Vertical boundaries of the firm Flashcards
The production of any good or service usually requires activites orgasnised in a:
Vertical value chain
Production activities flow from:
Upstream to downstream
What are upstream entities?
Suppliers of raw inputs
What are downstream entities?
- Manufacturers
- Distributors
- Retailers
Activites in the chain include activites which are:
- Associated directly with processing and distribution
- Professional support activities
What are examples of professional support activities?
-Accounting and planning
What’s the “make or buy” situation
Make - In house
Buy - outsource
What’s the name for outside specialist firms who can perform vertical chain tasks?
Market firms
What are the types of possibilities between make and buy?
- Arm’s length transactions
- Long term contracts
- Strategic alliances and joint ventures
- Parent/subsidiary relationship
- Perform activity internally
What are advantages of vertical separation?
- Lower costs
- Economies of scale
- Expertise and market incentives
What does vertical separation mean?
Buy
What are two advantages of using the market?
- Intangible benefits
- Reduction of influence costs
What are advantages of vertical integration?
- Effective control over supply chain
- More streamlined info chains
- Allow specific assets to be used
What are some disadvantages of using the market?
- Cost of coordination
- Contracts might be inadequate to deal with problems
- Unwillingness of suppliers/buyers to develop and share valuable info
Without good coordination, what arises in the vertical chain?
Bottlenecks
Firm’s decisions depend in part on:
Other firms along the vertical chain
To ensure coordination, firms rely on:
Contracts
The main costs associated with using the market are related to:
- Negotiating contracts
- Writing contracts
- Enforcing contracts
What are factors that prevent complete contracting?
- Bounded rationality
- Difficulties in specifying/measuring performance
- Asymmetric information
Why may firms not want to use outside firms in the vertical chain?
They don’t want to compromise the source of their competitive advantage and private company information
What are sources of transaction costs?
- Contracting cost
- Investments in relationship specific assets
- Possible opportunistic behaviour after the investment is made
What are relationship specific assets?
Assets essential for a given transaction
What are different forms of relation specific asset specificity?
- Site specificity
- Physical asset specificity
- Dedicated assets
- Human asset specificity
What is site specificity?
Assets being located in close proximity to improve efficiency
What is physical asset specificity?
Physical assets have to be designed for the specific transaction
What are dedicated assets?
Some investments made to satisfy a single buyer
What is human asset specificity?
Some employees may have to acquire relationship specific skills
What is an example of site specificity?
Can producing plants near can filling plants
What’s an example of physical asset specificity?
A refinery for a particular grade of oil
What are examples of dedicated assets
- Ports investing in certain assets
- Defense contractor’s investment in certain specialised facilities
What is the hold up problem?
On party buys a relation-specific asset and then is “trapped” after purchase so can be held up by their partner
Potential for holdup may lead parties to invest in:
Wasteful protective measures
As potential fro holdup and difficulty and cost of protection increases, vertical integration is:
More likely
Potential for holdups lead to:
- Underinvestment in assets
- Investment in safeguards
- Reduced trust
Firms should make an asset, rather than buy, if the asset is a source of:
Competitive advantage
A firm should buy, rather than make, to avoid incurring:
Associated costs
A firm should make, rather than buy, to keep:
Associated profits
What’s an advantage for vertically integrated firms over nonintegrated?
They can buy at cost instead of at market price
Firms should make rather than buy to:
Tie up a distribution channel
What is rent in terms of an asset?
The amount of profit gained from a contract relating to an asset
