Decisions to Vertically Integrate in the Construction Industry

Topics: Economics, Transaction cost, Ronald Coase Pages: 9 (2175 words) Published: May 21, 2011
26 February 2011

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Assignment Question3


The construction industry & the division of labour3

Key Characteristics of Transaction Cost Economics3

The Vertical boundaries of the firm3

Vertically integrated firms3

Vertical boundaries3

Defining the boundaries3


Assignment Question

Identify the key characteristics of TCE.

Analyse the vertical boundaries of a firm by describing the critical role played by coordination in a vertical chain.

Use the issue tree in Figure 5.4 pp144 of Besanko as a guide to your reply.


In a time of uncertainty; the construction industry which has in the past been widely criticised for its lack of trust, inefficiency and instability are leaving clients with little choice but to vertically integrate some of the functions that has previously been bought through the market.

This was evident in a current article in the Building magazine which recorded the following:

Fears are growing that housing associations are looking to take their repairs and maintenance work back in house in response to the collapses of Rok and Connaught and the rise in VAT.

The concerns come after housing association L&Q became the latest to launch a contracting arm last week. Other housing associations reliant on Connaught or Rok have set up in-house contracting arms, called Direct Labour Organisations (DLOs), using staff made redundant when the firms collapsed.

Analysts say the move to DLOs is being driven by clients worried about maintenance contractors going bust, and by the rise in VAT to 20% in January, which means in-house operations could generate 20% savings.

Chris Durkin, chief executive of Willmott Dixon support services, said: “A number have been forced to go in-house, a number have considered it, and I think some probably will. But they’ve got to do it with their eyes wide open.” (Gardener, 2011)

The biggest so far is Liverpool-based association One Vision, which has set up a 100-strong arm, One Vision Housing Property Services, to do maintenance work after its sole contractor, Connaught, collapsed.

Somerset-based housing association Knightstone said in January it was setting up a company to service its 1,800 tenants from ex-Rok employees.

Jeffrey Adams, chief executive of housing contractor United House, said: “Some housing associations are setting up their own building companies. The question is whether they’ll be able to manage them.”

Housing associations are also asking contractors for more proof of financial stability, as well as considering breaking contracts up into smaller parts.

Mike Brogan, director of housing association procurement consortium Procure Plus, said some clients had asked him to find ways of sourcing building and repairs work. .” (Gardener, 2011)

In this assignment we will explore the principles of transactional cost economics and try and explore the reasons for clients to vertically integrate construction skills previous acquired through the market.

The construction industry & the division of labour

In the first sentence of An Inquiry into the Nature and Causes of the Wealth of Nations (Smith, 1776) foresaw the essence of industrialism by determining that division of labour represents a qualitative increase in productivity. His example was the making of pins. The specialisation and concentration of the workers on their single subtasks often leads to greater skill and greater productivity on their particular subtasks than would be achieved by the same number of workers each carrying out the original broad task.

Smith saw the importance of matching skills with equipment - usually in the context of an organisation. For example, pin makers were organized with one...
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