Why Some Companies Are Re-embracing Vertical Integration
- December 15, 2017
- CBR - Economics
Using shipment records to assess companies’ stake in their own supply chain
The value a company places in sending a shipment to a business unit within its own parent company is equal to the value of shipping to an outside company - but only if the outside company is 60% closer than the sister business unit.
Among wholesalers and other goods distributers, the shipment distance to the outside company would have to be 46% closer.
Among manufacturers and other goods producers, it would have to be 70% closer.
Among manufacturers with lower tech investment, it would have to be 66% closer.
Among manufacturers with higher tech investment, it would have to be 81% closer.
Atalay et al., 2017
The researchers skirted these challenges by analyzing a US Census Bureau survey of shipments made by 35,000 multiunit companies in 2007—about 4 million domestic transactions in all. They used companies’ decisions about what to ship and to whom as a proxy for the value of keeping a transaction in-house. Because physical distance has been shown to depress transaction volumes, a company’s willingness to send internal shipments far demonstrates that its managers believe they are making up for the distance-related costs by reaping in-house benefits, the researchers reason. Measure the differences in transaction volumes, and you can put a value on these benefits, they argue.
Crunching the data reveals that the advantages perceived by company managers are significant: when companies were able to trade in-house, they were willing to send shipments farther—100 miles to every 60 miles for transactions with independent partners.
Managers in different industries put different values on the benefits of in-house transactions, the researchers find. In industries that ship bulky items such as timber, fertilizer, or animal feed, distance had a bigger impact on transaction volumes than common ownership between shipper and recipient. In industries with high levels of technology investment, groups were willing to send shipments 100 miles for in-house transactions for every 20 miles otherwise.
These figures might add to explanations of why tech leaders such as Google and Tesla are bucking the trend away from vertical integration. The search-engine giant is moving into smartphone manufacturing, and the maker of Tesla electric cars is buying into solar-panel production with its purchase of SolarCity.
Atalay, Li, Hortaçsu, and Syverson do not single out specific companies, but they did calculate the aggregate impact on the economy of vertical integration. They argue that real wages would be 0.2 percent lower in an environment without the advantages of in-house transactions boosting overall trade. Moreover, they say they believe their calculation understates the benefits measured here, reflecting their previous research demonstrating that companies that own multiple parts of a production chain see these benefits as just one small argument in favor of vertical integration.
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