Chapter 4 Flashcards
What does the property right theory of the firm explain
It explains how integration affects performance in the vertical chain
What is the main proposition regarding ownership of the Property right theory
Integration determines the ownership and control of assets, and it is through ownership and control that firms exploit contractual incompleteness
Alternative forms of organising transactions
Nonintegration
Forward Integration
Backward Integration
What is nonintegration form of transaction
The two firms are independent; each set of managers has control over its own assets
What is forward integration form of transaction
Firm 1 owns the assets of Firm 2
What is backward integration form of transaction
Firm 2 owns the assets of Firm 1
What is a important observation into PRT
In the sense of legal
The resolution of the make-or-buy decision determines the legal right to control assets and disburse revenues obtained form use of the assets. The owner of an asset may grant another part the right to use it or receive revenues from it, but the owner retains all rights of control that are not explicitly stipulated in the contract.
When is vertical integration desirable
When one firm’s investment in relationship-specific assets has a significantly greater impact on the value created in the vertical chain than does the other firm’s investment
What is technical efficiency
Technical efficiency indicates whether the firm is using the least-cost production process.
What is agency efficiency
Agency efficiency refers to the extent to which the exchange of goods and services in the vertical chain has been organised to minimize the coordination, agency, and transaction costs. If the exchange does not minimize these costs, then the firm has not achieved full agency efficiency.
What does the trade off between agency efficiency and technical efficiency illustrate
The figure illustrates a situation in which the quantity of the good being exchanged is fixed at a particular level.
What does the vertical axis of the trade off measure
The vertical axis measures cost differences between internal organisation and market transactions.
What does a positive value on the vertical axis of the trade off mean
A postive value indicates that costs from the internal organization exceed costs from the market transactions
What does a the horizontal axis of the trade off measure
The horizontal axis measures asset specificity. Higher values of k imply greater asset specificity.
What does curve ▲T depict
The ▲T curve depict the differences in technical efficiency. It measures the differences in production costs when the item is produced in a vertically integrated firm and when it is exchanged through an arm’s length market transaction.
What does curve ▲ A depict
The ▲ A curve reflects differences in agency efficiency. It measures differences in exchange costs when the item is produced internally and when it is purchased from an outside supplier in an arm’s-length transaction.
What does curve ▲ C depict
The ▲ C curve depict the vertical summantion of the ▲ A and ▲T curves.
What does scale and scope economics have to with the trade off?
We know that a firm gains less from vertical integration when outside market specialist are better able to take advantage of economies of scale and scope.
What does product market share and scope have to with the trade off?
The more the firm produces, the more its demand for input grows. This increases the likelihood that in-house input production can take as much advantage of economies of scale and scope as an outside market specialist.
What does asset specificity have to do with the trade off?
A firm gains more from vertical integration when production of inputs involves investments in relationship-specific assets.
What are alternatives to vertical integration?
- Tapered integration
- Franchising
- Strategic alliances and joint ventures
- Close-knit semiformal relationships among buyers and suppliers
Explain tapered integration
Tapered integration represents a mixture of vertical integration and market exchange.
What are the benefits of tapered integration
First, it expands the firm’s input and/or output channels without requiring substantial capital outlays
Second, the firm can use information about the cost and profitability of its internal channels
Third, the firm can motivate its internal channels by threatening to expand outsourcing, and at the same time motivate its external channels by threatening to produce more in-house.
Finally, the firm can protect itself against holdup by independent input sellers.
Explain franchising
If the business thrives, the owner may wish to expand to new markets. rather than borrow money and open new stores themselves, the franchiser gives partial ownership rights to franchisees.
Explain strategic alliances
Firms have increasingly turned to strategic alliances as a way to organize complex business transactions collectively without sacrificing autonomy. Which can be horizontal (same industry) or vertical (related in the vertical chain) or neither.
Explain joint ventures
A joint venture is particular type of strategic alliance in which two or more firms create, and jointly own, a new independent organisation.
