CHAPTER 6
Which organizational structure is used to implement a vertical integration strategy? A) matrix B) functional C) multidivisional D) product-divisional
B) functional
Evaluating a functional manager's performance relative to budgets can be an effective control when A) the process used in developing budgets is open and participative. B) the process reflects the economic best-case scenario developed by the functional manager. C) the process reflects the economic worst-case scenario developed by the functional manager. D) the process relies solely on quantitative criteria to evaluate the functional manager's performance.
A) the process used in developing budgets is open and participative.
The ________ logic suggests that compensation that has a fixed and known downside risk and significant upside potential is important for firms implementing vertical integration strategies. A) opportunism B) strategic C) capabilities D) flexibility
D) flexibility
The downside risks associated with investing in a strategic alliance are unknown but fixed.
FALSE
If one of a firm's exchange partners behaves opportunistically, this reduces the economic value of the firm.
TRUE
To the extent that other firms may have competitive advantages in business activities that a firm is considering to enter through vertical integration, vertically integrating into these activities could put the firm at a A) competitive advantage. B) temporary dynamic disadvantage. C) sustainable competitive advantage. D) competitive disadvantage.
D) competitive disadvantage.
Vertical integration is a type of A) business strategy. B) generic strategy. C) differentiation strategy. D) corporate strategy.
D) corporate strategy.
Which of the following is not used to determine a firm's level of vertical integration using the value added as a percentage of sales approach? A) value added B) net income C) sales D) gross margin
D) gross margin
Research suggests that, in general, vertically integrating is ________ than not vertically integrating. A) significantly more flexible B) somewhat more flexible C) comparatively flexible D) less flexible
D) less flexible
The ________ explanations call for compensation that focuses on individual employees, such as cash bonuses for individual performance. A) capabilities-based B) strategically-based C) flexibility-based D) opportunism-based
D) opportunism-based
According to ________ of when vertical integration creates value, vertical integration is valuable when it reduces threats from a firm's suppliers or buyers due to any transaction-specific investments a firm has made. A) firm capability explanations B) opportunity-based explanations C) flexibility-based explanations D) opportunism-based explanations
D) opportunism-based explanations
According to the opportunism-based explanations of vertical integration, which of the following would be the most appropriate type of compensation to support strategy implementation? A) cash bonuses for corporate performance B) cash bonuses for group performance C) stock options for individual performance D) stock grants for individual performance
D) stock grants for individual performance
Firms should not vertically integrate into business activities where they do not possess the resources necessary to gain competitive advantages.
TRUE
Flexibility is only valuable when the decision-making setting a firm is facing is uncertain.
TRUE
Flexibility refers to how costly it is for a firm to alter its strategic and organizational decisions.
TRUE
If a firm engages in vertical integration into a business activity where it does not possess any of the valuable, rare, or costly-to-imitate resources it needs to gain a competitive advantage, it may find itself at a competitive disadvantage to the extent that some firms already have competitive advantages in these business activities.
TRUE
If a firm has capabilities that are valuable and rare, then vertically integrating into businesses that exploit these capabilities can enable the firm to gain at least a temporary competitive advantage.
TRUE
Numerous conflicts can arise among functional managers in a vertically integrated U-form organization.
TRUE
One of the biggest uncertainties in providing customer service through call centers is the question of whether the people staffing the phones actually help a firm's customers.
TRUE
TerraLoc's decision to manufacture the battery in-house is most consistent with which explanation of vertical integration? A) Flexibility-based explanations B) Firm capability-based explanations C) Alliance-based explanations D) Opportunism-based explanations
D) Opportunism-based explanations
Firms should avoid vertically integrating in those businesses where they possess valuable, rare, and costly-to-imitate resources and capabilities.
FALSE
Firms should only bring market exchanges within their boundaries when the cost of vertical integration is more than the cost of opportunism.
FALSE
Flexibility is always valuable.
FALSE
Flexibility is low when the cost of changing strategic choices is low.
FALSE
From a CEO's perspective, coordinating functional specialists to implement a vertical integration strategy rarely involves conflict resolution.
FALSE
If Iron Horse Helmets (IHH) were to contract with a Chinese manufacturing firm to provide IHH with superior quality helmets for sale in the United States but discovered that the shipments were actually of inferior quality when they were received, IHH would be said to be acting opportunistically.
FALSE
If Wal-Mart were to purchase a factory to make socks and it planned to sell these socks in its stores, this would be an example of forward vertical integration.
