Vertical Integration Flashcards
Vertical chain
from acquisition of products up until distribution and sales of goods
Vertical Boundaries
activities performed by the firm itself
Upstream/Downstream
Earlier steps in VC/Later steps in VC
Why BUY?
- Markets are more efficient
- Market firms can achieve economies of scale
- Market firms may possess patents or private info
- Market firms need to be innovative in order to survive
- Market firms have stronger learning economies
Why MAKE?
- Complete contracting is impossible due to bounded rationality, difficulties measuring performance, asymmetric info
- Avoiding costs of using the market: direct costs of contracting, costs against hold-up, mistrust
- Inefficiencies due to under-investment in relationship-specific assets
What are the risks of making?
AGENCY COSTS (workers not working in the firm’s best interest):
- they arise when the objectives of the principal(max profits with reasonable risk) and the agent(selfish) do not align and the actions and info of the agent are not observed by the principal
- loss of efficiency due to internal costs
What are the risks of buying?
- coordination of production flow is compromised
private info can be leaked - transaction costs
What are the modes of resource-acquisition?
Arms-length contracting, Long-term contract, Non-Equity Alliance, Joint Venture, Acquisition
Why collaborate?
- obtaining needed skills or resources quicker
- reducing asset commitment
- learning economies
- sharing costs and risks
- launch new businesses or enter new geographic market
What are the risks of collaborating?
- Misrepresentation of skills
- Lower quality skills than promised
- Holdup problem
What types of alliances exist?
- Long-term contracts: multi-period contraction equity
- Equity alliance - each partner invests in the other to ensure compatibility of interests
- Joint Venture - new organisational entity in which partners invest
Mergers, Acquisitions and Takeover
Merger: two firms agree to integrate their operations on a relatively co-equal basis because they have resources and capabilities that together may create a stronger competitive advantage
Acquisition: one firm buys a controlling share of another with the intention of using a core competence more efficiently
Takeover: unsolicited acquisition
Problems with Acquisitions
- integration difficulties
- inadequate due diligence
- crippling debt
- inability to achieve synergy
- too much diversification
Make-Buy Fallacies
1] A firm should make something if it’s a source of competitive advantage
2] A firm should buy in order to avoid costs of making something
3]A firm should make in order to avoid paying the profit margin of a market firm (barriers to entry and the difference between accounting profit and economic profit)
4] A firm should make to avoid paying high market prices during periods of high demand or low supply
