Chapter 4 - integration and its alternatives Flashcards
property rights theory (PRT)
explains how integration affects performance in the vertical chain
integration matters because it …
determines who gets to control resources, make decisions, and allocate profits when contracts are incomplete and trading partners disagree
residual rights of control
owner obtains all rights of control that are not explicitly stipulated in the contract
three alternative ways to organize a transaction
- nonintegration
- forward integration
- backward integration
nonintegration
two firms are independent; each manager has control over its own assets
forward integration
firm 1 owns the assets from firm 2
backward integration
firm 2 owns the assets form firm 1
path dependence
past circumstances could exclude certain possible governance arrangements in the future
technical efficiency
whether the firm is using the least-cost production process
agency efficiency
the extent to which the exchange of goods/services in the vertical chain has been organized to minimize the coordination, agency and transaction costs
economizing
describes balancing act between technical and agency efficiency
scale and scope economies
a firm gains less from vertical integration when outside market specialists are better able to take advantage of economies of scale and scope
product market share and scope
a firm with a large product market share benefits more from vertical integration. same holds for a firm with multiple product lines (e.g., save costs by producing shared components)
asset specificity (reg. vertical integration)
a firm gains more from vertical integration when production of inputs involves investments in relationship-specific assets
double marginalization
applying another markup to already marked-up supply prices
double markup causes the prices of finished goods to …
exceed the price that maximizes the joint profits of the supplier and buyer
tapered integration
mixture of vertical integration and market exchange
benefits of tapered integration
- expands firm’s input and/or output channels without requiring substantial capital outlays
- firm can use information about cost/profitability of its internal channels for negotiation
- firm can motivate its internal channels by threatening to expand outside (vice versa)
- firm can protect itself against holdup
disadvantages of tapered integration
- forced to share production, both internal and external channels might not achieve sufficient scale to produce efficiently
- may lead to coordination, monitoring problems
- managers may maintain internal capacity rather than close facilities that had formerly been critical to a firm
drawbacks of strategic alliances/joint ventures
- firms also risk losing control over proprietary information
- there are often no formal mechanisms for making decisions or resolving disputes expeditiously
- agency costs can arise within departments of firms that are not subject to market discipline
- free rider problem: each firm is insufficiently vigilant in monitoring alliance’s activities because neither captures the full benefit of such vigilance
- influence costs arise due to employees that engage in influence activity
implicit contracts
unstated understanding between independent parties in a business relationship