FALSE
Discuss the opportunism-based explanation of vertical integration value creation and identify when, under this explanation, firms should vertically integrate. In your answer be sure to clearly define opportunism and the role that transaction-specific investments play in the opportunism-based explanation.
One of the best known explanations of when vertical integration can be valuable focuses on using vertical integration to reduce the threat of opportunism. Opportunism exists when a firm is unfairly exploited in an exchange. Obviously, when one of its exchange partners behaves opportunistically, this reduces the economic value of a firm. The threat of opportunism is greatest when a party to an exchange has made what are called transaction-specific investments. A transaction-specific investment is any investment in an exchange that has significantly more value in the current exchange than it does in alternative exchanges. One way to reduce the threat of opportunism is to bring an exchange within the boundary of a firm. That is, one way to reduce the threat of opportunism is to vertically integrate into this exchange. This way, managers in a firm can directly monitor and control this exchange instead of relying on the market to manage this exchange. If the exchange that is brought within the boundary of a firm brings a firm closer to its ultimate suppliers, it is an example of backward vertical integration. If the exchange that is brought within the boundary of a firm brings a firm closer to its ultimate customer, it is an example of forward vertical integration. Of course, firms should only bring market exchanges within their boundaries when the cost of vertical integration is less than the cost of opportunism. If the cost of vertical integration is greater than the cost of opportunism, then firms should not vertically integrate into an exchange. This is the case for both backward and forward vertical integration decisions.
A decision-making setting is uncertain when the future value of an exchange cannot be known when investments in that exchange are being made.
TRUE
Strategic alliances are the major substitute for vertical integration.
TRUE
Outsourcing can help firms reduce costs and focus their efforts on those business functions that are central to their competitive advantage.
TRUE
Compensation that focuses on groups of employees such as cash bonuses and stock grants are best suited for ________ explanations of vertical integration. A) flexibility-based B) capabilities-based C) strategically-based D) opportunism-based
B) capabilities-based
If one of the suppliers that Digipics purchases its components from purposefully delivered a batch of its product that was substandard but did not inform Digipics of this, this would be an example of A) flexibility. B) opportunism. C) uncertainty. D) vertical integration.
B) opportunism.
A(n) ________ is any investment in an exchange that has significantly more value in the current exchange than it does in alternative exchanges. A) opportunity-specific investment B) transaction-specific investment C) competition-specific investment D) opportunistic investment
B) transaction-specific investment
A firm's ability to conceive and implement vertical integration strategies tends to be highly susceptible to direct duplication.
FALSE
A firm's vertical integration strategy can only be rare when it is the only firm that is able to vertically integrate efficiently.
FALSE
Business strategy is a firm's theory of how to gain competitive advantage by operating in several businesses simultaneously.
FALSE
Which of the following statements regarding direct duplication and substitutes for vertical integration is accurate? A) A firm's valuable and rare vertical integration choices may be subject to direct duplication and substitutes. B) A firm's valuable and rare vertical integration choices are subject to neither direct duplication nor substitutes. C) A firm's valuable and rare vertical integration choices may be subject to direct duplication but not to substitutes. D) A firm's valuable and rare vertical integration choices may be subject to substitutes but not to direct duplication.
A) A firm's valuable and rare vertical integration choices may be subject to direct duplication and substitutes.
________ refers to how costly it is for a firm to alter its strategic and organizational decisions. A) Flexibility B) Dynamic capability C) Opportunism D) Uncertainty
A) Flexibility
In 1937, which Nobel Prize-winning economist first articulated the question of vertical integration, i.e., which stages of the value chain should be included within a firm's boundaries and why? A) Ronald Coase B) Adam Smith C) David Ricardo D) Milton Freidman
A) Ronald Coase
________ are payments to employees in a firm's stock. A) Stock grants B) Cash grants C) Flexibility grants D) Option grants
A) Stock grants
If Digipics were to begin manufacturing lenses for the cameras they assembled, this would be an example of A) backward vertical integration. B) a strategic alliance. C) forward vertical integration. D) opportunism.
A) backward vertical integration.
From a CEO's perspective, coordinating functional specialists to implement a vertical integration strategy almost always involves A) conflict resolution. B) competitive positioning. C) product differentiation. D) corporate expansion.
A) conflict resolution.
When Apple, Inc. opened retail stores to sell its computers and iPods, this was an example of A) forward vertical integration. B) backward vertical integration. C) forward horizontal integration. D) backward horizontal integration.
A) forward vertical integration.
