Chapter 10 Flashcards
What are transaction costs?
“Transaction costs are the costs of organizing an activity through the market, including the costs of search, negotiation, drawing up contracts, and monitoring and enforcing contracts.”
Search costs: Costs of finding a suitable supplier or buyer
Negotiation costs: Costs of negotiating a contract
Contract costs: Costs of drawing up a contract
Monitoring and enforcement costs:
Costs of monitoring and enforcing a contract
What’s the definition of Firms and Markets?
Firms are distinguished by the fact that they comprise a number of individuals bound by employment contracts with a central contracting authority
Markets are institutions that facilitate the exchange of goods and services between buyers and sellers
What is Vertical Integration?
Vertical integration refers to the extent to which a firm controls the different stages of production, from raw materials to final product
Vertical scope refers to the range of vertically linked activities that a firm encompasses
What are the pros (benefits) and cons (costs) of vertical integration?
Benefits of Vertical Integration:
Improved quality control
Increased efficiency
Better coordination and communication
Ability to respond quickly to changes in the market
Costs of Vertical Integration:
Increased administrative costs
Reduced flexibility
Potential for bureaucratic inefficiencies
What are the types of vertical integration?
Backward (or upstream) integration: a firm integrates into its suppliers’ activities
Forward (or downstream) integration: a firm integrates into its customers’ activities
Full integration: a firm owns and controls all stages of the supply chain
Partial integration: a firm owns and controls some, but not all, stages of the supply chain
What are the benefits of vertical integration?
Technical Economies: cost savings from physically integrating adjacent processes
Reduced Risk: a firm can better manage risk by controlling multiple stages of the supply chain
Improved Coordination: a firm can better coordinate activities across different stages of the supply chain
Transaction costs refer to the costs associated with exchanging goods or services between two parties. In the context of vertical exchanges, transaction costs can be a significant factor in determining the optimal level of vertical integration.
Explain Low vs High transaction cost.
Low transaction costs: When there are many buyers and sellers, information is readily available, and switching costs are low, market contracts can be an efficient way to organize vertical exchanges.
High transaction costs: When there are few buyers and sellers, information is scarce, and switching costs are high, vertical integration may be necessary to reduce transaction costs.
What is The Problem of Bilateral Monopolies?
When two firms are vertically integrated, they may become locked into a bilateral monopoly, where each firm has significant bargaining power over the other. This can lead to:
Opportunism: One firm taking advantage of the other firm’s dependence on it.
Strategic misrepresentation: One firm providing false or misleading information to the other firm.
What are some Coordination Benefits?
Vertical integration can provide coordination benefits by allowing firms to:
Internalize transactions: Reduce the need for external market transactions and the associated transaction costs.
Improve communication: Enhance communication and coordination between different stages of production.
What are the Advantages of Vertical Integration?
Increased control: By controlling multiple stages of the production process, a company can better manage quality, costs, and delivery times.
Improved coordination: Vertical integration can facilitate coordination between different stages of the production process, leading to increased efficiency and reduced errors.
Enhanced flexibility: With control over multiple stages, a company can respond more quickly to changes in demand or market conditions.
Increased bargaining power: Vertical integration can give a company greater bargaining power with suppliers and customers.
What are the Disadvantages of Vertical Integration?
Higher costs: Vertical integration can be expensive, as a company must invest in multiple stages of the production process.
Increased risk: By controlling multiple stages, a company is exposed to greater risks, including the risk of supply chain disruptions or changes in market demand.
Reduced flexibility: Vertical integration can make it more difficult for a company to adapt to changes in the market or industry.
Inefficient allocation of resources: Vertical integration can lead to inefficient allocation of resources, as a company may be forced to invest in stages of the production process that are not core to its business.
What are the different types of vertical relationships?
Arms-length market contracts:
Spot contracts with no resource commitment beyond the single deal.
Long-term contracts:
Contracts that involve a commitment to purchase or supply a specific quantity of goods or services over a specified period.
Vertical partnerships:
Relationships based on trust and mutual understanding, with no written contract.
Franchising:
A contractual agreement between the owner of a business system and trademark (the franchiser) and a franchisee.
Vertical integration:
A business strategy in which a company controls multiple stages of the production process.
