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

1. 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

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

Credible Commitments: Credible Commitments

1. Commitments’versus Threats  Credible commitments and credible threats share this common attribute: Both appear mainly in conjunction with irreversible, specialized investments. But whereas credible commitments are undertaken in support of alliances and to promote exchange, credible threats appear in the context of conflict and rivalry.63 The former involve reciprocal acts designed to safeguard a

Credible Commitments: The Hostage Model

The simple hostage model serves to illuminate both unilateral and bilateral exchange, permits the concept of specific capital to be extended beyond earlier uses, and clarifies how costs should be described in assessing exchange. While it is primitive and suggestive, rather than refined and definitive, it serves as a paradigmatic wedge by which the

Credible Commitments: Engaging the Supplier

Suppliers are passive instruments in this model. They are indifferent among contracts, since their expected profits are the same (zero) whichever choice the buyer makes. What drives the argument is that buyers can secure better terms only by relieving producers of demand cancellation losses. Buyers cannot have their cake (product supplied by the efficient

Credible Commitments: Unilateral Trading Applications

The technologies and contractual options discussed above are displayed sche- matically in Figure 7-2. If pˆ < p1 < p‾, then the relevant nodes are A and C: e uyer will either ask the supplier to employ the general purpose techno ogy an will pay p, upon delivery of product for which orders are’con-

Credible Commitments: Schwinn

Although issues posed in Schwinn are not precisely the same as the franchise matters discussed above, they are nevertheless closely related. Inasmuch as this case displays pretransaction cost type reasoning, it is instructive to consider the government’s arguments against the franchise restrictions employed by Schwinn and then to consider an alternative construction. 1. The Objections 

Credible Commitments: Reciprocity

1. General Reciprocity transforms a unilateral supply relation where A sells X to B into a bilateral one, whereby A agrees to buy Y from B as a condition for making the sale of X and both parties understand that the transaction will be continued only if reciprocity is observed. The resulting contractual relation

Credible Commitments: The Hostage Model Extended

Assume that the two firms are engaged in tied bilateral trade and that both have made specific asset investments of k in support of each other. Assume further that each firm incurs redeployable costs of production of v2 and that pˆ is the price at which product is traded. In deciding whether to take