The fact that it would be very costly for Digipics to alter its operations if the large customer referred to in the previous question decided to stop doing business with Digipics suggests that Digipics has ________ in this situation. A) low flexibility B) low opportunism C) high flexibility D) high opportunism
A) low flexibility
If a computer company decided to open its own call centers to provide technical support to its corporate customers because the employees in these call centers need a significant level of in-depth training that was highly specialized to the computer company's products, this would be consistent with which explanation of vertical integration? A) opportunism-based B) flexibility-based C) firm capabilities-based D) alliance-based
A) opportunism-based
Which of the explanations of vertical integration is the oldest and has received the greatest empirical support? A) opportunism-based B) flexibility-based C) firm capabilities-based D) alliance-based
A) opportunism-based
According to the flexibility-based explanations of vertical integration, which of the following would be the most appropriate type of compensation to support strategy implementation? A) stock options for individual performance B) stock grants for individual performance C) stock grants for corporate performance D) cash bonuses for individual performance
A) stock options for individual performance
A decision-making setting is ________ when the future of an exchange cannot be known when investments in that exchange are being made. A) uncertain B) opportunistic C) flexible D) dynamic
A) uncertain
A firm's ________ measures the percentage of a firm's sales that is generated by activities done within the boundaries of a firm. A) value added as a percentage of sales B) simple product diversification C) competitive advantage D) competitive dynamic
A) value added as a percentage of sales
According to the capabilities-based explanations of vertical integration, which of the following would be the most appropriate type of compensation to support strategy implementation? A) salary B) cash bonuses for corporate performance C) cash bonuses for individual performance D) stock grants for individual performance
B) cash bonuses for corporate performance
If TerraLoc were to use a U-form organizational structure and the CEO decided to use budgets as a management control but wanted to make sure that the managers did not become too focused on the short term, the CEO should do all of the following except A) use an open process in developing budgets. B) determine budgets for her managers and allow them to focus only on meeting the budgets. C) use both quantitative and qualitative evaluations of managers' performance. D) make sure that the process used in developing budgets reflects the economic reality facing the firm's managers.
B) determine budgets for her managers and allow them to focus only on meeting the budgets.
Which committee in a U-form organization meets weekly and reviews the performance of the firm on a weekly basis and typically consists of a CEO and two or three functional senior managers? A) top management team B) executive committee C) operations committee D) functional committee
B) executive committee
A(n) ________ approach to vertical integration suggests that rather than vertically integrating into a business activity whose value is highly uncertain firms should not vertically integrate and instead should form a strategic alliance to manage this exchange. A) alliance-based B) flexibility-based C) firm capabilities-based D) opportunism-based
B) flexibility-based
If a firm decided to maintain relationships with several different call center management companies, each of which have adopted different technological solutions to the problem of how to use call center employees to assist customers who are using very complex products, to reduce the uncertainty of whether the people staffing the phone can help the firm's customers, this would be consistent with which explanation of vertical integration? A) opportunism-based B) flexibility-based C) firm capabilities-based D) alliance-based
B) flexibility-based
A firm with a ________ ratio between value added and sales has brought ________ of the value-creating activities associated with its business inside its boundaries, consistent with a high level of vertical integration. A) low; many B) high; many C) medium; many D) medium; few
B) high; many
More vertically integrated firms accomplish fewer stages of the value chain within their boundaries than less vertically integrated firms.
FALSE
Once a firm has vertically integrated it has committed its organizational structure, its management controls, and its compensation policies to a particular vertically integrated way of doing business and it has enhanced its flexibility.
FALSE
Research suggests that, in general, vertically integrating is more flexible than not vertically integrating.
FALSE
The threat of opportunism is the least when a party to an exchange has made transaction-specific investments.
FALSE
When companies staffed and operated their own call centers in the United States, they were engaging in backward vertical integration, but when they started using independent companies in India to staff and operate these centers, they were more vertically integrated.
FALSE
A firm may be able to gain an advantage from vertically integrating when it resolves some uncertainty it faces sooner than its competition.
TRUE
A firm with a high ratio between value added and sales has brought many of the value-creating activities associated with its business inside its boundaries, consistent with a high level of vertical integration.
TRUE
A firm's level of vertical integration is the number of steps in its value chain that the firm accomplishes within its boundaries.
TRUE
A firm's vertical integration strategy is rare when few competing firms are able to create value by vertically integrating in the same way.
TRUE
A flexibility-based approach to vertical integration suggests that when the decision-making setting regarding a business activity is highly uncertain, firms should form a strategic alliance to enter this activity instead of vertically integrating.
