The Dynamic Limits of Specialization: Vertical Integration Reconsidered

Abstract

Existing studies, largely based in transaction cost economics, approach the issue of vertical scope as the decision of the individual firm about whether to make or buy, given the set of existing markets and well defined vertical segments. However, recent research has shown that the ability to make or buy should not be taken for granted. We argue that this applies not only to dis-integration, but also to re-integration, which often demands new ‘all-in-one’ markets. Drawing on the British building industry, we develop an inductive framework to explain why, after long periods of vertical specialization, industries shift to vertical reintegration. We observe that various groups, including professionals, play an active role in shaping the nature and the boundaries of the industry, facilitating the onset of vertical specialization, which, in turn, shapes a number of increasingly distinct knowledge bases in the industry, defining the trajectories along which capabilities evolve over time. As specialization in scope begets specialization in knowledge, difficulties in managing technical and organizational interdependencies arise, especially in the face of changing environmental conditions. The gap between what the vertically specialized system can produce, and what a changing environment demands, sets in motion a process of experimentation with integrated service provision, which is strengthened by broader social forces such as the deinstitutionalization of professions, or changes in demand structure. Reintegration is advanced by firms seeking to protect their position; enter new, related markets; or find new ways of leveraging their capabilities: Firms strategize to change their institutional environment, helping to create new all-in-one, integrated markets.