2. Vertical Integration Flashcards
1
Q
VI Definition
A
- Ownership and control of multiple stages in the supply of a product
- E.g. Ikea and Amazon Kindle
2
Q
Vertical Integration vs. Horizontal Integration
A
- Vertical = Purchase of companies at all levels of production/ Forward integration = Towards customer/ Backward integration = Towards Raw material/ Balanced integration = Same forward and backward steps in both directions
- Horizontal = Purchase of competing companies in same industry/ E.g. Buying more oil refineries for an oil company
3
Q
The greater .. the more or less advantageous is VI
A
- How many firms in the adjacent stage -> Less advantageous because there are low transaction costs
- Are transactions-specific investments necessary? -> More advantageous because partners can hold-up
- Is information evenly distributed across the stages? -> Less advantageous because market is already perfect
- There Is there uncertainty over the period of the relationship? -> More advantageous because risk of incomplete contracts is high
- How similar is optimal scale between two stages? -> More advantageous because of economic benefits
- How strategically similar are the two stages? -> More advantageous because of economic benefits
- Do capabilities in the adjacent stage need to be continually upgraded? -> Less advantageous because of continuous investments
- Are profit incentives critical to performance? -> Less advantageous because internal incentives are lower than external ones
- Is market demand uncertain? -> Less advantageous because of reduced flexibility to rapid changes
- Is the adjacent stage highly risky? -> Less advantageous because of risk spreading to other stages
4
Q
Vertical Integration Pros
A
- Technical economies from integrating processeses
- Superior coordination
- Leverage an Advantage of an adjacent (angrenzende) stage
- Protect technology to avoid exposing it to suppliers or intermediaries
- Cut out middleman and capture the profit of adjacent stages (Return on assets has to be better than middleman)
- Disintermediation = Don’t need assets of intermediate anymore (e.g. online store)
- Avoids transaction costs of market contracts in situations where there are 1. Small numbers of firms/ 2. Transaction-specific investments/ 3. Opportunism and strategic misrepresentations/ 4. Taxes and regulations on market transactions
5
Q
Vertical Integration Cons
A
- Differences in optimal scale of operations between different stages of production
- Inhibits (Hemmt) development of capabilities
- Difficulties of managing strategically different businesses
- Incentive problems (Between VI divisions because same businesses)
- Competitive effects
- Limits flexibility (Demand and supplies)
- Investing in unattractive business
- Compounding (Verbinden) of risks and more market specific risk
- Channel conflict = Other intermediaries don’t want to work with you in case of forward integration
- Loss of focus
6
Q
How to choose for VI
A
- Vertical integrations is not the sole solution to transaction costs
- Depends upon 1. The resources, 2. Capabilities, 3. Strategy of the corporation
- What are the core competences of the corporation?
- How can the corporation create a corporate advantage?
7
Q
Market failure- Motive for VI
A
- Market failure = Supply or distribution channel doesn’t exist yet
- Firm requires higher control over quality, quantity, timing, distribution that market is overcharging
- Potential to create value with vertical integration
8
Q
Transaction costs
A
- Inside the firm vs. Market contracts
- All costs that are related to making contracts with market partners (searching, negotiating, monitoring etc)
- Governance of activities depends on transactions costs vs. administrative costs
- Internalization if asset specificity is high because risk of being held up is high and there are increased monitoring and coordination costs otherwise
- VI requires upfront investment and can be more costly than market governance (Depends on asset-specificity)
