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Technical Change, Competition and Vertical Integration

Technical Change, Competition and Vertical Integration. Srinivasan Balakrishnan and Birger Wernerfelt Strategic Management Journal, 1986. BADM545, Fall 3012; Prepared by: Hyunsun Kim. Introduction. Strategic perspectives Purpose: long-term profit maximization Premises Future-oriented

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Technical Change, Competition and Vertical Integration

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  1. Technical Change, Competition and Vertical Integration SrinivasanBalakrishnan and BirgerWernerfelt Strategic Management Journal, 1986 BADM545, Fall 3012; Prepared by: Hyunsun Kim

  2. Introduction • Strategic perspectives • Purpose: long-term profit maximization • Premises • Future-oriented • Commitment of resources, costly to revoke • Emphasis: implications of changes in technological conditions • Research question: • Why certain investments in the long run would be more attractive to integrated firms than to independent suppliers?

  3. Introduction • Previous literatures • Transaction cost economics: higher profits in the value-added chain -> greater performance for vertically integrated firms • Standard economics: specialized assets (skills) -> greater profits • Predictions regarding uncertainty • Uncertainty, in general, will lead to more vertical integration (Williamson, 1975) • Greater numbers of contingencies: greater costs for contracting • However, a particular uncertainty, the possibility of technological obsolescence, reverses the relationship • Single contingency, decreasing value of the investment

  4. A Simple Model • the optimal level of integration in an industry • increases with: transactional economies • decreases with: bureaucratic diseconomies, competition and technological instabilities • Optimal level of integration: v* • The firm’s greater market share (s) -> high v* • Higher technological instability (1/T) -> low v* • Industry profitability (r,p) -> high v* • Rewarding alternative investment (i)-> low v* • Bureaucratic costs(b) -> low v*

  5. Empirical Test • Unit of analysis: industry • Greater variances for market share (s) and technological instability (1/T) • Measures • Vertical integration • Vertical integration index (VI): the proportion of economic activities carried out within the firm (=value added/sales ratio) • Market share for a representative firm (s) • Minimum economic scale (MES): the average size of the largest firms in the industry which account for 50 percent of the total value of the industry shipment • The mean life of the process technology (T) • Average age (AVAGE) of plant and equipment in use • Data • 93 industries, FTC Annual Line of Business Reports, 1974-76

  6. Empirical Test • Estimation of cross-sectional model • Estimation of pooled model (1974, 75, 76)

  7. Conclusion • Results • The frequency of technical change negatively affects vertical integration, when competition is high • The optimal level of integration depends negatively on the degree of competition in the industry • Implications • Transaction cost economics for strategic analysis/strategic flexibility

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