Paper to be presented at the DRUID-DIME Academy Winter 2010 PhD Conference on
Comwell Rebild Bakker, Aalborg, Denmark, January 21 - 23, 2010
VERTICAL INTEGRATION UNDER TECHNOLOGICAL CHANGE Jörg Claussen ICE. LMU Munich
[email protected] Tobias Kretschmer ICE. LMU Munich
[email protected] Nils Stieglitz SDU, University of Southern Denmark
[email protected]
Abstract: A pressing (and so far not satisfyingly answered) question at the interface between vertical integration and technological change is if higher rates of technological change make vertical integration more or less attractive. We address this question with a formal simulation model and find a non-monotonic relationship between vertical integration and technological change: vertical integration becomes more attractive for modest levels of technological change whereas outsourcing becomes more attractive in highly turbulent environments. We disentangle the underlying mechanisms and find that the shift towards vertical integration is driven by reduced benefits of discovery while the shift towards outsourcing is driven by reduced costs of divergence.
JEL - codes: L22, L24, C63
Vertical Integration under Technological Change Jörg Claussen
Tobias Kretschmer
Nils Stieglitz
ICE, LMU Munich Schackstr. 4/III, 80539 Munich, Germany
[email protected]
ICE, LMU Munich Schackstr. 4/III, 80539 Munich, Germany
[email protected]
University of Southern Denmark, Campusvej 55 5230 Odense, Denmark
[email protected]
PRELIMINARY VERSION – PLEASE DO NOT CITE Abstract – A pressing (and so far not satisfyingly answered) question at the interface between vertical integration and technological change is if higher rates of technological change make vertical integration more or less attractive. We address this question with a formal simulation model and find a non‐monotonic relationship between vertical integration and technological change: vertical integration becomes more attractive for modest levels of technological change whereas outsourcing becomes more attractive in highly turbulent environments. We disentangle the underlying mechanisms and find that the shift towards vertical integration is driven by reduced benefits of discovery while the shift towards outsourcing is driven by reduced costs of divergence. Keywords: vertical integration, outsourcing, technological change, NK JEL Classification: C15, L22, L24
1. Introduction A pressing question at the interface between vertical integration and technological change is if higher rates of technological change make vertical integration more or less attractive. Some studies find that high rates of technological change lead to outsourcing (Harrigan, 1984, 1986, Balakrishnan and Wernerfelt, 1986, Hill and Hoskisson, 1987, Jones and Hill, 1988, Bartel et al., 2005), while other studies come to opposite results (Armour and Teece, 1980, Masten, 1984, Masten et al., 1991, Monteverde, 1995, Monteverde and Teece, 1982, Forbes and Lederman, 2009). Afuah (2001) addresses these contradictory results and finds that in face of radical change, firms that are integrated in the new technology generation perform better than disintegrated firms and firms that are integrated in the old technology perform worse. Wolter and Veloso (2008) also attempt to integrate these conflicting results by deriving propositions on how different types of innovations influence integration incentives. Using Henderson and Clark’s (1990) taxonomy, they argue that incremental innovations do not influence integration incentives, modular innovations decrease integration incentives, and architectural as well as radical innovations increase integration incentives. Both contributions make important progress in answering how vertical integration and technological change interrelate. However, we still feel that the pressing question above remains partly unanswered: what happens if we do not have distinct generational change as in Afuah (2001)? Wouldn’t we contrary to Wolter and Veloso (2008) expect decreased integration incentives from architectural and radical innovations if this change renders existing in‐house knowledge obsolete (Afuah and Bahram, 1995)? We analyze the interdependencies of vertical integration and technological change with a formal agent‐based simulation which allows for direct modeling of interactions that would be difficult to isolate otherwise. We use the NK approach based on the work of Kauffman (1993) and extended to the field of management by Levinthal (1997)1. The NK model is well‐suited to analyze problems of technological and organizational interdependencies, of strategy‐making under uncertainty, and of
1
N stands for the number of attributes of a technology and K for the interdependency between these attributes in a value function. The K parameter reflects the complexity of a problem and is in line with Simon’s (1962) definition of complexity. From N and K, a technology landscape can be generated, on which invention can be seen as a process of recombinant search (Fleming and Sorenson, 2001).
