– Examples • Local baker buys flour • Independent restaurant outsources payroll • Can company buys aluminum • Disney might outsource running hotels
46 Economies of scale and scope • Economies of scope are less common in vertical relationships than horizontal – Sharing of brand / reputation less important – Technology and skills likely to be different – Examples • Steel and automobiles • Making movies and running movie theaters
47 Empirical evidence on vertical integration • Most studies find that observed vertical integration is efficiency-enhancing – Little evidence that it increases market power • Strong evidence that vertical integration is more likely when potential hold-up problems are big – “Design-specificity” in airline components predicts vertical integration – Inputs which are “complex” or require intensive coordination more likely to be produced in-house • Technology can change what contracts are optimal – Long-haul trucking was mainly owner-operated – Onboard computers made monitoring much easier, lead to less independent contracting and larger trucking firms
Testing the logic What do you think of the following scenarios? • A car company integrates into steel production to eliminate fluctuation in its input prices • The Gap opens its own factory to dye fabric to ensure consistency in its colors • Dell should merge with Intel to reduce supplier power • Coke should own a can company so it will locate close to its major bottling plant • Husky should produce its most critical components in-house so it can maintain strict quality control 48
Vertical Restraints 49
50 Alternatives to vertical integration • Even if you add all the pieces up and find that integration creates value on net, you need to ask: Can we capture the same benefits by means other than integration ? – Contracts – Alliances – Licensing – Joint ventures
51 Vertical restrictions to reduce free-riding downstream • Suppose beer brewer has concerns that distributors will – Under-invest in promoting the brand – Aggressively steal market share from each other • Solutions – Exclusive territories
52 Vertical restrictions to reduce free-riding downstream • Suppose Toyota dealer invests in showroom, coffee, test drives, sales effort • Consumers test drive at dealer and then buy at a discount online • Toyota is worried that if this continues dealers will stop exerting effort promoting cars • Solution – Resale price maintenance – Dealer licensing
53 Vertical restrictions to reduce free-riding upstream • Suppose an insurance agent sells policies for two insurance companies • Suppose the insurance companies have customer lists that the agent could use to increase sales • Company 1 is worried that its list would also be used to increase sales for company 2 • Solution – Exclusive dealing arrangements
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- Fall '15