Backward vertical integration
Oliver Williamson has made important contribution to the field of economics of organizations. He developed a modern transaction cost economics and his research has been striving to explain why different types of relationships between firms occur. His early work described inefficiencies that arise in bilateral relationships, for example bargaining under asymmetric information (Williamson 1979). Later on he studied relationship-specific assets and hold-up situations. The concept of hold-up was developed by Klein, Crawford and Alchian in their paper Vertical Integration, Appropriable QuasiRents, and the Competitive Contracting Process from 1978. The idea of hold-up is that when one firm invests in a specific asset that another firm needs but that is of no use for the investing firm, the second firm has a strong bargaining position since the investing firm is depending on getting the investment into use and earning revenue from it. The second firm can therefore after the contract and the investment is made change the conditions of the contract and the investing firm are in no position to decline. There is thus, a risk of opportunism for the investing firm. Williamson (1985) showed that three transaction characteristics are critical for a firm: frequency, uncertainty, and asset specificity. Higher levels of frequency, uncertainty and degree of asset specificity will result in a more complex contracting situation for firms. Therefore a hierarchical relationship can be preferable since it will lower transaction cost, that is, the cost associated with an economic exchange. This can be done through a vertical integration of firms; there are two types of vertical integration backward vertical integration and forward vertical integration. The former is when a firm buys a company that produces inputs to the production of the firms final good and the latter is when a company acquires the distribution centers and retailers that...
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