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organizational boundaries (cf. Chang & Harrington, 2006 or Ganco & Hoetker, 2009 for a recent survey)2. Consider a product for which supply of an upstream component (UC) can potentially be outsourced. In this case one can either decide keeping UC and downstream component (DC) integrated or one can select the UC from a range of external suppliers. Each of the potential suppliers of a vertically separated firm improves its product in a decentralized way, so one has to assess the best fit for the in‐house DC. The outsourcing firm has therefore the advantage of being able to select from a range of suppliers. In line with Almirall and Casadesus‐Masanell (2010), we call this the discovery effect. On the other hand, as suppliers usually sell their products to multiple customers and as they maximize their own profits, outsourcing has the disadvantage of unaligned coordination between UC and DC. We call this the divergence effect. Both effects taken together constitute the performance difference between outsourcing firms and integrated firms. In our experiments, we let a population of vertically integrated firms and a population of outsourcing firms act as described above. We model interdependencies between UC and DC similar to the approach taken by Levinthal and Posen (2007). We extend their model by additionally implementing an easy supplier selection mechanism and allow for technological change. We then compare the populations’ success in performance improvement. Our main result helps explaining the mixed empirical evidence on the relationship between vertical integration and technological change: the relationship is non‐monotonic in that vertical integration becomes first more attractive for modest levels of technological change but then becomes less attractive for highly turbulent environments. Following Almirall and Casadesus‐Masanell (2010) we then distinguish between the above introduced benefits of discovery and costs of divergence to disentangle the mechanisms driving the non‐monotonic relationship between vertical integration and technological change. We find that, as some turbulence is introduced to the environment, the increasing level of attractiveness for vertical integration is driven by reduced benefits of discovery, i.e. outsourcing firms benefit less from being able to choose from a range of suppliers if the environment is no longer stable. However, when environments become highly turbulent we see the benefits of discovery staying stable and the observed attractiveness of outsourcing being driven by reduced costs of divergence. I.e., in highly
2
Compared to other modeling platforms, the NK approach offers significant advantages: the two main dimensions of interest, vertical integration and technological change, can be implemented directly. This would be difficult, if not intractable in game‐theoretic simulation models such as Ericson and Pakes (1995). Further, compared to ad‐hoc simulation models like the one from Malerba et al. (2008), the NK modeling approach has already shown its usefulness in solving a wide setting of closely related problems in organization science, strategic management, and technology management as well as evolutionary economics.
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turbulent environments outsourcing firms do suffer less from imperfectly coordination with their suppliers. The remainder of this paper is structured as follows. We introduce the model in section 2 and perform a couple of experiments in section 3 to derive performance differences between outsourcing and vertical integration. We then disentangle the reasons for the observed performance differences in section 4 and conclude in section 5.
2. Model Consider a product consisting of two modules which have to be put together before it is sold to a customer. We denote the two modules as upstream component and downstream component. UC and DC could for example be a 3D engine for a video game and the video game itself. As depicted in Figure 1 we distinguish two possible scenarios: one in which UC and DC are provided by the same vertically integrated (VI) firm and one in which an outsourcing (OS) firm buys the UC from a supplier to complement their own DC. Our simulation model is designed to capture the key mechanisms of both scenarios to allow analyzing how they interact with different degrees of technological change. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 1 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ The building blocks of our simulation model are introduced step by step. We first address the product design before discussing how vertically integrated and outsourcing firms differ in their abilities to improve product performance. We then enhance the model by allowing for technological change and finish the section by reporting implementation details. 2.1. Interdependent product design As motivated above, we model a product consisting of two interdependent modules. We follow the approach introduced by Levinthal and Posen (2007) and adapted by Almirall and Casadesus‐ Masanell (2010) and combine two interdependent NK landscapes. The product design is partitioned ,…,
into design choices concerning the UC and the DC, where ⁄
,…,
and
are two equal‐sized binary vectors describing the configurations of the individual ,
modules. The product sold can therefore fully be described by the vector of elements. Each of the design choices contributes to the customer’s value: ∑
,…, 3
⁄
;
,…,
and consists
The performance contribution of each design choice
;
,…,
does not only depend on the
configuration of the element itself but also on the configuration of
other elements. These
interdependent elements can be located within the same module but also in the other module. 20 design
Figure 2 illustrates how these interdependencies can look like: in total there are
choices, 10 associated with the UC and 10 associated with the DC. Each configuration depends also on the configuration of
7 other product decisions, 5 of them stemming from the same module
and 2 from the other module. For example, the performance contribution of element depends on the configurations of , , , ,
from the UC and the configurations of
,
of the DC.
