Drivers of Vertical Integration

The second half of the 20th century was characterized by waves of vertical and horizontal integration that significantly changed the business landscape. A trend emerged towards ever larger companies that operate at multiple levels in the production chain to maximize their efficiency and profitability. The United States (US) Census Bureau reports that between 1998 and 2008, the number of firms with 10,000 or more employees increased by 10.7%. Over the same time period, the total number of paid employees in these firms increased by 17.2%. This shows that large businesses are not only becoming more frequent, but also grow in size over time. Vertical integration is one way for firms to expand their operations to multiple levels of the production chain. Integration is achieved commonly through either voluntary mergers between partner firms or forceful acquisitions of competitors. Since large scale mergers and acquisitions can have far reaching consequences on the competitiveness within industries, economists are trying to understand the factors that drive firms to integrate and the consequences integration has on competition and welfare. In the past, mergers between large companies have often been opposed by anti-trust authorities in fear of anti-competitive behavior by the integrator. Understanding whether the desire to create and exploit market power is a driver for integration is one of several ways in which research on integration can greatly impact policy making on mergers and acquisition laws. In their attempts to explain the factors driving vertical integration, economists have come up with two theoretical approaches that identify different factors: the organizational and the neoclassical approach. These two approaches have substantially different assumptions on how improving efficiency and market power impacts a firm’s desire to integrate, and therefore also identify different factors theorized to drive vertical integration. Drawing on a large variety of theoretical and empirical literature, this paper aims to identify the most prominent factors identified in both theories and determine whether these factors are found to be valid in empirical research. Identifying which theoretical approach and its respective factors is most supported by empirical literature will help guide further research and better the current understanding of vertical integration.