ABSTRACT
The degree of vertical integration in an industry depends on both supply and demand conditions. In the 200 years since Adam Smith, the effects of such supply factors as the division of labor, economies of scale, and the presence or absence of external economies have taken center stage. And we shall not ignore supply factors, especially the relative abilities of alternative structures to encourage technological change. But demand factors have always received less attention in analyzing issues of industry structure.72 In particular, the tendency of economists to assume product homogeneity has obscured the fact that the structure of an “industry” and the characteristics of the firms it comprises can vary greatly depending on how consumers define its “product.” Over time, the nature of what consumers believe is the essence of a given product often changes. Consumers may add certain attributes73 and drop others, or they may combine the product with another product that had been generally regarded as distinct. Alternatively, a product that consumers had treated as an entity may be divided into a group of subproducts that consumers can arrange into various combinations according to their individual preferences.
