Vertical Integration Essay

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Vertical Integration [pic] [pic] [pic] As Professor Yahooja explained, these graphs illustrate how big firms usually operate in different environments. In general, firms can choose between several growth “dimensions”: - Horizontal - Vertical - Geographic According to the scope of the firm – how many different things the company does – there are two possibilities: [pic] [pic] In the first graph, the whole firm becomes “multidivisional” – outputs of the first field of operation are inputs for the next one -, while in the second one, divisions work independently. The main advantage is that while in separate divisions there are separate Net Present Values (NPV(A) and NPV(B)), in multidivisional firms NPV(A+B) > NPV(A) + NPV(B) because of the existence of synergies. Differences arise also in terms of riskiness because if divisions are independent, they can operate without correlation between each other, rapidly adapting to the changing environment, while if the firm is multidivisional, what affects one division, will eventually influence the other. As a result, multidivisional companies are affected by higher potential risk. To understand what vertical integration is, it is necessary to start from the definition of production chain: all the necessary activities and operations to transform raw materials into finished products. However, these activities and operations also include those not regarding the physical transformation of the product such as transportation, distribution, promotions etc. Inside the chain, different companies specialize their selves in a specific phase of the production process, gaining competitive advantage (Hamel & Prahalad). According to Hirsch’s definition, "a vertically integrated firm is a single profit maximizing entity, in which a number of units, each performing

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