November 30, 2009
Bainbridge on Vertical Integration
Posted by Gordon Smith

I was talking about conglomeration (horizontal integration) today in class ... then returned to my email to find Steve Bainbridge's post describing differences between horizontal and vertical integration. Inspired by this W$J article, Steve wonders whether recent moves toward vertical integration mean that George Geis was wrong about outsourcing or whether outsourcing is a management fad. 

My impressionistic take, for what it's worth: George was right about outsourcing, and outsourcing is not a fad. Outsourcing still makes sense in some contexts. As noted in the W$J article:

In the past two years, Boeing bought a factory and a 50% stake in a joint venture that make parts for its troubled 787 Dreamliner jet. The moves partially reversed Boeing's aggressive outsourcing strategy to assemble the Dreamliner from parts made by hundreds of suppliers. Supply and assembly problems have knocked the Dreamliner more than two years behind schedule. Boeing CEO Jim McNerney says the company is still committed to outsourcing.

I don't see any reason to privilege one form of organization over the other in all circumstances. Even if transaction costs were the only motivator of organizational structure -- or perhaps I should say, especially if transaction costs were the only motivator of organizational structure -- we would still expect some institutional diversity to account for different frictions in different contexts.

Oh, and just in case you forgot, transaction costs are not the only motivator of organizational structure.

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