C G C G 5 Following Williamson’s notation. 6
k k ˆ k Figure 1. Comparative production and governance costs Source: Williamson 1985, p. 93 The result G C k k M ) ( ) ( is depicted in Figure 1. We can review three situations: 1. 0 ) ( ) ( G C k k M The difference in total costs G C lies above the horizontal access, which implies that the firm would achieve a greater profit by buying the item from the market rather than producing it. What we observe in this case is that the firm’s profit is a direct function of asset specificity where for low values of asset specificity below a critical value k ˆ buying the item promises greater returns than making it in the make-or-buy decision. 2. 0 ) ( ) ( G C k k M This is the point of indifference where some particular asset specificity k ˆ yields the same profits within and outside the firm. It is irrelevant to the firm which mode of procuring the item it would choose – to make or to buy it. 3. 0 ) ( ) ( G C k k M For a very high asset specificity where actual asset specificity exceeds the critical value k ˆ the profit of making the item exceeds that of buying it on the market. Profitability of producing to one’s own requirements increases with asset specificity, while that of buying from the market decreases. We can demonstrate the effect of asset specificity on individual profits with the help of differentiation 0 k M k C k M M As both partial derivatives on the right are positive, profitability of obtaining the item through the market falls with the increase in asset specificity. Asset specificity does not favor market procurement. 0 k k C k 7
The effect of asset specificity on the profit of producing the item is positive which implies that asset specificity favors own production. This conclusion follows from the fact that the two partial derivatives on the right are negative. As an industry matures, the uncertainty in it decreases and the benefits that accrue to vertical integration presumably decline. This means that vertical integration would mostly be observed in relatively new industries and in sectors producing new products. Thus, the emerging pharmaceutical sector in Bulgaria appears to be a good host for vertical integration. Larger firms will be more integrated into components than smaller ones, ceteris paribus . A multidivisional form firm will be more integrated than a unitary form firm, ceteris paribus . Integration of peripheral activities includes backward integration into basic materials, lateral integration into components and forward integration into distribution. Forward integration into wholesaling is observed for products that need coordination of marketing and distribution, where branding is practiced or products require special handling. For products and industries where product differentiation is
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