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Vertical Integration Vertical Integration

What Is Vertical Integration? What Is Vertical Integration?

• Vertical integration is a special exponent of unrelated

diversification
– A firm is engaged in several stages of a given industry’s value
chain

• Existence – why do firms emerge?

• Boundaries – why is the boundary between firms and

the market located exactly there as to size and output
variety?

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Vertical Integration Vertical Integration

What Is Vertical Integration? Value Chain Economies

The Logic of Value Chain Economies

Strategic Efficiency

Power Positioning Governance Transaction

Cost
Building Protecting Facilitating Improved
barriers to product quality investments in scheduling
entry specialized
assets

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Vertical Integration Vertical Integration

Value Chain Economies Value Chain Economies

The Logic of Value Chain Economies The Logic of Value Chain Economies

• Value migration
• Differentiation
• Customers demand integrated solutions
• Synergies
• Emerging industries
– Credibility
– Compatibility/standards

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Vertical Integration Vertical Integration

Arguments Against Vertical Integration Alternatives to Vertical Integration

• Cost disadvantages • Short-term contracts and competitive bidding

– Company-owned suppliers that have higher costs than external suppliers • Strategic alliances and long-term contracting
• Rapid technological change • Building long-term cooperative relationships
– Tying a company to an obsolescent technology
• Demand unpredictability
– Difficulty of achieving close coordination among vertically integrated
activities
• Bureaucratic costs

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Vertical Integration Vertical Integration

When is Vertical Integration More Attractive When is Vertical Integration More Attractive
than Outsourcing? than Outsourcing?
Do the different stages have similar Greater the similarity, the
How many firms are available The fewer the companies optimal scales of operation? more attractive is VI
to undertake the activities? the more attractive is VI

Are the two stages strategically Greater the strategic

Is transaction-specific investment If yes, VI more attractive similar? similarity ---the more
needed? attractive is VI

How great the need for entrepreneurship Greater the need, the greater
& continual upgrading of capabilities the disadvantages of VI
Does limited information permit VI can limit opportunism
cheating?
How uncertain is market demand? Greater the unpredictability
----the more costly is VI

Are taxes or regulation imposed VI can avoid them Are risks compounded by VI increases risk.
on transactions? linkages between vertical stages

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Vertical Integration

Summary
Vertical Integration…

• makes sense when value chain economies

can be created and captured

• may allow a firm to leverage capabilities

• may be a response to the threat of opportunism

and uncertainty

• as a form of exchange per se, is not rare nor

costly to imitate
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