Limits of vertical integration and firm size: Concluding Remarks

Internal organization ought to be regarded as a syndrome of charac- teristics: distinctive strengths and distinctive weaknesses, in a comparative institutional sense, appear nonseparably — albeit in variable proportions — as a package. Although the existence of market failure constitutes a pre- sumptive basis for internalizing transactions, the “defects” associated with market exchange may need to exceed a nontrivial threshold before internal organization offers a clear cost advantage.

The difficult cases, of course, are those where markets experience defects of intermediate proportions. An examination of the frictions of both market and organizational types is then indicated, but the current state of the art hardly permits a refined net evaluation to be made. An appreciation for the organizational failures to which vertical integration80 and radial expansion are subject should, at the least, counsel caution in making firm versus market choices.

The distortion propensities of internal organization are especially notable. This holds both with respect to integrating the incremental trans- actions, where a variety of subgoal related distortions are brought into play, and firm size, where the motivation of both leaders and followers may be impaired. The incentive and disincentive properties of the employment relation both have to be considered. As March and Simon have observed, in a related context, the argument for decentralization (markets) has been eviscerated in recent welfare theory by the neglect of motivation (1958, p. 203).

A special qualification mentioned at the outset concerns the matter of organization form. This issue is developed more extensively in Chapters 8 and 9, which follow. Suffice it to observe here that some of the transactional limitations of internal organization can be mitigated if the firm is expanded not in a radial expansion manner but rather along multidivisional lines.

Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.

Leave a Reply

Your email address will not be published. Required fields are marked *