vertical boundaries.pdf

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Economics for Management Studies
Victor Yu

The Vertical Boundaries of the Firm The production of any good or service usually requires a wide range of activities organized in a vertical chainProduction activities are said to flow from upstream suppliers of raw inputs to downstream manufacturers distributors and retailersActivities in the chain include processing and handling activities which are associated directly with the processing and distribution of inputs and outputs and professional support activities such as accounting and planningThis chapter intends to help the student understand how to answer some fundamental questions in strategy namely How do we define our firmWhat activities do we doWhat do we leave to the marketThis is known as the makeorbuy problemThe chapter presents several makeorbuy fallaciesYou should go over these and make sure that you understand eachThe solution to the makeorbuy decision depends on which decision leads to the most efficient productionThis is determined by assessing the benefits and costs of using the market and that of using the firmKeeping activities internally may lead to agency costs and influence costs but the firm may benefit if there are scale or scope economies or learning curve or if the firm has propriety knowledgeContracts may play a key role in whether or not market firms are used for productionGiven that contracts are typically incomplete if the firm has limited ability to specify performance or quality it might be best to insource rather than outsourceIn addition if the market firm has asymmetric information either r
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