Abstract
In vertical integration literature, the two processes leading to vertical integration, namely, (1) self-expansion of the scope of activities based on internal capabilities and (2) internalization of activities with external capabilities have not been distinguished. However, using internal capabilities or incorporating external capabilities is an alternative decision for managers and distinguishing them is crucial in practice. The purpose of this study is to distinguish self-expansion separated from internalization and to explain systematically when they likely occur. This study develops a unique vertical integration model by integrating transaction cost economics and the capability approach. With the model, we systematically analyzed the occurrence of (1) self-expansion and (2) internalization. Results reveal that the firm prefers self-expansion to internalization if it is easy to build the capabilities internally or difficult to procure them from outside the firm and if the costs of acquiring a firm or business with the required capabilities or the governance costs of the activities with external capabilities are high and vice versa. Our model leads to more understanding of vertical integration.
Highlights
Vertical integration, under which the control rights of sequential production activities are integrated in the firm (Perry 1989; Lafontaine and Slade 2007), has attracted a great deal of academic and practical interest
The vertical integration literature has not distinguished the two processes leading to vertical integration, namely, (1) self-expansion of the scope of activities based on internal capabilities and (2) internalization of activities with external capabilities
We discuss the results of our analysis of when self-expansion or inIn this section, we discuss the results of our analysis of when self-expansion or interternalization likely occurs, respectively, based on the integrated model of the transaction cost economics (TCE) and nalization likely occurs, respectively, based on the integrated model of the TCE and capacapability approaches
Summary
Under which the control rights of sequential production activities are integrated in the firm (Perry 1989; Lafontaine and Slade 2007), has attracted a great deal of academic and practical interest. The vertical integration literature has not distinguished the two processes leading to vertical integration, namely, (1) self-expansion of the scope of activities based on internal capabilities and (2) internalization of activities with external capabilities. Self-expansion is defined as expanding the scope of activities mainly by using the capabilities built internally, regardless of utilizing internal resources (such as human resources) or external ones. Internalization is to undertake a new activity mainly by using the external capabilities incorporated, regardless of the ways of incorporation (such as the acquisition of a firm or business or a merger)
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