A DYNAMIC ANALYSIS OF THE VERTICAL INTEGRATION STRATEGY
BALAKRISHNAN, SRINIVASAN; PHD
THE UNIVERSITY OF MICHIGAN, 1983
BUSINESS ADMINISTRATION, GENERAL (0310)
A strategic issue faced by the firm is the extent to which it should vertically
integrate to manufacture the
inputs for its products internally. Most theories of vertical integration approach
the subject from a static
perspective. In this dissertation, we have attempted a theoretical and empirical
analysis of the vertical
integration strategy of the firm, from a dynamic perspective. Our arguments
for a dynamic analysis rest on
two premises: (a) strategy, by definition, relates to the future and future
is almost always different from the
present and (b) strategic decisions imply resource commitments and few resource
commitments, if any,
can be made or revoked without incurring some costs. A far-sighted firm, therefore,
will base its vertical
integration decision, not only on the current market and technological conditions
but also on the
anticipated changes in these conditions. In the theoretical part of the dissertation,
we have developed
three dynamic models, based on the transaction cost approach, to analyse the
effects of changes in the
market and technological conditions on the vertical integration strategy. With
the firm facing non-trivial
adjustment costs, the optimal strategies of integration are derived, using mathematical
optimal control
theory. The results reveal that the long-run sustainable configuration of the
industry, the rate of
technology diffusion and the rate of innovation are crucial to the choice of
the firm's vertical integration
strategy. In the remaining part of the dissertation, we have sought to examine
the empirical implications of
our theory, by estimating somewhat simplified versions of our theoretical models.
Both inter-temporal
and cross-sectional analysis were performed using published data. The results
seem to establish the
three important implications of our theory: (1) the dynamics of changes in the
market and technological
conditions are important in explaining the momentary differences in the levels
of integration across
industries (2) the desirable level of integration in any industry depends on
the potential or long-run
profitability of the industry (3) the desirable level of integration is further
moderated by the frequency of
technological changes in the industry. The dissertation is concluded with a
discussion on the possible
theoretical and empirical extensions.
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