Vertical Integrations and Outsourcing

Firms often find that it is more easier and economical to coordinate transactions between internal organization units as compared to coordinating transactions between a series of suppliers. Vertical Integrations represent a decision by firms to utilize internal transactions rather than market transactions in fulfilling their economic objectives.

Benefits of Vertical Integrations:

1. Enhance Economies of Integrations
2. Access to Technology
3. Enhance Differentiation Ability
4. Increase Entry and Mobility Barrier
5. Entry into More Profitable Businesses
6. Reduce Suppliers' Bargaining Power
7. Reduce Risks of Opportunism by Suppliers'

Pitfalls of Vertical Integrations:

1. Increase in Operating Leverage
2. Reduce the Flexibility to Change Partners
3. Higher Capital Investment Requirements
4. Reduce Access to Suppliers Know-How and Technology
5. Higher Exit Barriers
6. Increase in the Cost of Overcoming Mobility Barrier
7. Increase Dependency of Managerial Capability to Innovate

Outsourcing is the opposite of Vertical Integrations. Outsourcing promotes firms to intelligently use external suppliers for products and/or services rather than building internal production units for products and/or services that are not core to the firms long term objectives and plans.

Outsourcing Definition

Outsourcing can be defined as sourcing for products and/or services that either used to be done internally or can be done internally, from an external supplier or several external suppliers.

There are many variances of outsourcing. Some of the more popular variances include:

1. Strategic Outsourcing
2. Offshoring
3. Business Process Outsourcing

Regardless of the type of outsourcing, the basic idea remains the same, which is to source for products and/or services that either used to be done internally or can be done internally, from an external supplier or several external suppliers.