Riassunti BIE Business And Industrial Economics

HOLD UP

When "A" firm has bigger RSI than "B" firm, the "B" firm can hold "A" up by imposing to "A" the minimum price for which "A" still wants to serve "B" and not the second best offer in the market. This price is just an ε higher than the price offered by the market.

For these reasons, it is better to vertically integrate. However, note that if one pillar is not met, markets work:

• If there is no bounded rationality, all contracts are complete
• If there is no opportunism, there is no need for complete contracts
• If there is no relationship-specific investments, there is no need to defend from opportunism, because there is no loss in switching from one transaction to another

CLASSIFICATION of TRANSACTION (Williamson):

So what is better? Vertically integrate or market? It depends on:

1. Relation-specific investment needed for the transactions
2. Frequency of the transactions

Some investments could not be justified if the transactions are infrequent.

STATE OWNED ENTERPRISES

There are two major alternative policy options for dealing with natural monopoly: Monopoly regulation and State Owned Enterprises (SOEs) = Supply of goods or services by the State through own business enterprises. They are not public administrations, they produce and sell a product and they are owned by the state. SOEs concentrate in a few industries: energy, financial services, utilities. The assumptions are that the state is benevolent and care about the social welfare and do not exploit its market power but IS NOT ALWAYS TRUE that SOEs spontaneously pursue the creation of social welfare, make decision in the public interest and do not exploit market power. In principle, SOEs are seen as a remedy to market failure; Control of "strategic industries" fundamental for the State (supply of Energy or arms); Ideology and Redistribution (create firm in poorer regions). SOEs is better than

private firms the opportunity to take over and manage the SOEs. This reduces the influence of politicians in the decision-making process and allows for more efficient and market-oriented management. 2) BUREAUCRACY: The second theory suggests that the problem lies within the bureaucratic structure of SOEs. Bureaucracy refers to the complex and rigid administrative system that often hinders productivity and innovation. In SOEs, bureaucratic procedures and red tape can slow down decision-making processes and prevent the implementation of cost-saving measures. Additionally, the lack of competition in the public sector can lead to complacency and a lack of incentive for improvement. To address the bureaucracy problem, reforms such as streamlining administrative processes, introducing performance-based incentives, and promoting competition within the public sector can be implemented. These measures aim to increase efficiency, reduce costs, and improve overall productivity. In conclusion, the productive inefficiency problem in SOEs can be attributed to patronage and bureaucracy. Privatization and bureaucratic reforms are potential solutions to improve the performance and efficiency of SOEs.

Away owner shares, this could be a remedy to natural monopoly inefficiency, obviously after the privatization they will be regulated.

2) MANAGEMENT DISCRETION: (or agency theory) By contrast, according to management discretion theory, the bad is the manager which is pursuing his interest because the government suffers information asymmetries with him:

• Politicians and government officials have poor information about SOEs' managers, their characteristics and conducts (adverse selection)
• Moral hazard is a particularly big issue in SOEs: Top public managers use their autonomy for serving own private objectives (moral hazard)

A solution could be corporate governance the set of instruments and rules to correctly run a firm with Better scrutiny (Performance management system) and Objectives' Alignment (Accompanying measures). This could be too hard to implement.

16 BUSINESS AND OTHER MARKETS: VERTICAL INTEGRATION AND COOPERATIVE AGREEMENTS

VERTICAL INTEGRATION: Presence of the

same business enterprise in 2 or more stages of the supply chain TAXONOMY: Type of entry (entry mode), 3 ways: 1) Greenfield investment (when I start from scratch (da zero) in another country); 2) Acquisition of existing business activities (acquire supplier or distributor); 3) Joint venture with existing businesses (associazione temporanea di imprese) TYPE OF INTEGRATION: The vertical integration could be Upstream or Backward (Supply of own inputs) or Downstream or Forward (Distribution or transformation of own outputs). It could be even along the main (my industry) or extended (common even in other industries for ex logistic services) supply chain or an hybrid form (vertical integration and diversification). PROPERTY RIGHTS THEORY PRT VS TRANSACTION COST ECONOMICS TCE: Following the TCE th. (Williamson), integration allows to solve the incomplete contracts issue but according to Property Rights Theory PRT (Grossman-Hart): within organizations contracts are incomplete as well (opportunistic

PROPERTY RIGHTS THEORY: Contract incompleteness determines residual right of control, who decides in all the situations that are not included in the contract are the firm who control the resources.

PROS VERTICAL INTEGRATION: Lower Transaction cost: Independence from external suppliers; Lower search negotiating and monitoring costs; Better coordination; Larger control; Know-how protection.