TRUE
A transaction-specific investment is any investment in an exchange that has significantly more value in the current exchange than it does in alternative exchanges.
TRUE
Capability explanations of vertical integration acknowledge the importance of firm-specific investments in creating value for a firm.
TRUE
Decisions about whether or not to vertically integrate often determine whether or not a firm is operating in a single business or industry or multiple businesses or industries.
TRUE
Within the flexibility-based approach to vertical integration when should firms engage in strategic alliances instead of vertical integration, and what are the advantages of alliances under these conditions?
A flexibility-based approach to vertical integration suggests that rather than vertically integrating into a business activity whose value is highly uncertain, firms should not vertically integrate and, instead, should form a strategic alliance to manage this exchange. A strategic alliance is more flexible than vertical integration but still gives a firm enough information about an exchange to estimate its value over time. An alliance has a second advantage in this setting. The downside risks associated with investing in a strategic alliance are known and fixed. They equal the cost of creating and maintaining the alliance. If an uncertain investment turns out to not be valuable, parties to this alliance know the maximum amount they can lose, an amount equal to the cost of creating and maintaining the alliance. On the other hand, if this exchange turns out to be very valuable, then maintaining an alliance can give a firm access to this huge upside potential.
Opportunism exists when a firm is unfairly exploited in an exchange.
TRUE
If TerraLoc wanted to expand into selling its GPS units through company-owned retail stores, this would be an example of ________ A) forward vertical integration. B) backward vertical integration. C) opportunism. D) a joint venture.
A) forward vertical integration.
Firm-specific investments are a type of ________ investments. A) operational B) contingent C) transaction-specific D) horizontal
C) transaction-specific
Investments made by employees that have more value in a particular company than in alternative companies are known as A) firm-specific investments. B) individual-specific investments. C) group-specific investments. D) opportunistic investments.
A) firm-specific investments.
Budgets are an important control tool and they contribute to only positive outcomes.
FALSE
Some observers predict that by ________ an additional 3.3 million jobs in the United States will be outsourced, many to operations overseas. A) 2014 B) 2015 C) 2016 D) 2017
B) 2015
TerraLoc's development of the new battery technology is likely to A) reduce the rarity of TerraLoc's vertical integration strategy since competitors can purchase batteries from other sources. B) increase the rarity of TerraLoc's vertical integration strategy since TerraLoc has reduced uncertainties related to increased battery life in its products. C) increase the imitability of TerraLoc's vertical integration strategy since competitors can purchase traditional batteries from other sources. D) decrease the imitability of TerraLoc's vertical integration strategy since it increases competitors' flexibility.
B) increase the rarity of TerraLoc's vertical integration strategy since TerraLoc has reduced uncertainties related to increased battery life in its products.
The major substitute for vertical integration is A) vertical disintegration. B) strategic alliances. C) a product-differentiation strategy. D) a low-cost strategy.
B) strategic alliances.
Discuss the role of the budgeting process as a control mechanism in vertically integrated U-form organizations, the potential unintended negative consequence budgets can have, and three things CEOs can do to counter this potential consequence.
Budgeting is one of the most important control mechanisms available to CEOs in vertically integrated U-form organizations. Indeed, in most U-form companies, enormous management effort goes into the creation of budgets and the evaluation of performance relative to budgets. Budgets are developed for costs, revenues, and a variety of other activities performed by a firm's functional managers. Often, managerial compensation and promotion opportunities depend on the ability of a manager to meet budget expectations. Although budgets are an important control tool, they can also have unintended negative consequences. For example, the use of budgets can lead functional managers to overemphasize short-term behavior that is easy to measure and underemphasize longer-term behavior that is more difficult to measure. CEOs can do a variety of things to counter the "short-termism" effects of the budgeting process. Three things a CEO can do to counter "short-termism" are to 1. Ensure that the process used in developing budgets is open and participative 2. Make sure the budgeting process reflects the economic reality facing functional managers and the firm, and 3. Augment quantitative evaluations of a functional manager's performance with qualitative evaluations of that performance.
________ exists when a firm is unfairly exploited in an exchange. A) Competitive advantage B) Business level strategy C) Opportunism D) Corporate level strategy
C) Opportunism
________ are when employees are given the right, but not the obligation, to purchase stock at predetermined prices. A) Flexibility grants B) Stock grants C) Stock options D) Grant options
C) Stock options
If Digipics were to agree to spend a significant amount of money to establish a new assembly line for a large client, PicPro, that has unique needs that would make this assembly line largely useless for any other customer, the funds Digipics spent in establishing this line would be an example of A) forward vertical integration. B) backward vertical integration. C) a transaction-specific investment. D) opportunism.
