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Description

Vertical Integration has long been a topic of continual interest and study among economists. Being a multi-dimensional concept, an explanation of vertical integration (VI) has been attempted over the ages through several theoretical models and measures, none of which have captured it in its entirety though several have highlighted and explained key aspects of VI. VI itself is of two types – forward integration where for example manufacturers / suppliers may expand the limits of their activities to include the distributors in markets / industries which enjoy large distributor power and margins or backwards integration where players downstream in the value chain move upwards to include e.g. manufacturing to gain access and control over some scarce resource / technology.
While several causes have been attributed to lead to VI, one of the most important one’s remains the transactional cost of business across the market. VI could also be a result of a strategy to improve the top line (i.e. command higher prices and hence improve margins) by creating or strengthening market position and power e.g. through establishment of oligopolies. Thus improving profitability, achieving efficient economies of scope / scale and improving market power are often are the driving forces behind VI. This has over time led to two schools of thought regarding VI – the ‘transactional cost economics’ (TCE) perspective and the ‘resource based view’ (RBV). While TCE focuses on market failures resulting from asset specificity as the main reason why firms choose to vertically integrate activities, it has also been argued that, when studying vertical integration, there is a need for theories that can explain the limits of firm size beyond the market failure argument and therefore, many researchers consider the resource-based view (RBV) a suitable perspective for this issue focussing on organizational resources and competencies. The RBV perspective emphasizes performance gains that result from assessing the internal capabilities and competencies that are important for understanding boundary decisions. (Gulbrandsen, B., Sandvik, K. and Haugland, Sven A, 2009).