Every time one of the interdependent elements changes the configuration, the performance contribution of the focal element is redrawn from 0; 1 . For example, if the configuration of changed from 0 to 1, the performance of contribution of changes, but a change in
is
does not
results in changes to the performance contribution of . Therefore the performance contribution of each element can take 2
different values. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 2 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
2.2. Firm behavior To enable comparison between the performance of integrated and outsourcing firms, both types of firms act in the same landscape described above. They only differ in how they are able to change their configurations. 2.2.1
Vertically integrated firm
In a vertically firm, both components are produced within the boundaries of the firm. Each firm starts the search for high‐performing configurations with a randomly drawn configuration ,
. We model the integrated firm to keep the two modules as distinct departments within
the firm. For every time step of the simulation the two departments search in parallel for a higher‐ performing solution by evaluating how the change of one of the module’s element configuration influences overall performance of the firm. Taken the other module’s configuration as given, the configuration of the focal module is adjusted to the alternative configuration if this increases overall firm performance.
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2.2.2
Outsourcing firm
The outsourcing firm has an in‐house DC and sources the UC from one of the possible suppliers. To keep complexity tractable and to allow clear disentangling of the underlying mechanisms we focus in this work on value creation and not on value appropriation. I.e. we are not interested how supplier and buyer split up their profits but we want to know how the joint performance of buyer and supplier compares to the performance of the integrated firm. The configuration of an outsourcing firm’s product is uniquely defined by the configuration of the in‐ house DC and the configuration of the currently selected supplier. Each OS firm and each supplier start with a random configuration for DC and UC respectively and each OS firm randomly selects one of the suppliers initially. For every time step of the simulation, the outsourcing scenario is then divided into two sub‐steps. In the first sub‐step, both OS firm and supplier try to improve the performance of their respective module in parallel. The OS firm changes one of the configurations
,∈ ⁄
…
of the DC and
changes the configuration if firm performance (given the unchanged UC configuration) increases. The supplier considers the module‐performance of all current customers to evaluate if it is worth to change one of the UC configurations. Therefore, the supplier compares the mean current module‐ performance of the existing customers with the potential mean module‐performance of the same customer group and changes the configuration only if mean performance increases. After this parallel search process is completed, the OS firm performs a selection process and decides whether it changes the current supplier. Therefore, the OS firm first decides on one potential new supplier that should be evaluated. The buyer uses the maximum UC performance a supplier currently achieves as an indicator of this supplier’s attractiveness. This is in line with the observation that suppliers usually showcase their highest performing deal to attract new customers. The buyer chooses a potential supplier for evaluation according to the following formula:
max ,
∑
max
Therefore more successful suppliers are selected more often for evaluation than less successful suppliers. Once a potential supplier is selected for evaluation, the buyer checks if firm performance increases compared to the current supplier and exchanges the current supplier if it does.