C) a transaction-specific investment.
The essence of the ________ to vertical integration is that if a firm possesses valuable, rare, and costly-to-imitate resources in a business activity, it should vertically integrate into that activity otherwise it should not vertically integrate into that activity. A) flexibility-based explanation B) opportunism-based explanation C) firm capability explanation D) opportunity-based explanation
C) firm capability explanation
If Digipics were to begin selling the cameras it assembled directly to customers through a website operated by the company, this would be an example of A) backward vertical integration. B) a strategic alliance. C) forward vertical integration. D) opportunism.
C) forward vertical integration.
TerraLoc is most likely to use the ________ organizational structure. A) matrix B) product-based multidivisional C) functional D) geography-based multidivisional
C) functional
Which committee in a U-form organization meets monthly and usually consists of the CEO and each of the heads of the functional areas included in a firm? A) executive committee B) functional committee C) operations committee D) managerial committee
C) operations committee
A firm is likely to be among the first in its industry to vertically disintegrate an exchange when A) the firm concludes that the level of specific investment required to manage an economic exchange is high. B) the firm believes that the exchange is costly to imitate. C) the level of uncertainty about the value of an exchange has increased. D) the firm believes that the exchange is rare.
C) the level of uncertainty about the value of an exchange has increased.
The number of steps in a firm's value chain that it accomplishes within its boundaries describes the firm's level of A) product differentiation. B) diversification. C) vertical integration. D) competitive dynamics.
C) vertical integration.
If Dell computers were to open its own factory to manufacture the LCD televisions it sells at its online store, this would be an example of A) forward vertical integration. B) product differentiation. C) forward horizontal integration. D) backward vertical integration.
D) backward vertical integration.
If Brenda Thompson, Tom Mix's supervisor, wanted to use a budgeting process to help evaluate Tom's performance but wanted to ensure that using a budget did not encourage Tom to focus on short-term behaviors at the expense of long-term results, she should A) develop the budget herself using realistic goals based on the economic reality facing Tom's function and use both quantitative and qualitative evaluations of the performance of Tom's function and then give the budget to Tom to follow. B) work with Tom in an open and participative process to develop the budget based on the most optimistic scenario possible and use both quantitative and qualitative evaluations of the performance of Tom's function. C) develop the budget herself based on the most pessimistic scenario possible and use both quantitative and qualitative evaluations of the performance of Tom's function and then give the budget to Tom to follow. D) work with Tom in an open and participative process to develop the budget based on the economic reality facing Tom's function and use both quantitative and qualitative evaluations of the performance of Tom's function.
D) work with Tom in an open and participative process to develop the budget based on the economic reality facing Tom's function and use both quantitative and qualitative evaluations of the performance of Tom's function.
A firm engages in backward vertical integration when it incorporates more stages of the value chain within its boundaries and those stages bring it closer to gaining access to raw materials.
TRUE
The use of budgets in a vertically integrated U-form organization can lead functional managers to overemphasize short-term behavior that is easy to measure and underemphasize longer-term behavior that is more difficult to measure.
TRUE
Transaction-specific investments make parties to an exchange vulnerable to opportunism, and vertical integration solves this vulnerability problem.
TRUE
Discuss the firm capabilities-based explanation of how vertical integration can create value. In your discussion identify the two broad implications of this approach and when, under this approach, firms should engage in vertical integration.
The capabilities-based explanation of how vertical integration can create value focuses on firm capabilities and their ability to generate sustained competitive advantages. This approach has two broad implications. First, it suggests that firms should vertically integrate into those business activities where they possess valuable, rare, and costly-to-imitate resources and capabilities. This way, firms can appropriate at least some of the profits that using these capabilities to exploit environmental opportunities will create. Second, this approach also suggests that firms should not vertically integrate into business activities where they do not possess the resources necessary to gain competitive advantages. Such vertical integration decisions would not be a source of profits to a firm since they do not possess any of the valuable, rare, or costly-to-imitate resources needed to gain competitive advantages in these business activities. Indeed, to the extent that some other firms have competitive advantages in these business activities, vertically integrating into them could put a firm at a competitive disadvantage. Under this approach, a firm should pursue vertical integration into an activity when it has valuable, rare, and costly-to-imitate resources in a business activity, vertically integrate into that activity. If a firm does not have valuable, rare, and costly-to-imitate resources in a business activity and other firms already engaging in this activity do, the firm will find itself at a competitive disadvantage.
