Fafco Case

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Fafco Case

According to the Transaction Cost Theory, since there is a high level of uncertainty between Hercules and Fafco as well as problems renegotiating, Fafco should vertically integrate. The uncertainty is probably a result of the rapid growth Fafco is experiencing. This rapid growth is causing demand and volume uncertainty. As the technology available to design and manufacture the panels advances, there is also some technology uncertainty. These uncertainties combine to cause a renegotiating problem: Fafco doesn’t think Hercules will renegotiate the existing contract even with all the uncertainty. Hercules is also able to decrease the value to Fafco by producing panels outside the required specifications as well as missing delivery timetables which increase the relationship friction, exasperating the renegotiating problem. Three other important reasons for Fafco to vertically integrate the panel process is the control Hercules has over price, Fafco’s lack of investment decision for Hercules, and Fafco’s of lack of control over Hercules incentives. First, Fafco seems to be under the impression that Hercules will increase the price of the panels since the panels are of more importance to Fafco than Hercules. Basically, it appears the Hercules is balking at giving up its profits. Giving the fact that Hercules is willing to give up profits and since there are no other suppliers and the internal return for operations are higher, Fafco should vertically integrate. Second, the lack of control over investment decisions shows that Fafco should vertically integrate. The case paints a picture that Fafco has no input in the process and that Hercules is not doing any investments to help improve the quality and price of materials. Finally, Fafco has no control over incentives which is evident by the lack of quality panels being delivered and helps reinforce the fact that Fafco should vertically integrate to produce higher quality products. Finally, using the...
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