What is the vertical chain?
The process that begins with the acquisition of raw materials and ends with the distribution and sale of finished goods and services
What are the vertical boundaries of a firm
Define the activities that the firm itself performs as opposed to purchases from independent firms in the market.
What is the make-or-buy decision
A firm’s decision to perform an activity itself or to purchase it from an independent firm
What is upstream
early steps in the vertical chain
What is downstream
later steps in the vertical chain
What is the make-or-buy continuum
- Arm’s-lengths market transactions
- long-time contracts
- Strategic alliances and joint ventures
- Parent relationships
- perform activity internal
What are the benefits of using the market
- Achieving economies of scale
- Make use of the efficiency and innovations of the market
What are the costs of using the market
- Lack of coordination
- Private information may be leaked
- Transaction costs
Forms of vertical foreclosure (integration to tie op the channel)
- A downstream monopolist acquires a competitive upstream firm and refuses to purchase from other upstream suppliers.
- An upstream monopolist acquires a competitive downstream firm and refuses to supply other downstream firms.
- A competitive downstream firm acquires an upstream monopolist and refuses to supply its downstream competitors.
- A competitive upstream firm acquires a downstream monopolist and refuses to purchase from its upstream competitors.
Reasons to buy
- Exploiting scale and learning economies
- Bureaucracy effects: avoiding agency and influence costs
What are agency costs?
Costs associated with shirking and the administrative controls to reduce it
What is shirking
Managers and workers who knowingly do not act in the best interests of their firm
What are influence costs
Costs that arise when transactions are organized internally
Factors that prevent complete contracting
- bounded rationality
- Difficulties specifying or measuring performance
- Asymmetric information
What aspects to include in the Coordination of Production Flows through the Vertical Chain
- Timing Fit
- Sequence Fit
- Technical Specification
- Color Fit
What is a relationship-specific investment?
Relationship-specific investments are investments made to make a transaction with a partner firm more efficient. They create value but are at the same time only useful for that specific transaction (relationship specific)
What are Forms of Asset Specificity
- Site specificity
- Physical asset specificity
- Dedicated assets
- Human asset specificity
What is Rent
The profit you expect to get when you build the plant, assuming all goes as planned.
What is Quasi- Rent
Is the extra profit that you get if the deal goes ahead as planned versus the profit you would get if you had to turn to your next-best alternative
What is the holdup problem
Its trading partner by attempting to renegotiate the terms of a deal
Generates quasi-rent for trading partners
Can occur when incomplete contracting
Consequences of the holdup problem
- More difficult contract negotiations and more frequent renegotiations
- Investments to improve ex-post bargaining positions
- Distrust
- Reduced ex-ante investment in relationship-specific investments and/or reduced ex-post cooperation.
What are the reasons to make?
- Incomplete contracting
- Coordination of production flow through the vertical chain
- To avoid leakage of private information
- Avoid paying transaction costs
- relationship-specific assets causing them not to switch partners
- To avoid rents and quasi-rents
- To avoid the holdup problem
What is the role op relationship-specific assets in a transaction?
RSA is an asset that supports a transaction
What is the RSI?
It is the amount of the investment that can not be recovered if the company does not do business with the first choice (Ford)
Relationship-specific investment (RSI)
Investment - Q(P-C)
8.5 - 1 ( 4 - 3 ) = 7.5 (you loose 7.5 million)
