Vertical Integration: Technological Determinism

Ours is indisputably a technologically advanced society. That complex orga- nization is needed to serve a complex technology is surely common sense. In particular, comprehensive integration—backward into materials, laterally into components, and forward into distribution—is widely believed to be the organizational means by which complex products and services are created, produced, and efficiently brought

Vertical Integration: A Heuristic Model

As discussed in earlier chapters and sketched in section 1 above, the principal factor to which transaction cost economics appeals to explain vertical integration is asset specificity. Without it, market contracting between successive production stages ordinarily has good economizing properties. Not only can production economies be realized by an outside supplier who aggregates orders,

Vertical Integration: Further Implications

1. Asset Specificity Distinctions  Additional implications of a transaction cost economizing kind can be derived by recognizing that asset specificity takes a variety of forms and that the organizational ramifications vary among these. Four types of asset specificity are usefully distinguished: site specificity—e.g. successive stations that are located in a cheek-by- jowl relation to

Vertical Merger Guidelines

The cognitive map of contract set out in Chapter 1 (Figure 1-2) identifies two main approaches to the study of contract: monopoly and efficiency. Of the two, the monopoly approach was the more fully developed and more widely favored through the early 1970s (Coase, 1972). Vertical integration is one of the areas to which

Vertical Integration: Types of Evidence

There is no single correct unit of analysis for addressing issues of economic organization. Which units are most appropriate depends on the questions being asked. The issues of interest in this book require a semi-microanalytic level of analysis—more microanalytic than received price theory, but less microanalytic than many sociological and social psychological studies of

Vertical Integration: Mundane Integration

Vertical integration, and the evidence that relates thereto, of two kinds is usefully distinguished. The first, which 1 will refer to as mundane vertical integration, involves integration of successive stages within the core technology. (These are the on-site stages referred to as SI, S2, and S3 in Figure 4-3.) The second, which is more

Vertical Integration: Forward Integration into Distribution

1. The Observed Transformation  The principal development that induced forward vertical integration into dis- tribution to occur in the second half of the nineteenth century was the appearance of the railroads (Porter and Livesay, 1971, p. 55). To be sure, there were other significant technological developments, including the telegraph (Chandler, 1977, p.189), the development

Vertical Integration: Lateral Integration

The distinction between lateral and backward integration is somewhat arbitrary. 1 shall include in the former the supply of components, body panels, and the like and reserve backward integration for more basic materials. 1. A Case Study  Klein, Crawford, and Alchian’s (1978, pp. 308-10) treatment of the bilateral exchange relationship between Fisher Body and

Vertical Integration: Backward Integration

Backward integration into raw materials may occur for three main reasons: (I) to realize prospective transaction cost economies; (2) for strategic purposes; or (3) for-mistaken reasons. Transaction cost economies will warrant integration where the parties are tightly joined in a bilateral exchange relation, making problems of harmonizing the interface crucial, and where integration does

Vertical Integration: Some Remarks About Japanese Manufacture

The Japanese rely much more extensively on subcontracting than is true in the United States. The experience of Toyota Motor Company, which has crafted an unusual relationship with its parts suppliers, is frequently cited in this connection. What explains Toyota’s success with subcontracting? What is the Japanese experience more generally? Definitive answers to neither

Vertical Integration: Some Alternative Explanations

The leading alternative theories that have been offered to explain organizational changes are domination theory, market power, technology, life cycle, pecuniary economies, and strategic behavior. 1 shall consider them seriatim. 1. Domination Theory  Domination theory focuses on human actors. There are those who possess economic power and those who do not. The organization of

Vertical Integration: Concluding Remarks

Although characterizing the firm as a production function is a convenient and useful abstraction, such an approach suppresses much of the interesting action that accounts for the high performance features of an enterprise economy. It facilitates marginal analysis within a given institutional framework at the expense of organization and comparative institutional features. The firm

The Limits of Firms: A Chronic Puzzle

Frank Knight made early reference to the limitations to firm size puzzle when, in 1921, he observed that the “diminishing returns to management is a subject often referred to in economic literature, but in regard to which there is a dearth of scientific discussion” (1965, p. 286, n. 1). And in 1933 he elaborated

The Limits of Firms: Integration of an Owner-Managed Supply Stage

The obvious answer to the puzzle of why firms do not comprehensively integrate is that selective intervention is not feasible. But why should that be? If the reasons were obvious, the puzzle of what is responsible for limitations on firm size would not persist. I attempt here to identify some of the main reasons

The Limits of Firms: Acquisition of a Supply Stage in Which Ownership and Management Are Separated

Suppose, arguendo, that vertical integration of the kind described above experiences the incentive disabilities that are ascribed to it. It is nevertheless noteworthy that the conditions described above are very special. In particular I have assumed that ownership and management are joined in the preacquisition supply stage. What if that condition does not obtain?

The Limits of Firms: The Costs of Bureaucracy

The costs of acquisition discussed in section 2 are mainly ones that will accrue to any separation of ownership from control, merger-related or otherwise. Although the costs of acquisition discussed in section 3 are not confounded in ownership and control respects, they are also more speculative in nature and are probably weaker in effect.

The Limits of Firms: Low-Powered Incentives in Markets

A symmetrical treatment of economic organization will examine not merely the strains that result when the high-powered incentives associated with markets are introduced into firms, but will also consider whether the low-powered incentives employed by firms can be introduced without strain into markets. The latter question is the matter of concern here. Assume, for

The Limits of Firms: Illustrative Examples

Evidence on the incentive limits of firms is not well developed. For one thing, firms are understandably chary of admitting administrative strains that may be interpreted as managerial failures. Additionally, the incentive limits of firms has eluded analytic scrutiny. There is simply no place, within the production function framework in which a profit maximization

The Limits of Firms: Concluding Remarks

Why can’t a large firm do everything that a collection of small firms can do and more? The basic argument of this chapter is this: Selective intervention, whereby integration realizes adaptive gains but experiences no losses, is not feasible. Instead, the transfer of a transaction out of the market into the firm is regularly

Credible Commitments: Private Ordering

As indicated earlier, the legal centralism tradition maintains that the courts are well suited for administering justice whenever contract disputes arise. If few cases are brought to the courts for disposition, that is only because contracts are carefully drawn and/or because the law of contract is fully nuanced and the relevant facts are easy