Vertical Integration and Performance in the United States Computer Hardware Industry

This study examines the relationship between firm performance and the vertical integration strategies of 50 U.S. computer hardware manufacturers. We propose that between-stage and within-stage vertical integration have differential effects on performance. Our findings indicate that in the computer hardware industry within-stage vertical integration is negatively related to performance. Between-stage integration is not associated with performance. These results suggest that the core extension benefits of within-stage integration may be outweighed by the costs to manage a wide breadth of activities in more than one value-added chain. The implications for future research are discussed. Introduction and Theoretical Background Vertical integration is a crucial portion of corporate strategy as it often represents a firm's first attempt to diversify (Galbraith, 1983; Harrigan, 1985a). The relationship between vertical integration and its performance outcomes are unclear, however. Most research in this area assumes that firms vertically integrate to lower transaction costs (Williamson, 1975) and thereby increase performance (Harrigan, 1985a). But some research has shown that vertical integration may increase strategic inflexibility (Harrigan, 1985b) and systematic and bankruptcy risk (D'Aveni & Ilinitch, 1992), eventually leading to poor performance. Most recently, others suggest that there may be managerial costs of vertical integration that would lead to inferior performance (Ilinitch & Zeithaml, 1995). In this exploratory study we investigate the relationship between vertical integration and performance with respect to the type of vertical integration, between-stage and within-stage, focusing on one dimension of integration as advised by D'Aveni and Ravenscraft (1994). Vertical Integration and Performance Using the logic of center of gravity theory (Galbraith, 1983) we propose that the vertical integration strategy may have differential effects on firm performance, dependent on its type. That is, we focus on whether vertical integration is between or within the stages of the value-added chain. Between-stage vertical integration occurs between stages such as mining and manufacturing or manufacturing and distribution. Within-stage vertical integration occurs within a single stage of the value-added chain such as when a manufacturer's product is used in the manufacture of a second product in another industry (Davis & Duhaime, 1992). The center of gravity (Galbraith, 1983) refers to the stage of the vertical chain in which a firm's operations first began, and where critical lessons were learned which influenced organizational values and mind-sets (Ilinitch & Zeithaml, 1995). Related to this construct are the concepts of dominant logic (Bettis & Prahalad, 1995) and core competence (Prahalad & Hamel, 1990). The dominant logic can be viewed as the fundamental aspect of organizational intelligence and as the information filter which shapes responses to environmental change. Similarly, the core competence construct is defined as the firm's unique combination of financial, managerial, and organizational capabilities that enabled it to do some things particularly well (Collis, 1991). The dominant logic and core competence constructs therefore appear to be indicative of the driving force that leads to a firm's initial success in the industry in which it "grew up" (Galbraith, 1983). If a firm's center of gravity embodies its dominant logic or core competence, then the logic of center of gravity theory suggests that between-stage vertical integration may be detrimental to performance and within-stage vertical integration beneficial to performance. Center of gravity shifts occur when firms diversify into other industries or vertically integrate forward or backward into different stages of the production chain. Galbraith (1983) suggests that center of gravity shifts such as entry into between-stage vertical integration require the dismantling of power structures, rejection of parts of old cultures, and the establishment of new management systems. …