Chapter 19 - Vertical Integration and Outsourcing

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Chapter 19 - Vertical Integration And Outsourcing

CHAPTER 19 VERTICAL INTEGRATION AND OUTSOURCING

CHAPTER SUMMARY This chapter analyzes the vertical boundaries of the firm. It begins by defining the vertical chain of production. The benefits of acquiring inputs through competitive markets (when they exist) is stressed. Reasons for nonmarket transactions (vertical integration and long-term contracting) are introduced. The choice between long-term contracts and vertical integration is analyzed with attention focused on the importance of firm-specific investment in affecting this decision. Other major topics include: choosing the length of a contract, contracting with distributors, and recent trends in outsourcing. The appendix provides a more detailed example of how ownership rights can affect investment incentives (in this case, investments in effort).

CHAPTER OUTLINE VERTICAL CHAIN OF PRODUCTION Managerial Application: Long-Term Contracts Managerial Application: Vertical Outsourcing by Taiwan Semiconductor Managerial Application: Outsourcing Logistics BENEFITS OF BUYING IN COMPETITIVE MARKETS Managerial Application: Merck and Astra—Joint Venture Managerial Application: Made in the USA REASONS FOR NONMARKET TRANSACTIONS Contracting Costs Firm-Specific Assets Managerial Application: Kodak-IBM Outsourcing Renewal Measuring Quality Controlling Externalities Extensive Coordination Market Power Managerial Application: Price Discrimination and Antitrust Law Taxes and Regulation Other Considerations VERTICAL INTEGRATION VERSUS LONG-TERM CONTRACTS Incomplete Contracting Ownership and Investment Incentives Managerial Application: Contracting Problems and Investment Incentives—Evidence from China Managerial Application: Renting and Asset Abuse Specific Assets and Vertical Integration Managerial Application: Owning versus Leasing Networks 19-1

Chapter 19 - Vertical Integration And Outsourcing

Managerial Application: Lease versus Buy Managerial Application: Vertical Integration in the Aerospace Industry Asset Ownership Other Reasons Continuum of Choice CONTRACT LENGTH Managerial Application: Short-Term Leases Managerial Application: Divorce between Outsourcing Partners CONTRACTING WITH DISTRIBUTORS Free-Rider Problems Advertising Provisions Managerial Application: Conflicts over Advertising Provisions Exclusive Territories Managerial Application: Conflicts over Exclusive Territories Academic Application: Company Ownership versus Franchising Double Markups Example Two-Part Pricing Quotas Regulatory Issues RECENT TRENDS IN OUTSOURCING Managerial Application: The Politics of International Outsourcing SUMMARY APPENDIX: OWNERSHIP RIGHTS AND INVESTMENT INCENTIVES Basic Problem Ideal Effort Choices Actual Effort Choices under the Contract Vertical Integration Optimal Organizational Choice

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Chapter 19 - Vertical Integration And Outsourcing

TEACHING THE CHAPTER This chapter builds on the profit-maximization analysis presented in Chapters 5 and 6, and the price-discrimination analysis of Chapter 7. The chapter begins by presenting the quantitative analysis of vertical integration but also includes numerous Managerial Applications that can be used to illustrate the key points and generate class discussion. Figure 19.5 provides a good summary of the factors that affect whether a firm obtains assets in the market or chooses to vertically integrate. Students should be quite interested in the section on outsourcing since it is a topic that is frequently in the news. The associated Managerial Application should generate good class discussion. The appendix presents additional coverage of the topic, including a final Analyzing Managerial Decisions scenario. The main concepts of the appendix should be accessible for all students, however those students with a more advanced mathematical background will be able to follow the quantitative analysis as well. There are only a few questions that allow students to practice the...
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