The Lim-O: An exercise in market failure and vertical integration

Abstract

Vertical integration and more generally, corporate-level strategy, are rather difficult for students to grasp, being such abstract concepts. This exercise provides a way for participants to experience issues leading to market failure (and vertical integration) by engaging them as buyers and sellers of a component for very unique car—a limousine with square tires. Suppliers for square tires are solicited, followed by post-contract renegotiation. The ensuing frustration and heated interactions are leveraged to explain the concepts of asset specificity and uncertainty, causing elevated risk, leading to lack of suppliers and buyers, and forcing firms to become their own suppliers.

Keywords:

• Corporate strategy
• market failure
• vertical integration

Notes

1 The theory is alive and vibrant to this day. The term “transaction cost economics” was searched in abstracts of peer-reviewed, scholarly journals. ABI/INFORMS reports 494 results in the past 10 years (2011–2020) and 243 in the past five years (2016–2020); Proquest reports 489 and 276 (respectively); and EbscoHost reports 550 and 289 (respectively). Moreover, the theory is not restricted to scholarly journals and is commonly included in strategic management textbooks (for instance, Dess, McNamara, Eisner, & Lee (2019, pp. 181–182), Grant (2019, pp. 297–312), Hitt, Ireland, & Hoskisson (2017, p. 220), Rothaermel (2018, pp. 271–285), and Wheelen, Hunger, Hoffman, & Bamford (2015, pp. 188–191)). In terms of areas where the theory has been applied, Masten (1996) lists these: aerospace, automotive, electric power generation, fast food, natural gas, ocean shipping, petroleum, coke refining, rail transportation, soft drink distribution, shoe manufacturing, and tuna processing. An article search of the last five years (2016–2020) found further applications to marketing, information technology, computing, construction, social enterprises, organizational change, public budgeting, public schools, venture capital, agribusiness, finance, health care, sustainability, supply chain, production, franchising, defense management, hospitality, innovation, public transportation, accounting, and land use.

2 Two accessible sources for the topic of vertical integration are Anand, Khanna, & Rivkin (2000) and Stuckey & White (1993).