4 - Integration And Its Alternatives

Question 1

Property Rights Theory of the firm

Answer 1

The resolution of the integration decision determines the ownership and control of assets. If contract were complete, asset ownership would not matter. Because of contract incompleteness, integration changes the pattern of asset ownership and control, and thur alters the bargaining power between parties in vertical relationships.

Question 2

Alternative forms of organising transactions

Answer 2

Nonintegration
Backward integration
Forward integration

According to PRT, vertical integration is desirable when one firm’s investment into relationship specific assets has a significantly greater impact on the value chain than does the other firm’s investment.

Question 3

Governance

Answer 3

Delegate decision rights and the control of assets within firms. The success of the integration rely on the central office ability to reward and punish workers.
PRT suggests that governance of an activity should fall to managers whose decisions have the greatest impact on the performance of that activity.

Question 4

Possible merger scenarios

Answer 4

• centralised decision authority
• independence of central authorities
• integration into them CDA of firm 1

Question 5

Path dependence

Answer 5

Past circumstances could exclude or enable certain possible governance arrangements in the future.

Question 6

Making the integration decision

Answer 6

Trade off between technical and agency efficiencies called economizing.
Technical efficiency occurs if the firm is using least-Cost production techniques.
Agency efficiency refers to the extent to which the exchange of goods and services in the vertical chain has been organised to minimise the coordination, agency and transaction costs.

Question 7

Graph normal

Answer 7

Make - Buy

Horizontal axis = k, asset spécificities
Vertical axis = cost

Technical efficiency is above the xaxis because outside suppliers can aggregate demands from other buyers and thus can take better advantage of economies of scale and scope.

Agency efficiency is across the xaxis because when asset specificity is low, hold-up and contract costs are not a significant problem and market exchange is likely to be more agency efficient because they have more incentives to be efficient and innovative

Question 8

Graph increasing scale

Answer 8

Vertically integrated firms can take better advantage of scale and scope therefore the production cost disadvantage relative to a market specialist will go down.

Increase scale accentuates the advantage of the organisational mode with the lowest exchange cost. Thus agency efficiency curve twists clockwise.

The intersection moves leftward expanding the range in which vertical integration is the least-cost organisational mode.

Question 9

Vertical integration is more attractive when

Answer 9

a) the ability of market firms to achieve scale/scope economies is limited
b) the larger the share of the product market and scope
c) the greater the extent to which production involves investments in relationship specific assets

Question 10

Double marginalisation

Answer 10

Results when an upstream supplier exploits its power by marking up prices above marginal costs and the downstream buyer exploits its power by applying yet another markup to these prices. This double markup causes the price of the finished food to exceed the price that maximises their joint profit.

Question 11

Alternatives to vertical integration

Answer 11

• Tapered Integration: make and buy
• Franchising
• alliances and JV
• Business groups
• LT relationships

Question 12

Franchising

Answer 12

Franchisee put up the capital to build and operate their stores and pay a fee to use the franchiser’s name and business model (partial ownership rights).

The franchisee keep their substantial profit and the franchiser activities such as purchasing and branding.

Can dictate certain aspects to avoid free riding.

Useful when local market needed.

Question 13

Alliances and JV

Answer 13

Alliance: rely on norms of trust and reciprocity
JV: new independent organisation created

When:

• complex not routine (class action)
• creation of relationship specific assets
• too costly for one party to develop the assets
• market opportunity that justifies the production is uncertain or transitory
• need help of à patiner to overcome contracting and regulatory environment.

Question 14

Business groups

Answer 14

In developing nations thrive by relying on strong central governance, access to local labor markets and unique opportunities to innovate.

Question 15

Implicit contract

Answer 15

Can substitute for formal vertical relationships

Question 16

LT market relationships

Answer 16

Can provide strong incentives for cooperative behaviour and thus achieve the advantages of vertical integration (avoidance of transaction costs, flexibility of governance) without incurring the disadvantages (softening incentives for innovation and efficiencies).

Question 17

Tapered Integration: make and buy

Answer 17

Japanese Keiretsu, Korean chaebol

Pros:

• expansion without requiring substantial capital outlays
• use internal information about costs and profitability to negotiate external contracts
• motivate of its internal channels by threatening
• protection against holdup

Cons:

• not efficient scale to be profitable to do both
• coordination problem
• monitoring problems may occur
• managers may maintain inefficient capacity

Question 18

Bilateral monopoly

Answer 18

When a firm with market power contemplates vertical integration with another firm with market power.