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2.3. Technological change For a static environment, the
∙2
;
performance contributions
,…,
are drawn at the
beginning of the simulation and stay unchanged over the whole observation period. However, as we are interested how integrated and outsourcing firms can cope with technological change, we extend the model to allow for technological change. The performance contributions no longer stay stable but perform a random walk. The speed of technological change is adjusted with the parameter , which determines in how far a shock ∈
1; 1 changes the original performance contribution: ,
∙
,
The specification above already generates a random walk but does not guarantee that the payoff contributions stay bounded to the interval 0; 1 . We therefore insert an adjustment which “reflects” the values of the performance contributions if they leave the interval 0; 1 : ,
max min
For example, if the old fitness value has been
,
,2
,
0.94,
,
,
,
0.1, and
0.8, then
,
With reflecting barriers, the performance contribution is kept within the interval 0; 1 at
1.02. ,
0.98. Figure 3 shows how performance contribution can be affected for different degrees of turbulence. 2.4. Implementation details We stick closely to Levinthal and Posen (2007) and implement a
20 landscape partitioned into
10, i.e., the overall product consists of 20 design
two equal‐sized modules with
choices distributed over two modules. The within‐module interdependence is set to between‐module interdependence
5 and the
is varied in our simulation runs between 0 and 5, i.e. the
payoff of one design choice depends on 5 to 10 other design choices. Furthermore, we vary the turbulence parameter between 0 and 0.5. We model a population of 100 vertically integrated firms and of 100 outsourcing firms, which can choose between 10 different suppliers. We set a higher number of outsourcing firms than suppliers as one supplier usually provides its product to several buyers to realize economies of scale. The simulation is conducted over 100 time steps and if not reported otherwise, the discussed results are for
100. Results for every configuration pair
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, are averaged over 10,000 simulation runs.
3. Performance differences between outsourcing and vertical integration We run two sets of simulations: first, we analyze how between‐module interdependencies affect the performance of vertical integration in a stable environment. Building on this base case, we then allow for technological change. The underlying effects driving the interdependencies between technological change and incentives for vertical integration are subsequently analyzed in section 4. For both sets of simulations, we first consider the simulation outcomes before disentangling the underlying mechanisms into benefits of discovery and costs of divergence. 3.1. Performance differences in stable environments As a base case, we first restrict our focus of analysis to stable environments, i.e. we set the parameter of turbulence to
0.
For each simulation run, both vertically integrated and outsourcing agents are set on the same landscape and try to improve their performance. There is no interaction within the group of integrated firms and the group of outsourcing firms as well as between the groups. However, outsourcing firms indirectly interact with each other as they choose from the same set of suppliers. If two outsourcing firms select the same supplier, their UC configuration is identical and it is also likely that there is some correlation emerging as both firms have to adapt to the same UC. Figure 4 reports how mean performance of vertically integrated firms and outsourcing firms develop over the duration of analysis3. We see that performance of both integrated and outsourcing firms saturates at
50. We later report our results at
100, which can therefore be seen as the
equilibrium outcome4. The main result that can be derived from Figure 4 is that outsourcing results in superior performance for low levels of between‐module interdependence
while vertical
integration becomes more attractive as between‐module interdependence increases. We also see that outsourcing is relatively more beneficial in the short run: even though long‐run performance of vertical integration clearly dominates outsourcing for high
, we do not observe this dominance in
the short run. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 4 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
3 4
The same results are reported in a more condensed way in Figure A. 1. Turbulence leads to even faster saturation, as can be seen in Figure A. 2.
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Even though the scope of Almirall and Casadesus‐Masanell (2010) differs in that they distinguish between open and closes innovation instead of between outsourcing and vertical integration and their modelling mechanisms differ substantially5, we can relate our results to their finding. Our results for stable environments are in line with their findings in that we also find that closed innovation (VI) becomes more attractive, the higher product complexity becomes. 3.2. Performance differences under technological change Building on the above discussed results for stable environments we now turn to our core question of interest and ask in how far technological change influences integration incentives. We answer this question by tuning the parameter of turbulence from 0 to 0.5, therefore going from a completely stable to a highly turbulent und unstable environment. As we are also interested in how far the effects of turbulence and between‐module interdependencies interact, we individually analyze the effect for all
between 0 and 5.
Figure 5 illustrates how the performance differential of
is affected by technological change.