Define vertical integration and differentiate between forward vertical integration and backward vertical integration.
Vertical integration is a corporate strategy. A firm's level of vertical integration is simply the number of steps in this value chain that a firm accomplishes within its boundaries. More vertically integrated firms accomplish more stages of the value chain within their boundaries than less vertically integrated firms. Less vertically integrated firms accomplish fewer stages of the value chain within their boundaries than more vertically integrated firms. A firm engages in backward vertical integration when it incorporates more stages of the value chain within its boundaries and those stages bring a firm closer to the beginning of the value chain, i.e., closer to gaining access to raw materials. A firm engages in forward vertical integration when it incorporates more stages of the value chain within its boundaries and those stages bring a firm closer to the end of the value chain, i.e., closer to interacting directly with final customers.
Discuss the flexibility-based explanation of vertical integration. In discussing this explanation be sure to define flexibility, the role of uncertainty in this explanation, and identify when, under this explanation, firms should engage in vertical integration.
The flexibility-based explanation of vertical integration focuses on the impact of vertical integration on a firm's flexibility. Flexibility refers to how costly it is for a firm to alter its strategic and organizational decisions. Flexibility is high when the cost of changing strategic choices is low; flexibility is low when the cost of changing strategic choices is high. In general, vertical integration reduces flexibility since it has committed its organizational structure, its management controls, and its compensation policies to a particular vertically integrated way of doing business. When a decision-making environment is uncertain, that is when the future value of an exchange cannot be known; when investments in that exchange are being made, the value of vertical integration is decreased and should be avoided.
Identify the organizational structure that is used to implement a vertical integration strategy and why from a CEO's perspective coordinating functional specialists to implement a vertical integration strategy almost always involves conflict resolution and how this conflict can be resolved.
The organizational structure that is used to implement a cost-leadership and product-differentiation strategy, the functional or U-form structure, is also used to implement a vertical integration strategy. Indeed, each of the exchanges included within the boundaries of a firm as a result of vertical integration decisions are incorporated into one of the functions in a functional organizational structure. From a CEO's perspective, coordinating functional specialists to implement a vertical integration strategy almost always involves conflict resolution. Conflicts among functional managers in a U-form organization are both expected and normal. Indeed, if there is no conflict among certain functional managers in a U-form organization, then some of these managers probably are not doing their jobs. The task facing the CEO is not to pretend this conflict does not exist, or to ignore it, but to manage it in a way that facilitates strategy implementation. The CEO's job is to help resolve conflicts in ways that facilitate the implementation of the firm's strategy. Functional managers do not have to "like" each other. However, if a firm's vertical integration strategy is correct, the reason that a function has been included within the boundaries of a firm is that this decision creates value for the firm. Allowing functional conflicts to get in the way of taking advantage of each of the functions within a firm's boundaries can destroy this potential value.
Identify three reasons why a firm may be able to create value through vertical integration when most of its competitors are not able to create value through vertical integration.
There are at least three reasons why vertical integration can be rare. First, a firm may have developed a new technology or a new approach to doing business that requires its business partners to make substantial transaction-specific investments. Firms that engage in these activities will find it in their self-interest to vertically integrate, while firms that have not engaged in these activities will not find it in their self-interest to vertically integrate. If these activities are rare and costly to imitate, they can be a source of competitive advantage for a vertically integrating firm. Second, a firm may have unusual skills or capabilities. If these skills or capabilities are valuable and rare, then vertically integrating into businesses that exploit these capabilities can enable a firm to gain at least a temporary competitive advantage. Finally, a firm may be able to gain an advantage from vertically integrating when it resolves some uncertainty it faces sooner than its competition. In this situation, the firm no longer needs to retain the flexibility and can gain some of the advantages of vertical integration sooner than its competitors and can gain at least a temporary competitive advantage.
Identify the three fundamental explanations of how vertical integration can create value and discuss how value is created under each.
There are three explanations of how firms can create value through vertical integration: a. Opportunism-Based Explanation: Reducing opportunistic threats from a firm's buyers and suppliers due to any transaction specific investments it may have made. b. Capabilities-Based Explanation: By enabling a firm to exploit its valuable, rare, and costly-to-imitate resources and capabilities. c. Flexibility-Based Explanation: When the decision-making environment is uncertain, firms create value by engaging in vertical integration. Under high uncertainty vertical integration can commit a firm to a costly-to-reverse course of action and the flexibility of a non-vertically integrated may be preferred.