CONS VERTICAL INTEGRATION: Difficult to achieve economies of scale and Learning economies; No market discipline (even though is not efficient you can't go to other firm since u integrate it); High investment required and low flexibility.

MARKET or HIERARCHY? (TRANSACTION COST AS A DRIVER): The decision needs to take into account:

TECHNICAL EFFICIENCY: cost-efficient production process, the same of productive efficiency so

cost efficiency. Market is always more efficient than vertical integration due to: economies of scale, scope & learning, market discipline (if a firm is not efficient, I'll not buy from her) but it will become weaker for high specialized products. If ΔC≥0 is better use the Market (vedi fig)

AGENCY EFFICIENCY: How easy, how cheap it's exchange (exchange=comprare) goods and services in the vertical chain so minimizing the transaction cost inside the chain. At high levels of asset specificity (K>K*), integration is better than market. If there is an increase in economies of scale, there will be more transaction so it will be even better stay where we are market or firm (increase slope and k shift to left). If ΔC≤0 is better use Firm So advantage of vertical int. are stronger when there are specific investment and large economies of scale.

MARKET or HIERARCHY? (MARKET POWER AS A DRIVER)?: The decision needs to take into account:

• DOUBLE MARGINALIZATION: If

upstream the supplier and downstream the distributor set a markup, there is double marginalization (due margini che gravano su di me) so Vertical integration could be a solution because curbs (frena) this market power.

• VERTICAL FORECLOSURE: Vertically integrated monopolists may prevent the independent suppliers from accessing downstream customers (or independent customers from reaching supply sources) "bottleneck". When the bottleneck is operated to monopolize the upstream or downstream market like with discrimination, we talk about strategic entry deterrence.
• SUPPRESSION OF INNOVATIVE PROJECTS AND COMPETITIVE THREATS: Acquisition of innovative startups are anticompetitive if the startup would have developed its innovation absent the merger or it may develop a close substitute of the incumbent product.

INTERMEDIATE FORMS AND COOPERATIVE AGREEMENTS:

TAPERED INTEGRATION: mixture of vertical integration and market exchange.

Good aspects: Competition with external suppliers

Gives some degree of market discipline to internal production; Internal production gives protection from hold-up and asymmetries; lower investment compared to full integration

Bad aspects: Difficult coordination; Loss in economies of scale; My firm is not a good benchmark so I don't know exactly the potentiality of the market.

COOPERATIVE AGREEMENTS: are hybrid forms between market and integration BUT with two necessary conditions: 1) long-term partnership between two or more entities to coordinate activities of the firms; 2) substantiated agreement: some form of contract is required (tacit or explicit, informal or formal). Cooperative agreements allow to reduce risks coming from potential opportunistic behavior of the other side, without incurring in huge investments, coordination costs and rigidity of a hierarchical integration. So, in some cases, it could be the most efficient option.

ALTERNATIVE TO VERTICAL INTEGRATION: RESTRAINTS: Restraints are a wide range of business practices which prevent,

Restrict or distort competition. Horizontal restraints comprise measures such as cartels, collusion while Vertical restraints include practices such as exclusive dealing, some (not all, see next paragraph) of these activities are sanctioned by the antitrust authority.

VERTICAL RESTRAINT: FRANCHISING

Franchisers (Mc Donald) may require franchisees (shop) to follow particular standards like: get their supplies only from the franchisers or sell only supplies provided by the franchiser; but in this way, the franchiser exploit scale economies and let franchisee operates the business and perform local adaptation. Franchisers assure quality standards of franchisees with hostage like giving to them strategic locations that they don't want to lose (HOSTAGE = an often asymmetric asset that one party gives in exchange for something to ensure that the other party does not exploit opportunistic behaviors: at the tennis court they ask me for the health card so I don't run away with the

Racchetta in affitto.

• LICENSING: is an agreement in which an enterprise (licensor) authorize another firm (licensee) to exploit a peculiar material or immaterial asset behind the payment of an upfront fee: Commercial, Productive, Technological or other kind for ex Disney toy inside Happy Meal
• STRATEGIC ALLIANCES: cooperation, coordination and information sharing for a joint project by the participating firms
• JOINT VENTURES: a new independent organization is created and jointly owned by the promoting firms. Alliances and joint ventures can be: Horizontal (firms in the same industry); Vertical (firms at different stages of the value chain); Involving firms that are neither in the same industry nor related through the vertical chain. Are better than market transaction (buy) when there are: complex transaction, incomplete contracts or relationship-specific assets. Are better than vertical integration (make) when: is too costly, needs too much time or local partner. The risk are

losing control over proprietary information and it's costly.17 IND