Need for fast firms rise relative external responses to external to transaction environment change costs of markets. 1995 – 2004 Rapid increase in global concentration (autos, alu[r]
(1)Vertical Integration and The Scope of the Firm
Vertical Integration and The Scope of the Firm
• Transactions Costs and the Scope of the Firm Why does the firm exist?
The evolution of firms and markets
• The Costs and Benefits of Vertical Integration • Designing Vertical Relationships
• Recent Trends
(2)From Business Strategy to Corporate Strategy: The Scope of the Firm
From Business Strategy to Corporate Strategy: The Scope of the Firm
• Business Strategy is concerned with how a firm computes within a particular market
• Corporate Strategy is concerned with where a firm competes, i.e the scope of its activities • The dimensions of scope are
– geographical scope – vertical scope
(3)P1 P2 P3 C1 C2 C3
Vertical Product Geographical
Scope Scope Scope
V1 V2
V3 P1 P2 P3 C1 C2 C3 V1
V2 V3
[A] Single Integrated
Firm
[B] Several Specialized Firms linked by Markets
In situation [A] the business units are integrated within a single firm.
In situation [B] the business units are independent firms linked by markets. Are the administrative costs of the integrated firm less than the transaction costs of markets?
Transactions Costs and the Scope of the Firm
(4)Transactions Costs and The Existence of the Firm
Transactions Costs and The Existence of the Firm
• Transaction cost theory explains not just the boundaries
of firms, also the existence of firms.
• In 18th century English woollen industry, no firms –
independent spinners and weavers linked by merchants.
• Residential remodeling industry mainly independent employed builders, plumbers, electricians, painters.
• Key issue transaction costs of the market vs administrative costs of firms.
• Where transaction costs high—firm is more efficient means of organization
(5)Changes in Aggregate Concentration Over Time
Concentration Over Time
• For most of the 19th & 20th centuries industrial firms have expanded their
vertical, geographical and product scope Why?
• From the late 1970s to the mid-1990s, this trend reversed Large companies began downsizing, outsourcing, and refocusing Why?
• Why the recent renewal of concentration in the industrial sector?
(6)Determinants of Changes in Corporate Scope
Determinants of Changes in Corporate Scope
1800 – 1980 Expanding scale and scope of industrial corporations due to declining administrative costs of firms:
• Advances in transportation, information and communication technologies
• Advances in management—accounting systems, decision sciences, financial techniques, organizational innovations, scientific management
1980 – 1995 Shrinking size and scope of biggest industrial corporations Increasingly Increased no of managerial Admin costs of
turbulent decisions Need for fast firms rise relative external responses to external to transaction environment change costs of markets
1995 – 2004 Rapid increase in global concentration (autos, aluminium, oil, beer, banking, cement)
Key drivers: quest for market power and scale economies.
(7)The Costs and Benefits of Vertical Integration: BENEFITS
The Costs and Benefits of Vertical Integration: BENEFITS
• Technical economies from integrating processes e.g iron and steel production
—but doesn’t necessarily require common ownership
• Superior coordination
• Avoids transactions costs of market contracts in situations where there are:
small numbers of firms
transaction-specific investments