ECONOMIES OF INTEGRATION VERSUS BUREAUCRACY COSTS: DOES VERTICAL INTEGRATION IMPROVE PERFORMANCE?

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Abstract
This study tested links between vertical integration, cost structure, and performance at the line-of-business level of analysis. Major findings were (1) Vertical integration results in economies even after industry effects and economies of scope and scale are controlled. Vertically integrated lines of business economized on general and administrative, other selling, advertising, and R&D expenditures but had higher production costs and thus only marginally better profitability than nonintegrated lines of business in the same industry. (2) The higher production costs were linked to backward vertical integration, suggesting insulation from market pressures and lack of incentive to manufacture the lowest cost inputs. Forward vertical integration was associated with lower transaction-related costs. Thus, evidence of both efficiency effects and bureaucratic costs emerged, with the benefits of vertical integration slightly outweighing its costs.

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