ABSTRACT
Most of the literature on vertical integration to date has focused mainly on two sets of motives: market power and efficiency. In market power considerations, the purpose of a firm's vertical integration was either to gain extra profit through price discrimination, or to forestall entry through market foreclosure or denial of material supply. It has been pointed out that transaction costs might create important incentives for vertical integration. In his famous book, Markets and Hierarchies, Williamson located the sources of transaction costs in the characteristics of human nature. These characteristics are labeled "bounded rationality" and "opportunism". This chapter examines the costs and benefits involved in a firm's "make" decision and "buy" decision in order to explain the costs and benefits of vertical integration in a transaction-cost framework. It focuses on the knowledge complementarity effect as a benefit of the "make" decision and on its relevant transaction cost as a cost of the "buy" decision.
