Vertical Integration
How easy or difficult is it to write contracts is informed by what
- Specificity of the assets involved in the transaction - uncertainty of the transaction - Frequency of the transaction The more difficult it is to write contracts pertaining to the management of an asset the more necessary or valuable it may be to vertically integrate (i.e. own) that asset.
Forward integration
entails a firm purchasing or creating a downstream operator in the supply chain (e.g. Apple opening its own chain of retail stores).
backward integration
entails a firm purchasing or creating an upstream supplier (e.g. Starbucks acquiring coffee plantations or Netflix getting into the development of original TV content).
How critical is the management of the asset, resource, or activity, to the creation and maintenance of competitive advantage is informed by
How critical is the management of the asset, resource, or activity, to the creation and maintenance of competitive advantage.
Two dimensions are critical for a vertical integration decision
How easy or difficult is it to write contracts How critical is the management of the asset, resource, or activity, to the creation and maintenance of competitive advantage.
Purpose and objective
It helps managers and practitioners make decisions about which assets and elements of a value chain a firm should own and which they can buy in from other firms.
Risks and limitations
Managements ability to properly understand and categorize the assets, resources, or activities within a supply chain or business activity system. Difficult to objectively evaluate the extent to which an asset, resource, or activity is central to competitive advantage and how to asses TCE. VI framework is tends to prompt strategic decisions based on current and historic data, rather than on how things may play out in the future.
Transaction frequency
the higher the frequency of transactions associated with an asset, resource or activity, the greater the chance of haggling over contracts every time firms transact, hence the greater the benefit for a firm in owing the asset, resource, or activity
Specificity of the assets
the more specific the assets involved in the transaction, the greater the chance that one party in the transaction may "hold up" the contract to extract value, hence writing a contract is more difficult and there is a higher benefit for a firm in owning the asset
Insight or value created
VI creates a systematic way for managers and practitioners to work through strategic decisions pertaining to firm scope. It gives them a means to evaluate carefully what a firm should own and what it might buy or source from the outside.
Uncertainty of the transaction
The higher the uncertainty of transactions associated with a transaction, the more difficult it is to write contracts allowing others to use or produce the asset, resource, or activity, the higher the benefit of owning it.
