Question 6.10
Vertical integration encompasses a company orienting its business operations to gain control of its supply chain under the same production vertical. Each component in the supply chain produces an essential element, either a product or service, which are brought together to satisfy a common need. Vertical integration increases a company’s power within the market as it enables it to gain control over its industry’s value chain ( Alfaro, Conconi, Fadinger, & Newman, 2016). It is a strategy that has been incorporated in most corporate level operations with the objective of reducing transaction costs in procuring supplies and distribution channels. Companies have used this strategy to reduce overall production costs, achieve higher economies of scale, and grow their market share.
Firm A is more vertically integrated compared to Firm B. Vertical integration incorporates the supply chain required to produce a product within a company. This comprises of materials, suppliers and distributors. Firm A has controlled its production entities by integrating manufacturing, sales, finance, and human resources within its precincts. Finance and human resources are essential elements of production and sales. By integrating these elements, the company has control over manufacturing, supply and distribution, which are the major components of the supply chain in this scenario. Incorporating legal and customer services would mean venturing into a new service industry which may not be cost-effective. Firm B has decided to integrate the least essential supply chain elements, leaving out key stages at the top of the chain. By leaving out finance and human resources, they disrupt their manufacturing and supply, which are the first stages in the supply chain. This significantly reduces their power and control in the market as it is impossible to control the bottom of the production chain without control of the top part. Furthermore, it is more cost-effective for the firm to outsource legal and customer services than it is to outsource finance and human resources.
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Question 6.12
Firm A should make the needed technology to avoid suppliers with power who might disrupt supply as the technology needed is unique. Outsourcing a new and unique technology may be very costly due to its demand; hence vertical integration will be more cost-effective in acquiring the technology.
Firm 1 should consider vertical integration and incorporate distribution in its supply chain. The decision to continue outsourcing distribution places the firm at risk of losing its demand. They should incorporate a distribution channel on its own, which will not only be cost-effective but will also gain the company power in the market as there are no alternative distributors.
The cost of producing the product is at the same price quality as firm Alpha. The production cost is, therefore, not affected in this scenario. Firm Alpha has always manufactured its products. Therefore, allowing other firms to manufacture their products might alter its reputation among its customers. New supplies might also be difficult to manage and control, leading to the firm losing its power over its value chain. Vertical integration is, therefore advised in this scenario for the firm to maintain its competitiveness in the market.
Firm 1 has very minimal assurances of the product value in the market. Investing in all eight technologies places the firm at a high risk of loss, as only one product is certain to be dominant. To mitigate this risk, firm 1 should avoid vertically integrating to manufacture the product and instead partner with other firms that are investing in the different technologies.
Ethics and Strategy
While vertical integration can have a significant impact on a company’s performance, its value to a company can reduce creating the necessity for the company to adopt an outsourcing strategy. This is done to revive the company’s economic value. However, outsourcing significantly affects employees within the production chain, as some of them may be retrenched. The ethical dilemma created is whether to lay off some employees and pave the way for the outsourced services. If the impact of the process is ignored, the effects it has on employees can be tremendous. There should be a consideration of how laying off of employees is done. Most companies have come up with methods such as early retirements and severance settlements to mitigate the effect. While this might reduce the impact, it does eradicate its effect. The need to come up with outsourcing methods which do not affect the welfare of employees remains unsolved.
Research Made Relevant
Theoretically, vertical integration has been associated with a lot of benefits. However, the viability of these benefits needs to be tested in a practical business environment. The opportunities brought about by vertical integration have received a lot of empirical support. The business environment is dynamic and experiences rapid changes over time. Therefore, there is still a need to research whether this opportunism is still a viable need for vertical integration. Current research has found that opportunism is still an effective benefit to vertical integration. However, it is greatly affected by uncertainties in the current business environment. Transaction-specific investments, although beneficial, might be costly if they fail to succeed ( Alfaro, Conconi, Fadinger, & Newman, 2016). The effect would be damaging to the entire supply chain. As a result, companies are now vertically integrating only when they are sure of the outcomes. Uncertainty will lead to companies avoiding integration due to fear of how extensive the risk can be.
Reference
Alfaro, L., Conconi, P., Fadinger, H., & Newman, A. F. (2016). Do prices determine vertical integration?. The Review of Economic Studies , 83 (3), 855-888.
