How Does Transaction Cost Economics Apply to Vertical Growth? to Concentric

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Examlex · Accepted Answer

The Answer is Transaction cost economics is especially applicable to the question of vertical growth versus outsourcing (i.e., the classic make-or-buy decision). It argues that vertical growth is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great. The transaction costs become too great when the transactions (a) involve a high level of uncertainty, (b) involve highly specialized assets, and (c) must occur frequently. However, when highly integrated firms become excessively large and bureaucratic, the costs of managing the internal transactions may become greater than simply purchasing the goods on the open market, thus justifying outsourcing over vertical growth.
The second part of the question is a "mind stretcher." Because the text does not apply transaction cost economics to either concentric or conglomerate diversification, this question really forces the student to do some original thinking. Transaction cost economics might suggest that diversification of any kind is more efficient than just concentrating in one industry when the costs of one firm's operating in two industries are lower than the summed costs of two separate firms. This phenomenon can occur when synergies exist to provide economies of scale or scope. Given that such synergies are more likely to exist when a firm engages in concentric diversification, transaction cost economics would propose that concentric diversification should be generally more efficient than conglomerate diversification. (Try this question out on your grad students to see what they can do with it!)

How Does Transaction Cost Economics Apply to Vertical Growth? to Concentric

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