We can first confirm the result already obtained for stable environments: the higher the between‐ module interdependencies, the more attractive vertical integration becomes. However, our core result is the non‐monotonic relationship between integration incentives and technological change. We see that as we add some turbulence to a stable environment vertical integration becomes relatively more attractive. But as we add more and more turbulence, the effect turns and the attractiveness of outsourcing increases. When comparing how much turbulence it needs to fully offset increased attractiveness of vertical integration (i.e. when for
0), we see that this takes longer for intermediary values of
higher values of higher
reaches the same value as than for
0 and for
. Finally, we see that the relative advantage of outsourcing increases faster, the
becomes. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 5 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
5
E.g. a core ingredient of our model is that multiple buyers buy from one supplier, whereas the number of open innovation firms is the same for both product modules in Almirall and Casadesus‐Masanell (2010).
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4. Effects driving the difference between outsourcing and vertical integration In a next step we try to disentangle the underlying mechanisms driving the relative advantage of vertical integration and outsourcing. To do this, we follow Almirall and Casadesus‐Masanell (2010) in splitting the performance difference between outsourcing and vertical integration in a discovery effect and a divergence effect. In the following we first discuss what we understand under the divergence and discovery effect in the scope of our work. We then identify how these effects are responsible for the performance differences between outsourcing and vertical integration. In order to separately identify the two effects, we have to introduce a hypothetical supercharged firm. Finally, we can use the two effects to explain the non‐monotonic relationship between vertical integration and technological change. 4.1. Discovery and divergence The first effect of interest is the discovery effect. This effect captures the advantages which come with being allowed to adopt not only one product configuration, but being able to choose between several product configurations. If one is bound to only one configuration, one is also bound to the technological trajectory associated with this configuration. However, if one can choose between several configurations, this also allows accessing different technological trajectories, and therewith changing the product configuration in a much more disruptive way. When comparing a setting where one can choose between different product configurations (i.e. there is an effect of discovery), everything else equal, this solution is always superior to a setting where one is stuck with only one configuration. This is because the availability of additional choices can only increase performance as one can always stick with the original configuration. Therefore, we talk about benefits of discovery. The divergence effect is the other effect we need to identify to disentangle the differences between outsourcing and vertical integration. This effect captures everything associated with reduced coordination. For a problem which is partitioned into sub‐goals, perfectly coordinated action always takes into account the overall goal, i.e. changes are only implemented if overall short‐term performance increases. On the other hand, if coordination is not perfect, problem‐solving actions for the different sub‐goals can also be detrimental to the overall goal. While the discovery effect is unambiguously positive, the long‐term outcome of the divergence effect can have both a negative and a positive sign. Even though we expect a lack of coordination being usually associated with a performance decrease, one could also expect a positive effect. This positive effect can again stem 9
from two different sources: speaking in the spirit of Rivikin and Siggelkow (2003) divergence could lead to either an increase of search or an increase in stability, both of which can be performance‐ increasing if there is currently too much stability respectively search. On the one hand, uncoordinated search is less prone to get stuck on local peaks (i.e. we see more search), while on the other hand, if many parties try to change a configuration into different directions, the overall result could be that little changes are implemented at all and we therefore see more stability. Considering that we expect the negative impact of the divergence effect to usually outweigh the positive impact, we talk about costs of divergence. 4.2. Differences between vertical integration and outsourcing Having discussed the effects of discovery and divergence in general, we now apply these effects to identify differences between vertical integration and outsourcing. Figure 6 depicts two key characteristics that distinguish vertically integrated firms and outsourcing firms: the number of suppliers and the coordination between modules. An outsourcing firm can choose between multiple suppliers but coordination between the self‐produced DC and the externally purchased UC is obviously not perfectly aligned. On the other hand, an integrated firm has only one “supplier”, its own UC department, which acts in a coordinated manner together with the department developing the DC. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 6 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ We can identify the existence of a discovery effect, as only OS firms can benefit from choosing between multiple suppliers. And we identify a divergence effect, as OS firms lack the coordination between UC and DC that is available to VI firms. Taken together, these two effects constitute the performance difference between outsourcing and vertical integration: 4.3. Disentangling the discovery and divergence effect So far, we are able to tell that there are two probably counteracting effects that determine the performance difference between OS and VI. To quantify the strength of the two effects, we also follow Almirall and Casadesus‐Masanell (2010) in introducing a hypothetical supercharged firm. The supercharged firm is designed in a way that it captures the full advantages of discovery but does not suffer from divergence because incentives between buyer and supplier become coordinated. We 10
