Chapter 11: transaction costs, scope, and vertical integration

transaction costs

Search cost Negotiating costs Agreement costs (contracts) Monitoring costs (are the parties actually doing what they said they would do?) Legal costs if the answer above is NO.

avoids transaction costs of market contracts in situations where there are:

Small numbers of firms Transaction-specific investments Opportunism and strategic misrepresentation Taxes and regulations on market transactions

costs from vertical integration

Differences in optimal scale of operation between different stages of production: prevents balanced vertical integration Inhibits development of distinctive capabilities Difficulties of managing strategically different businesses Incentive problems: lack of "high-powered" incentives Limits flexibility: in responding to demand changes Compounding of risk

if transaction costs of moving across market > administrative costs of integrating into existing firm, then....

business should organize within the firm

corporate strategy

concerned with where a firm competes -->the "scope" of it's activities

technical economies from physical integration process

cost savings arise from processes But doesn't necessarily require common ownership The benefits of delivering the raw material of the production phase to the next phase?

relative cost

determines which activities are done within a firm and which are done through markets markets are not costless

if administrative costs of the integrated firm are LESS than transaction costs of markets, then...

determines which is more efficient

dimension of vertical scope in firm

Is it better to have all of the activities within a single firm or several different firms?

dimension of geographic scope in firm

Is it better to have all operations within a single firm or separate entities in different regions or countries of the world?

dimension of product scope in firm

Is it better to have different products produced by different entities or all of them produced by one?

business strategy

how a firm competes

forward (downstream) vertical integration

into its customers activities/domain

backward (upstream) vertical integration

into its suppliers activities/domain

vertical integration

ownership of vertically related activities --> the greater the firm's ownership extends over successive stages in value chain for its product, the greater their degree of vertical integration

benefits from vertical integration

technical economies from physical integration process avoids transaction costs of market contracts in situations (small number of firms, transaction-specific investments, opportunism, taxes on market transactions) superior coordination

from business strategy to corporate strategy...

all firms are subject to ask --> "should we make this or buy it?"