marketfailures final

7/28/2019 Marketfailures Final

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Market FailuresUsing Vertical Integration to prevent


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Market Failures

Why do deals between two parties not come through?

Contracts

Long term relationships

in a dynamic setting

Relationship-specific

investments

Unclear property rights

Captive power plants

Enforcing contracts and

property rights

Information disparity

between buyer and

seller

True Value, First Choice

T R A N S A C T I O N C O S T S


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Vertical Integration The degree to which a firm owns its upstream

suppliers and its downstream buyers is

referred to as vertical integration.

Why do deals between two parties not come through?

^

One party


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Types of Vertical Integration

Raw Materials

IntermediateManufacturing

Assembly

Distribution

End Customer

Raw Materials


Assembly

Distribution

End Customer

Raw Materials


Assembly

Distribution

End Customer

No Integration Forward Integration Backward Integration


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Why Vertical Integration?

TransactionCosts

Relationship-specific

assets

Propertyrights

Informationflows


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American Apparelan Industrial Revolution

2005 - World's fastest growing companyinUS, 440% 3-year growth

2005 - Marketerof the Year

2008 - Retailerof the Year

2008 - Top 2nd trendsetting brandafter Nike

Retail sales of$341 million in 2008, a 62%

increase over 2007

One of the few companies to export "Made inUSA goods

Sweatshop Free" goods


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Designing

Fabric

Storage


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1990 Wholesale -> Retail

1997 Acquiring sub-contractors

2000 Single 800,000 sq. feet building in Los

Angeles, California

2008 Took over US Dyeing and Finishing Inc.

2009 200 self-operated stores across the

world, no franchise

Owns subsidiary in US to replenish stores


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O t h e r B e n e f i t s

Synchronization of supply and demand along the chain of products

Provide more opportunities to differentiate by means of increasedcontrol over inputs

Capture upstream or downstream profit margins

Gain access to downstream distribution channels that otherwisewould be inaccessible

Facilitate investment in highly specialized assets in which upstreamor downstream players may be reluctant to invest

Lead to expansion of core competencies

Ability to monopolize market throughout the chain by marketforeclosure

Increase entry barriers to potential competitors, for example, if thefirm can gain sole access to a scarce resource


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I s s u e s w i t h V e r t i c a l I n t e g r a t i o n

Capacity balancing issues. For example, the firm may need to

build excess upstream capacity to ensure that its downstream

operations have sufficient supply under all demand conditions

Potentially higher costs due to low efficiencies resulting from

lack of supplier competition

Decreased ability to increase product variety if significant in-

house development is required

Developing new core competencies may compromise existing

competencies.

Increased bureaucratic costs


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When to vertical ly integrate?

Can derive benefits from

economies of scale

Strategic similarity between

vertically related activities

Regulations /Tax on market

transactions, other obstacles

Investments by other firmstowards the activities

Create unnecessary

competition with partners

I N T E G R A T E DON T

I N T E G R A T E

YES NO

YES

Related core

competencies

NO

Different core

competencies

VERY HIGH MANAGEABLE

RELUCTANCE WILLINGNESS

NO YES


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S u m m a r y

Deals between two parties in a market fail

because of various transaction costs

Vertical integration minimizes the number of

deals between two separate parties hence

reduces/removes transaction costs

However, vertical integration can be applied

only after looking at suitable factors

marketfailures final

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