implement this supercharged firm by assigning each outsourcing firm an own set of suppliers that are perfectly coordinated with their assigned firm. We can therefore quantify divergence and discovery as follows: As depicted in Figure 7, discovery is therefore defined as the difference between the supercharged firm, which benefits from discovery and does not suffer from divergence and the vertically integrated firm, which does not benefit from discovery but does also not suffer from divergence. Divergence on the other hand is obtained by subtracting the performance of the outsourcing firm from the performance of the supercharged firm, as the only difference between the two firms is that the supercharged firm does not suffer from divergence. ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 7 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 4.4. Causes for the relationship between vertical integration and technological change We now try to explain the somehow non‐intuitive relationship between vertical integration and technological change by splitting the performance difference in a discovery and a divergence effect6. First, we focus on a specific configuration of
3. Figure 8 shows how the performance
difference between outsourcing and vertical integration is explained by the two effects. If we go from a stable environment to an environment with modest turbulence of
0.05 we see that
increased attractiveness of vertical integration is driven by a decline in the benefits of discovery while the effect of divergence remains fairly stable. However, as turbulence increases we see the increased attractiveness of outsourcing being driven by a decline in the costs of divergence and do no longer observe changes in the benefits of discovery. 6
We do not focus on the drivers responsible for the differences of the static case as this would to a large part reproduce Almirall and Casadesus‐Masanell (2010). Still, we shortly describe the results in the following. Figure B. 1 plots the performance differential OS‐VI, the benefits of discovery DISC, and the costs of divergence DIV. As stated above, we see that outsourcing is more attractive for low levels of between‐module interdependencies and vertical integration becomes more attractive for higher levels. Regarding the underlying drivers, we see that the costs of divergence clearly drive the increasing attractiveness of vertical 0, costs of divergence steadily increase with . integration: while there are no costs of divergence for 0 the incentives of the buyers coincide with the suppliers’ incentives. This is quite intuitive as for However, as between‐module interdependencies increase, it is no longer possible to optimally serve all buyers as changes in the UC can have different performance‐changing effect.
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‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 8 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ How can we make sense of these results? The reduced benefits of discovery when changing from a stable environment to an environment with modest turbulence can probably be explained with better buffering abilities of vertically integrated firms which take effect if technological change is introduced but do not work anymore for highly turbulent environments. On the other hand, reduced costs of divergence for highly dynamic environments can probably be attributed to a stabilizing effect of divergence counteracting the destabilizing effect caused by high rates of technological change. As a supplier usually sells its product to multiple customers, it is torn by differing customer requirements as technological change becomes turbulent. The resulting reduced rate in changing the product configuration is therefore a valuable counter‐element to the destabilizing effects of technological change. After analyzing the results for
3, we broaden our scope of analysis to cover all
Figure 9 shows how the costs of divergence develop over the interval
0; 5 .
0; 0.5 .
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 9 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ First, we can observe that for
0 we cannot talk about “costs” of divergence, we actually see
benefits from having the same set of suppliers for all OS firms instead of having an own set of perfectly coordinated suppliers for each OS firm. As for
0, we don’t have any potential for
conflicts between modules even if only module‐performance is considered. Therefore, we also see 0 for a stable environment. And for increasing turbulence , we can identify the performance‐increasing, stabilizing effect without being obstructed by potentially unaligned goals. And second, we see that reduced costs of convergence drive the increasing attractiveness of OS for all observed
, i.e. our results regarding the divergence‐side seem to be stable.
Finally, in Figure 10 we analyze how the benefits of discovery depend on benefits of discovery. Again, we can confirm that the results obtained for
3 hold true for the whole range of
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ INSERT FIGURE 10 HERE ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 12
.
