ECONOMICS OF VERTICAL INTEGRATION
 

 

 

 

 

 

 

 

 

 

 

 

As markets and technologies change more and more rapidly, organizations must respond quickly and frequently to strategic moves if they are to sustain competitive advantage. Although corporations have learned to make changes in strategy quickly, their organizations may lack parallel market responsiveness. One major reason for this failure is the conflict between scale economics, which is geared to the expansion and aggregation of resources, and the economics of vertical integration, which links differentiated functions and resources for maximum efficiency in responding to market changes. The opposing pressures fueling this conflict are both subtle and complex. On one side of the equation are all the forces contributing to the need to reap maxi- mum scale advantage. On the other side of the equation, the accelerated pace of change—environmental, competitive, and technological—drives corporations toward increased flexibility, high levels of internal integration, and smaller oper- ating units.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management has basically three options for resolving the conflict between scale and integration. First, a company can choose to centralize its functions in order to achieve scale at the expense of market responsiveness. Second, it can opt for market responsiveness over scale; that is, it can emphasize small, inde- pendent units. Third, it can adopt another, more difficult approach, exploiting the strengths associated with both large and small organizational units to achieve benefits of scale and market responsiveness simultaneously. The key to sustainable competitive advantage lies in successful pursuit of the third alternative. Exploiting the benefits of both large and small organizational structures involves creating market-responsive units within a framework of shared resources. Such units can combine the strengths of a small company (lean, entrepreneurial management; sharp focus on the business; immediacy of the relationship with the customer; dedication to growth; and action-oriented viewpoint) with those of the large company (extensive financial information and resources; availability of mul- tiple technologies; recognition as an established business; people with diverse skills to draw on; and an intimate knowledge of markets and functions).