Question

5.         JayCo has been asked to build bumper for Ford Explorers. To manufacturer these bumpers, JayCo will have to build a factory that costs $10 million. The marginal cost of producing each bumper is $100. Ford has agreed to pay $300 for each bumper and has an order for 60,000 bumpers.

            

Suppose that once the factory is built, JayCo can modify the assembly line at a cost of $1 million and produce a generic bumper that can be used as a replacement for Chevy truck bumpers. The marginal cost of each bumper is $100 and Chevy would be willing to buy 50,000 of these bumpers for $200 each.

b.         What is the quasi-rent? What does it mean? (3 points)

c.         Offer a scenario whereby Ford holds up Jayco. (2 points)

d.         Can JayCo hold up Ford? Why? (2 points)

e.         How does the potential for holdup affect the decision to vertically integrate? (6 points)

Answer 1

b.

Quasi rent is a temporary phenomenon, where in the owner of a particular asset can utilize it to gain economically for a short period of time. For example, consider a situation where you are a seller of face masks. Suddenly because of COVID 19, there would be a sudden increase for this good, which will only be temporary. However, you would be gaining more economically during this period of time. This temporary economic gain is called as Quasi - rent.

c.

Consider the scenario where JayCo has invested $10 million and built a factory. Their factory can produce bumpers only for Ford Explorers and Ford is aware of this fact. Now Ford also knows that there are other suppliers out there who have the capability to build the bumper, whenever they need it. This would lead to Ford exerting more power in the relationship since JayCo has already invested a significant amount in the factory. Now, Ford can hold up JayCo by threatening to go with some other supplier for their bumpers, if JayCo does not reduce the price of their bumpers.

d.

JayCo can also hold up Ford Co. Consider the situation where Ford is expecting a lot of sales for the Ford Explorer in the near future and have chosen JayCo as their exclusive bumper supplier and are counting on them to deliver the bumpers soon. In this situation, JayCo has more power in the relationship, at least temporarily, and can use this to renegotiate and increase the prices of bumpers.

e.

The potential for holdup effect can be one of the primary reasons because of which a firm might decide to vertically integrate. Vertical integration would ensure that the other firm is also under the control of the buying firm and thus creates higher flexiblity, thereby reducing the possiblity of a hold up. For example, in this scenario, Ford might decide to vertically integrate and start manufacturing the bumpers themselves. This would ensure that the manufacturing of bumpers is totally under their control and there would not be any hold up from their own subsidiary.