Vertically Integrated Chain

A vertically integrated chain represents a series of make or buy decisions made by firms, beginning with raw materials and manufacturing (backward integration) and moving forward to distribution and marketing (forward integration). To this end, a firm may build or buy a wholly owned subsidiary, secure a minority shareholding, or join in a formal or informal strategic alliance to provide a specific segment of its value chain anywhere in the world where costs are lower and access to consumer markets are closer. The anticipated end result is a higher ratio of value to cost at each stage of the value chain. The assessment of value versus cost is complex because host country market characteristics, trade barriers, attitude toward foreign direct investment, and some 27 other location advantages, many industry specific, will influence ultimate cost.

The vertically integrated chain represents trade-creating as well as efficiency-seeking forms of foreign direct investment, reflecting both the rationalization of the operations of the multinational enterprise and the value chain specialization of affiliated companies in its internal and external network. While the vertically integrated chain increases intrafirm knowledge and goods flows, as well as the international exposure of the affiliates, in-depth, fine-grained analysis of location advantage factors is needed to understand exactly how location matters to the firm. It is important to understand the specific role given to or earned by affiliates in the company. They may act as “globally rationalized” subsidiaries performing a particular set of activities in the vertical chain or have a regional or world product mandate. John Cantwell argues that the vertically integrated chain increases intrafirm trade, building upon the location advantages benefiting each subsidiary, thereby leading [Page 1681]to an increase of both intermediate goods trade and international production.

While traditional vertical integration has declined, vertically integrated chains have become more common as companies have begun to outsource critical elements of their business processes and sources of their supplies, whether through the minority investments and strategic alliances mentioned above or through contracts with outsource companies. The multitude of relationships needed to keep their businesses running and their customer needs satisfied compounds the firm's business risks. While companies benefit from lower labor costs, their risks increase substantially because of the political and economic instability in some of these regions. Contracts among companies are also difficult to monitor when the companies operate in a continually evolving network.

It is not enough to create a culture within individual organizations. The challenge is to create a cross-organizational culture in which the interests and the values of the partners coincide. In all forms of networks, the important managerial characteristics to be developed are trust and commitment as well as social norms of mutuality, solidarity, role integrity, harmonization of conflict, and restraint of power. As a result, constant monitoring of political and economic conditions in these regions must occur in addition to the regular risk metrics. Today, there is an increased focus on operations risks. In the United States, Sar-banes-Oxley has contributed to the focus by requiring senior managers and boards of directors to achieve a deep understanding of all significant financial/nonfi-nancial risks threatening their businesses.

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