Monday, January 23, 2012

Vertical mergers: the "why" is not as clear as we thought

The "why" for vertical mergers just got more cloudy.  Vertical mergers are those that go up or down a firm's supply chain.  For instance buying your supplier or buying your customer.

The standard explanation for the "value added" by such a deal has been a reduction of transaction costs (negotiation, cost or reneging, etc) as well as control of a supply source and quality etc issues.  And they MAY still be the explanations, but they are at least drawn more into question by new findings from University of Chicago economists Hortacsu and Syverson  who examine where firms buy from and sell to (the flows of the article).  There finding?  More often than not even after a vertical acquisition the firm does not buy from nor sell to its new "relative".

From Bloomberg's BusinessClass article:

"If most vertically integrated companies aren’t supplying themselves, then why do they own production chains? It is harder to get a clear answer to this question from the data, but there are some clues to an explanation. Trying to understand why companies own production chains by looking at the way goods flow along the chain could be misleading. Instead, it might be the things we can’t see -- managerial oversight, marketing know-how, customer contacts, intellectual property, and other information- based capital -- that drive most vertical integration.

By integrating, companies can spread these types of capital over the production chain. Integrated firms appear to let the market and contracted suppliers handle most of the flow of tangible goods along the chain, while using control through ownership to apply the necessary intangible capital, which is by nature harder to write contracts over."

Ironically we covered vertical mergers TODAY in class. Guess I better update my notes.

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