A DYNAMIC ANALYSIS OF THE VERTICAL INTEGRATION STRATEGY

                         BALAKRISHNAN, SRINIVASAN; PHD

                         THE UNIVERSITY OF MICHIGAN, 1983

                         BUSINESS ADMINISTRATION, GENERAL (0310)
 

                         A strategic issue faced by the firm is the extent to which it should vertically integrate to manufacture the
                         inputs for its products internally. Most theories of vertical integration approach the subject from a static
                         perspective. In this dissertation, we have attempted a theoretical and empirical analysis of the vertical
                         integration strategy of the firm, from a dynamic perspective. Our arguments for a dynamic analysis rest on
                         two premises: (a) strategy, by definition, relates to the future and future is almost always different from the
                         present and (b) strategic decisions imply resource commitments and few resource commitments, if any,
                         can be made or revoked without incurring some costs. A far-sighted firm, therefore, will base its vertical
                         integration decision, not only on the current market and technological conditions but also on the
                         anticipated changes in these conditions. In the theoretical part of the dissertation, we have developed
                         three dynamic models, based on the transaction cost approach, to analyse the effects of changes in the
                         market and technological conditions on the vertical integration strategy. With the firm facing non-trivial
                         adjustment costs, the optimal strategies of integration are derived, using mathematical optimal control
                         theory. The results reveal that the long-run sustainable configuration of the industry, the rate of
                         technology diffusion and the rate of innovation are crucial to the choice of the firm's vertical integration
                         strategy. In the remaining part of the dissertation, we have sought to examine the empirical implications of
                         our theory, by estimating somewhat simplified versions of our theoretical models. Both inter-temporal
                         and cross-sectional analysis were performed using published data. The results seem to establish the
                         three important implications of our theory: (1) the dynamics of changes in the market and technological
                         conditions are important in explaining the momentary differences in the levels of integration across
                         industries (2) the desirable level of integration in any industry depends on the potential or long-run
                         profitability of the industry (3) the desirable level of integration is further moderated by the frequency of
                         technological changes in the industry. The dissertation is concluded with a discussion on the possible
                         theoretical and empirical extensions.
 
 

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