Vertical Integration and The Scope of the Firm. OUTLINE. Transactions Costs and the Scope of the Firm --Why does the firm exist? --The trend over time The Costs and Benefits of Vertical Integration Designing Vertical Relationships: Long-term Contracts and Quasi-Vertical Integration
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--Why does the firm exist?
--The trend over time
Which is more efficient : several specialist firms linked by markets, or the combination of these specialist firms under common ownership.
VERTICAL PRODUCT GEOGRAPHICAL
SINGLE V1 P1 P2 P3 A1 A2 A3
SEVERAL V1 P1 P2 P3 A1 A2 A3
Common Issue--- What are TRANSACTION COSTS of markets compared with administrative costs of the firm?
Note: transaction costs = cost of locating, negotiating, and enforcing a contract.
Sales of 100 biggest cos. as % of US industrial output
1930 1940 1950 1960 1970 1980 1990
1975 - 1995: Contraction in size & scope of biggest industrial corporations. Increased market turbulence, more competition, accelerated technological change
Need for speed, flexibility, responsiveness
Large, complex corporations become relatively less efficient
-- but doesn’t necessarily require common ownership
-- small numbers of firms
-- transaction-specific investments
-- opportunism and strategic misrepresentation
-- taxes and regulations on market transactions
-- in responding to changes in technology,
customer preferences, etc.
(But VI may be conducive to system-wide flexibility)
How many firms are availableThe fewer the companies
to undertake the activities?the more attractive is VI
Is transaction-specific investmentIf yes, VI more attractive needed?
Does limited information permitVI can limit opportunism cheating?
Are taxes or regulation imposed VI can avoid them on transactions?
Do the two stages have similar Greater the similarity, the optimal scale of operation?more attractive is VI
Are the two stages strategically Greater the strategic similar?similarity ---the more attractive is VI
How uncertain is market demand?Greater the unpredictability ----the more costly is VI
Does VI increase risk?If heavy investment required and risks between stages are inter-related----VI increases risk.
---such relationships may combine benefits of both market transactions and internalization
-- How is risk allocated between the parties?
-- Are the incentives appropriate?
General conclusion:- boundaries between firms and markets becoming increasingly blurred.
Low Degree of CommitmentHigh
Informal supplier/ customer relationships
Supplier/ customer partnerships
Spot sales/ purchases