BESANKO The Vertical Boundaries of The Firm
BESANKO The Vertical Boundaries of The Firm
BESANKO The Vertical Boundaries of The Firm
Fifth Edition
Besanko, Dranove, Shanley and Schaefer
Chapter 5
length transactions
Long term contracts
Strategic alliances and joint ventures
Parent/subsidiary relationship
Activity performed internally
Make-or-Buy Continuum
Defining Boundaries
Firms need to define their vertical
boundaries.
Outside specialists who can perform vertical
chain tasks are market firms.
Market firms are often recognized leaders in
their field (Example: UPS).
Market Firms
Benefits of using market firms
Economies
advantages
Outsourcing an activity eliminates the cost of that activity
Making instead of buying captures the profit margin of the market
firms
Vertical integration insures against the risk of high input prices
Making ties up the distribution channel and denies access to the rivals
A firm may believe that a particular asset is a source of competitive
advantage
But if the asset is easily available in the market the belief regarding
competitive advantage will have to be reevaluated
Agency Costs
Agency costs are due to slacking by
Influence Costs
Performing a task in-house will lead to
influence costs.
Internal Capital Markets allocates scarce
capital within the firm
Allocations can be favorably affected by
influence activities
Resources consumed by influence activities
represent influence costs.
Role of Contracts
Firms often use contracts when certain
Contracts
Contracts protect each party to a
completeness of contracts
the body of contract law
Complete Contract
A complete contract stipulates what each
the contingency
observe the actions by the parties
impose the stated penalties for non-performance
Real life contracts are usually incomplete
contracts
Incomplete Contracts
Incomplete contracts involve some
ambiguities
They do not anticipate all possible
contingencies
They do not spell out rights and
responsibilities of parties completely
performance
Asymmetric information
Bounded Rationality
Individuals have limited capacity to
process
information
deal with complexity
pursue rational aims
Individuals cannot foresee all possible
contingencies
Asymmetric Information
Parties to the contract may not have equal
Coordination Problems
Coordination is especially important when
Transactions Costs
If the market mechanism improves
Transactions Costs
Costs incurred due to opportunistic
Transactions Costs
Sources of transactions costs
Investments
Relationship-Specific Assets
Relation-specific assets are assets essential
specificity
Physical asset specificity
Dedicated assets
Human asset specificity
Site Specificity
Assets may have to be located in close
Dedicated Assets
Some investments are made to satisfy a single
buyer, without whose business the investment
will not be profitable.
Ports
Fundamental Transformation
Prior to the investment in relationship specific
transaction
Redeploying to other uses is costly
Quasi rents become available to one party
and there is incentive for a holdup
Potential for holdups lead to
Underinvestment
in these assets
Investment in safeguards
Reduced trust
Double Marginalization
Vertical integration helps if both the