summary chpter 14 vertical integration
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7/28/2019 Summary Chpter 14 Vertical Integration
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Vertical integration refers to a firms ownership of vertically related activities. The greater a
firms ownership extends over successive stages of the value chain for its product, the greater its
degree of vertical integration.
When to integrate vertically: Markets are not costless: making a purchase or sale involves
search costs, the costs of negotiating and drawing up a contract, the costs of monitoring to ensure
that the other partys side of the contract is being fulfilled and the enforcement costs ofarbitration or litigation should a dispute arise. All these costs are types of transaction costs. Ifthe transaction costs associated with organizing across markets are greater than the
administrative costs of organizing within firms, we can expect the coordination of productive
activity will be internalized within firms.
Types of VI : Vertical integration can be eitherbackward, where the firm takes over ownership
and control of producing its own components or other inputs, or forward, where the firm takes
over ownership and control of activities previously undertaken by its customers.
Benefits of Vertical Integration
VI eliminates hold-up problems ( the hold-up problem is a situation where two parties(such as a supplier and a manufacturer or the owner of capital and workers) may be able
to work most efficiently by cooperating, but refrain from doing so due to concerns thatthey may give the other party increasedbargaining power, and thereby reduce their ownprofits.)
New capabilities: Where one capability builds on capabilities in adjacent activities,vertical integration may help develop distinctive capabilities. For example: IBMs half-
century of success in mainframe computers owes much to its technological leadership insemiconductors and software. The efficiency of Wal-Marts retailing operations depends
critically on specialized IT and logistics from its in-house departments.
Extension of market power: Vertical integration can be used to extend a monopolyposition at one stage of an industrys value chain to adjacent stages. Doubleedge swordsince customer might be reluctant to buy from competitor. Disneys acquisition of the
ABC TV network adversely affected Disneys relationships with other TV networks andmade other studios (for example, Dreamworks) more reluctant to collaborate with ABC
in developing new TV productions.
Flexibility (System-Wide): Where system-wide flexibility is required, verticalintegration may allow for speed and coordination in achieving simultaneous adjustment
throughout the vertical chain. For example, Zara is another fashion clothing business thathas cut cycle times and maximized market responsiveness through a vertically integrated
strategy that challenges the industrys dominant model of contract manufacture
Costs of Vertical Integration
Optimal ScaleSuppose that Federal Express requires delivery vans that are designed andmanufactured to meet its particular needs. The transaction costs avoided by FederalExpress are likely to be trivial compared with the inefficiencies incurred inmanufacturing its own vans. Federal Express purchases over 40 000 trucks and vans eachyear, well below the 200 000 minimum efficient scale of an assembly plant.
Difficult to manage strategically different business: These strategic dissimilarities area key factor in the trend to vertical disintegration. Marriotts split into two separate
companies, Marriott International and Host Marriott, was influenced by the belief thatowning hotels is a strategically different business from operating hotels.
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7/28/2019 Summary Chpter 14 Vertical Integration
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Manage Cyclic demands: Where the required flexibility is rapid responsiveness touncertain demand, there may be advantages in market transactions. VI has larger fixed
costs and lower variable costs, firing employees and reducing capacity is more costly
than not renewing an outsourcing contract.
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