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On synergies and vertical integration

  • Schmitz, Patrick W.
  • Sliwka, Dirk

We analyze in an incomplete contracts model whether a supplier should be integrated if in addition to his investment level he chooses the intensity of specialization towards the buyer's needs. A basic trade-off arises: While non-integration leads to higher investment incentives, potential synergies are foregone. Hence, integration can be optimal even though only the supplier makes an investment decision. This may also yield some insights for the discussion on which activities belong to a firm's core competencies. Furthermore, we show that if specialization is contractible, underspecialization will deliberately be chosen since investment incentives are thereby improved.

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Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 19 (2001)
Issue (Month): 8 (September)
Pages: 1281-1295

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Handle: RePEc:eee:indorg:v:19:y:2001:i:8:p:1281-1295
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  1. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  2. Che, Y.K. & Hausch, D.B., 1997. "Cooperative Investments and the Value of Contracting," Working papers 9714, Wisconsin Madison - Social Systems.
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  4. Williams, I., 1996. "Integration and investment specificity," Discussion Paper Series In Economics And Econometrics 9614, Economics Division, School of Social Sciences, University of Southampton.
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  11. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
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  14. Rosenkranz, Stephanie & Schmitz, Patrick W., 1999. "Know-how disclosure and incomplete contracts," MPRA Paper 12533, University Library of Munich, Germany.
  15. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
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  19. Moore, John, 1992. "The firm as a collection of assets," European Economic Review, Elsevier, vol. 36(2-3), pages 493-507, April.
  20. Holmstrom, Bengt & Tirole, Jean, 1991. "Transfer Pricing and Organizational Form," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(2), pages 201-28, Fall.
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