5. Conclusion We have been able to identify a reason why prior empirical work on the interdependencies between vertical integration and technological change has produced mixed results: the relationship is non‐ monotonic in that vertical integration becomes first more attractive and then less attractive as the level of technological change increases. This relationship is driven by reduced benefits of discovery for modest levels of turbulence and by reduced costs of divergence for highly dynamic environments. In addition to explaining the mixed empirical results on the relationship between vertical integration and technological change, we are also able to derive an important implication for future empirical studies. Our results can be validated in empirical settings by using appropriate measures of technological change and then explicitly allowing for a non‐monotonic influence of technological change on integration incentives. As mentioned before, the scope of this paper is to analyze in how far different organizational designs are able to create value. This allows us to clearly disentangle the effects leading to performance differentials between integrated and outsourcing firms. A possible next step would be to analyze how the created value is appropriated by allowing for competition both within organizational designs as well as between integrated and outsourcing firm. We would expect interesting and non‐ trivial results for two main reasons: first, outsourcing firms have been shown to be faster in improving short‐term performance and second, we would expect profit‐reducing effects if many outsourcing firms select the same supplier.
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15
Figures and tables
Integration (VI)
Outsourcing (OS) UC
UC
UC
UC
DC
DC
Figure 1: Organizational difference between vertical integration and outsourcing.
X
X X X X X X X X X X X X X X X X X X X X X X X within X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X between X X X X X X X X X
K
(UC)
K
X X X X X X
X X X X X X
X X X X X
X X
X X X X X
Kbetween X X X
X X X X X X X X X X X X X X X X X X X X X X X X X X
K
(DC)
X X X X X X X X X X X X X X X X X X X
,
16
X X X X
X X X X X X within X X X X X X X X X X X X
Figure 2: Example for an interaction map with
X
and
.
=0 1 0.5 0
0
20
40 =0.1 60
80
100
0
20
40 =0.2 60
80
100
0
20
40 =0.3 60
80
100
0
20
40
60
80
100
0
20
40
60
80
100
0
20
40
60
80
100
1 0.5 0 1 0.5 0 1 0.5 0
=0.4
1 0.5 0
=0.5
1 0.5 0
Figure 3: Examples for different degrees of technological change.
17
Fitness for Kb=0
Fitness for Kb=1
0.7
0.7
0.6
0.6 VI OS
0.5
20
40
60
80
VI OS 100
0.5
20
Fitness for Kb=2
40
60
80
Fitness for Kb=3
0.7
0.7
0.6
0.6 VI OS
0.5
20
40
60
80
VI OS 100
0.5
20
Fitness for Kb=4
40
60
80
100
Fitness for Kb=5
0.7
0.7
0.6
0.6 VI OS
0.5
100
20
40
60
80
VI OS 100
0.5
20
40
60
80
Figure 4: Mean performance development of integrated (VI) and outsourcing (OS) firms from t=1…100 for a stable environment (
).
18
100
0.05
0.04
0.03 K=0 K=1 K=2 K=3 K=4 K=5
OS-VI
0.02
0.01
0
-0.01
-0.02
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
Figure 5: Difference between outsourcing and vertical integration (OS‐VI) for varying degrees of technological change .
19
Integration (VI)
Outsourcing (OS) Number of suppliers Between-module incentive
Discovery effect
Multiple
Divergence effect
Uncoordinated
One Coordinated
Figure 6: Different characteristics of outsourcing and vertical integration.
VI
SC Number of suppliers Between-module incentive
Number of suppliers
Discovery effect
Multiple
One
Coordinated
Coordinated
OS
SC Multiple
Multiple
Between-module incentive Uncoordinated
Divergence effect
Coordinated
Figure 7: Introduction of a supercharged firm to identify the discovery and the divergence effect.
20
KB=3 0.03 0.025 0.02
OS-VI
0.015 0.01 0.005 0 OS-VI DISC DIV
-0.005 -0.01
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
Figure 8: Drivers of the difference between outsourcing and vertical integration (OS‐VI) for
: benefits
of discovery (DISC) and costs of divergence (DIV). The degree of technological change varies from 0 to 0.5.
