Vertically Integrated Chain Essay ⋆ Business Essay Examples ⋆ EssayEmpire

A vertically integrated chain represents a series of make or buy decisions made by firms, beginning with raw materials and manufacturing (backward integration) and moving forward to distribution and marketing (forward integration). To this end, a firm may build or buy a wholly owned subsidiary, secure a minority shareholding, or join in a formal or informal strategic alliance to provide a specific segment of its value chain anywhere in the world where costs are lower and access to consumer markets are closer. The anticipated end result is a higher ratio of value to cost at each stage of the value chain. The assessment of value versus cost is complex because host country market characteristics, trade barriers, attitude toward foreign direct investment, and some 27 other location advantages, many industry specific, will influence ultimate cost.

The vertically integrated chain represents trade creating as well as efficiency-seeking forms of foreign direct investment, reflecting both the rationalization of the operations of the multinational enterprise and the value chain specialization of affiliated companies in its internal and external network. While the vertically integrated chain increases intra-firm knowledge and goods flows, as well as the international exposure of the affiliates, in-depth, fine-grained analysis of location advantage factors is needed to understand exactly how location matters to the firm. It is important to understand the specific role given to or earned by affiliates in the company. They may act as “globally rationalized” subsidiaries performing a particular set of activities in the vertical chain or have a regional or world product mandate. John Cantwell argues that the vertically integrated chain increases intra-firm trade, building upon the location advantages benefiting each subsidiary, thereby leading to an increase of both intermediate goods trade and international production.

While traditional vertical integration has declined, vertically integrated chains have become more common as companies have begun to outsource critical elements of their business processes and sources of their supplies, whether through the minority investments and strategic alliances mentioned above or through contracts with outsource companies. The multitude of relationships needed to keep their businesses running and their customer needs satisfied compounds the firm’s business risks. While companies benefit from lower labor costs, their risks increase substantially because of the political and economic instability in some of these regions. Contracts among companies are also difficult to monitor when the companies operate in a continually evolving network.

It is not enough to create a culture within individual organizations. The challenge is to create a cross organizational culture in which the interests and the values of the partners coincide. In all forms of networks, the important managerial characteristics to be developed are trust and commitment as well as social norms of mutuality, solidarity, role integrity, harmonization of conflict, and restraint of power. As a result, constant monitoring of political and economic conditions in these regions must occur in addition to the regular risk metrics. Today, there is an increased focus on operations risks. In the United States, Sarbanes-Oxley has contributed to the focus by requiring senior managers and boards of directors to achieve a deep understanding of all significant financial/nonfinancial risks threatening their businesses.

Industries, as well as individual firms, may constitute vertically integrated chains. Technology, chemicals, and pharmaceuticals are three examples. In industries that constitute parts of a vertically integrated chain of system-compatible components, survival and success are not necessarily the result of superior performance, but may be determined by the possession and exercise of power to set the rules. A dominant integrated-system firm in the industry sets the rules under which potential competitors can enter and survive in the peripheral equipment and software markets. The critical rules are those that govern product design. The nature of these rules is determined by industry structure and, in particular, firm specialization or integration on the one hand and market concentration on the other hand. By introducing incompatibilities, large firms can impede rivals without having to suffer the losses of price cutting. Control of the rules of the game across the industry’s markets includes the power to regulate the rate, direction, timing, and source of commercially viable innovations. Control of product design standards also enables large leading firms to block the pioneering effort of rivals. Here, the problem is the oligopoly control of innovation by others, which in the case of developing countries may affect total national host country output as well as national economic growth.

Bibliography:

John Cantwell, “The Relationship Between International Trade and International Production,” in Surveys in International Trade, David Greenaway and L. Alan Winters, eds. (Blackwell, 1994);
Anthony J. Daboub and Jerry M. Calton, “Stakeholder Learning Dialogues: How to Preserve Ethical Responsibility in Networks,” Journal of Business Ethics (v.41, 2002);
John H. Dunning, “The Determinants of International Production,” Oxford Economic Papers (v.25/3, 1973);
John H. Dunning and G. Norman, “The Location Choice of Offices of International Companies,” Environment and Planning (v.19/5, 1987);
Naushad Forbes, From Followers to Leaders: Managing Technology and Innovation in Newly Industrialized Countries (Routledge, 2002);
Kathryn Rudie Harrigan, “Matching Vertical Integration Strategies to Competitive Conditions,” Strategic Management Journal (v.7/6,1986);
Alan M. Rugman, Multinationals and the Canada–United States Free Trade Agreement (University of South Carolina Press, 1990).

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