Question

How will investment externalities influence a firm’s choice to vertically integrate or disintegrate? Explain your answer. 300 words please

Answer 1

Answer- Vertical Integration can be backward (when the firm move to the producing/manufacturing side) and forward (when the firm move towards customers). The decision whether to move backwards or forward or to hold all the chain totally depends on the objectives of the firm. Now when firm decide to indulge in vertical integration, it has many investment options but the ambiguity is that whether these available options will results in the desired benefits or these will be just costs, or the tradeoff between benefit and cost will not be maintained properly, we call this in other words investment externalities. Investment externalities affect the decision of the firm as the firm before selecting investment opportunities for vertical integration have to do a deep cost and benefit (for short and long term) analysis through which the firms decide that to opt the integration or not. On the other hand for a firm who has already done integration, investment externalities will make the firm think about whether it is still providing benefits as per the requirements or not, by analysing this with the help of investment externalities and take the decision to disintegrate or not. We can say that firm who opt backward integration are looking for reduced cost and the firm who are looking for forward integration are interested in more profits. For backward integration, investment externalities shows that whether the investment will be able to reduce the cost and in the case of forward integration, investment externalities shows that whether the investment will leads to more profits or not.