21
0.05 K=0 K=1 K=2 K=3 K=4 K=5
0.04
Costs of Divergence
0.03
0.02
0.01
0
-0.01
-0.02
0
0.05
0.1
0.15
0.2
0.25
Figure 9: Divergence effect for
∈
; and ∈
; .
22
.
0.3
0.35
0.4
0.45
0.5
0.036 K=0 K=1 K=2 K=3 K=4 K=5
0.034
Benefits of Discovery
0.032
0.03
0.028
0.026
0.024
0.022
0
0.05
0.1
0.15
0.2
0.25
Figure 10: Discovery effect for
∈
; and ∈
; .
23
.
0.3
0.35
0.4
0.45
0.5
Appendix A Performance for varying Kb 0.74 0.72 0.7 0.68 VI, t=5 OS t=5 VI, t=20 OS t=20 VI, t=100 OS t=100
0.66 0.64 0.62 0.6 0.58
0
1
2
3
4
5
Figure A. 1: Mean performance at t= (5, 20, 100) of vertical integrated (VI) and outsourcing (OS) firms for varying between 0 and 5.
24
Fitness for Kb=0
Fitness for Kb=1
0.75
0.75
0.7
0.7
0.65
0.65
0.6
0.6 VI OS
0.55 0.5
20
40
60
80
VI OS
0.55 0.5
100
20
Fitness for Kb=2 0.75
0.7
0.7
0.65
0.65
0.6
0.6 VI OS
0.55 20
40
60
80
20
0.7
0.7
0.65
0.65
0.6
0.6 VI OS
0.55 60
40
60
80
100
Fitness for Kb=5 0.75
40
100
VI OS
0.5
100
0.75
20
80
0.55
Fitness for Kb=4
0.5
60
Fitness for Kb=3
0.75
0.5
40
80
VI OS
0.55 0.5
100
20
40
60
80
100
Figure A. 2: Mean performance development of integrated (VI) and outsourcing (OS) firm from t=1…100 for a turbulent environment (
. ).
25
Appendix B (not intended for publication) Performance for =0 0.05
OS-VI DISC DIV
0
-0.05
0
1
2
3
4
5
KB
Figure B. 1: Drivers of the difference between outsourcing and vertical integration (OS‐VI): benefits of discovery (DISC) and costs of divergence (DIV).
26
0.05
0.04
0.03
=0 =0.1 =0.2 =0.3 =0.4 =0.5
0.02
0.01
0
-0.01
-0.02
0
1
2
3
4
5
KB
Figure B. 2: Difference between outsourcing and vertical integration (OS‐VI) for varying between‐module interdependence (
).
27
KB=0
K B=1
0.05
0.05
0
0
-0.05
0
0.1
0.2
0.3
0.4
0.5
-0.05
0
0.1
0.2
KB=2 0.05
0
0
0
0.1
0.2
0.3
0.4
0.5
-0.05
0
0.1
0.2
KB=4
0
0
0.1
0.2
0.3
0.4
0.5
0.3
0.4
0.5
K B=5 0.05
0
0.5
0.05
-0.05
0.4
K B=3
0.05
-0.05
0.3
0.3
0.4
0.5
-0.05
0
0.1
0.2
OS-VI DISC DIV
Figure B. 3: Drivers of the difference between outsourcing and vertical integration (OS‐VI): benefits of discovery (DISC) and costs of divergence (DIV). The degree of technological change varies from 0 to 0.5.
28
Performance for =0
Performance for =0.1
0.05
0.05
0
0
-0.05
0
1
2
3
4
5
-0.05
0
1
2
KB Performance for =0.2 0.05
0
0
0
1
2
3
4
5
-0.05
0
1
2
KB Performance for =0.4
0
0
1
2
3
4
5
4
5
Performance for =0.5 0.05
0
5
KB
0.05
-0.05
4
Performance for =0.3
0.05
-0.05
3 KB
3
4
5
-0.05
0
1
KB
2
3 KB
OS-VI DISC DIV
Figure B. 4: Drivers of the difference between outsourcing and vertical integration (OS‐VI): benefits of discovery (DISC) and costs of divergence (DIV).
29
