions proceed in a single direction, from "upstream" to "downstream." It is often assumed that a unidirectional flow of goods in a value chain implies a corresponding hierarchy in the transaction networks of firms participating in the chain. However, this is an untested hypothesis: in fact, little is known about whether hierarchy varies across transaction networks, and, if so, what causes such variation. In this study, we apply network-based methods to define and measure the degree of hierarchy in interfirm transaction networks in two industry sectors in Japan: automotive and electronics. Our empirical results show that the electronics sector exhibits a much lower degree of hierarchy than the automotive sector due to the existence of numerous interfirm transaction cycles. Transaction cycles in turn can arise when a subset of firms adopt the strategy of vertically permeable boundaries. Such firms are vertically integrated in the sense of participating in multiple stages of the value chains, but their internal upstream units also sell into and downstream units buy from intermediate markets. Our comparative analysis suggests that firms elect the strategy of vertically permeable boundaries when they face low transaction costs and high rates of product innovation, but at the same time believe there are knowledge complementarities between different stages of the value chain. Vertically permeable boundaries allow such firms to take advantage of cross-division knowledge complementarities while maintaining the competitiveness of upstream units through their participation in intermediate markets.