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EMGT 722
November 14, 2009
THE FOLLOWING PRESENTATION HAS BEEN RATED
SF Stossel-Free
Why are We Talking About This?
Vertical Integration in the News
And, Finally
?
Recognizing Vertical Integration
?
Recognizing Vertical Integration
?
Recognizing Vertical Integration
?
Value Chain
Firm Infrastructure
Technological Development
Procurement
Service
Operations
Outbound Logistics
Inbound Lo
Forward Integration
Backward Integration
Vertical Integration Decisions
O
One off you is
i buyer
b and
d th
the other
th
supplier
Assign alphabetically
Da Rules
1. Buyer decision #1: Invest or Not
Buyer has an opportunity to make an investment that will
save $1
$1,500
500 in the long term
term.
Investment costs $500 and is only useful in conjunction with
the one Supplier.
Buyer is potentially $1
$1,000
000 better off by deciding to invest
invest,
provided that he/she continues the business relationship with
the Supplier.
2. Supplier decision: Raise price or Not
Supplier has an opportunity to raise price by $750, knowing
that the Buyer has made a net saving of $1,000 and can
therefore afford to pay more.
3. Buyer response: Keep or fire supplier
If price increase, buyer may change suppliers
Buyer ends up $500 worse off due to the wasted investment
Supplier ends up $1,000 worse off due to the loss of business from
the Buyer.
Scenarios
New Scenario
Now rather than saving the buyer $1,500, the investment
saves $
$1,000
, ((so net g
gain of $
$500 after $
$500 cost))
Vertical Integration
and
Transaction Costs
Forms of Economic Organization
O
Organizational
i ti l Form
F Continuum
C ti
Coordination
C di ti costst
Relying
Relying on outside suppliers is not a
game for the nave player. It demands
careful study
study. If you bungle a relationship
with the Japanese, you can lose your
technology your business
technology, business.
Roger Levin, VP of Technology &
Development Xerox
Development,
Contracting
People
p are boundedly
y rationalityy
Enforcement
E f li i i
limitations
Transaction Costs and Contracting
Sources
S off transactions
t ti costs
t
Small numbers of players (hard to find right partner)
Investments that need to be made in relationship-specific assets
Possible opportunistic behavior after the investment is made
(hold up problem)
Costly Transactions
Hard to allay
Costly to find a
concerns of being
trading partner
taken advantage of
Long-term Relationship-
Unclear property
relationships, specific
rights
dynamic settings investments
I do
d want you to b
be aware that
h there
h are
some people out there who will behave this
way, and you should protect yourself
Site specificity
Physical
Ph i l assett specificity
ifi it
Dedicated assets
In worst case,
case potential for holdup leads to total
unwillingness to invest in relationship-specific
assets
Remember our Game
It introduces a repeated
repeated relationship
relationship that
reduces uncertainty and makes relationship-
specific
p investment more pprofitable
Itt may
ay a
allow
o oorganizational
ga at o a cu culture
tu e to p
promote
o ote a
an
atmosphere of cooperation
Bad Reasons for Vertical Integration
Assuring
A i supply
l
Do it in the market
Unless there are compelling reasons to bring the
transaction within the firm
Vertical integration
g MAY allow yyou to tie up
p necessary
y
inputs or means of distribution
Buy only if you can enter for less than the capitalized
value of future profits
Evading Regulation Motive
Two separate
p consumer g
groups
p who use same
product in different manners