The Measurement and Determinants of Vertical Coordination: A Transactions Cost Approach

There is increased interest in vertical coordination as a more comprehensive industry structural variable than the traditional vertical integration measure. Vertical coordination includes not only vertical integration but all other vertical coordinating structures. Previous studies of vertical industrial organization did not examine the role of non-market exchange mechanisms outside the domain of vertical integration. The concept of a vertical coordination variable incorporating all coordinating structures bridges the gap in the dichotomy of market versus ownership coordination. There is an extensive literature examining the factors affecting vertical integration. More recently, attention has focussed on transactional inefficiencies as a primary motivation for vertical integration. However, little empirically has been done to examine the economic motivations for vertical coordination. This paper proposes an innovative measure of vertical coordination and examines the determining factors motivating the use of vertical coordinating structures. The vertical coordination measure incorporates product flow interdependencies between vertically related firms/industries plus coordinating structures utilized in the transfer of control. Coordinating structures examined include: 1) spot markets, 2) market specification contracts, 3) production management contracts, 4) resource providing contracts, and 5) integration. To explain the food industries' incidence of vertical coordination due to transactional inefficiencies, several industrial characteristics affecting transaction costs are examined. These factors include future demand growth and uncertainty, market power, product and technical differentiation, flow economies, and firm size and specialization. Based on four progressively comprehensive specifications of vertical coordination, the empirical analysis confirms the hypothesis that transaction costs are a primary motivation for vertical coordination. The most comprehensive vertical coordination measure incorporating product flow linkages and coordinating structures performed very well. The transaction cost factors most influential were those related to research and development, internal costs, flow economies, and input supplier concentration. Moreover, a comparison of the vertical coordination and vertical integration measures revealed the significance of the use of coordinating structures as a response to transactional inefficiencies.

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 Record created 2017-04-01, last modified 2018-01-23

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