Opportunism
Probably the best constraint on such opportunism is (rather than the , because of the difficulty of , writing and enforcement of ). If a reputation for opportunism significantly damages an agent’s dealings in the future, this alters the to be opportunistic.
Asymmetric information
Williamson sees the limit on the size of the firm as being given partly by costs of delegation (as a firm’s size increase its hierarchical bureaucracy does too), and the large firm’s increasing inability to replicate the high-powered incentives of the residual income of an owner-entrepreneur. This is partly because it is in the nature of a large firm that its existence is more secure and less dependent on the actions of any one individual (increasing the incentives to shirk), and because intervention rights from the centre characteristic of a firm tend to be accompanied by some form of income insurance to compensate for the lesser responsibility, thereby diluting incentives. Milgrom and Roberts (1990) explain the increased cost of management as due to the incentives of employees to provide false information beneficial to them, resulting in costs to managers of filtering information, and often the making of decisions without full information. This grows worse with firm size and more layers in the hierarchy. Empirical analyses of transaction costs have rarely attempted to measure and operationalize transaction costs. Research that attempts to measure transaction costs is the most critical limit to efforts to potential falsification and validation of transaction cost economics.
Agency theory
Consider finally the agency theory set-up. Agency theory is predominantly a theory of the employment relation in which output is jointly determined by the state realization and the effort expended by the agent. Complications arise by reason of asymmetric information and risk aversion (where the agent has better information about effort expenditure and is normally assumed to be more risk-averse), whereupon a trade-off between incentive intensity and efficient risk-bearing is posed, and/or by the need to induce efficient effort expenditure across multiple tasks. Although Bengt Holmstrom (1996) contends that boundary of the firm issues are usefully informed by this framework, applications to date are limited.
Vertical integration
Background of Crystal Group
The Crystal Group of Companies employs over 35,000 people in five locations including USA, UK, China, Vietnam, Bangladesh (new location). One of largest garment original-equipment-manufacturer (OEM) in the world and provides the quality products to its customers whom cover USA, Europe, Japan and China e.g. Uniqlo, H&M, Levi’s, Gap, Wal-Mart, JCP, M&S, etc.
Crystal Group’s total turnovers were HK$7,800 million in year 2010. Per its 5-years plan, its total turnovers will be HK$13,500 million in year 2015. During the future 5-years, its production bases will be increased from 2 locations (China & Vietnam) into 3 locations (China, Vietnam & Bangladesh) to achieve its increasing capacity needs. After year 2015, it will become one of the most productive enterprises in Garment industry. To achieve the above-mentioned capacity increase, management proposed to set up vertical integration from fabrics (raw material) to garments in Bangladesh.
New production base in Bangladesh
Cost of manufacturing in China and Vietnam has increased significantly since mid 2007 due to increase in wages, inflation, appreciation of RMB, and implementation of new labor law, which is driving China to be non-competitive against Bangladesh. Unfortunately, the cost increase cannot be passed on to customers and actually they are demanding for price reduction due to economic slow-down and pricing pressure. Some major customers are also trying to diversify their sourcing to Bangladesh due to cost, duty, potential anti-dumping risk and other political factors.
In order to maintain Crystal Group competitiveness, the strategy is to expand the offshore production facilities and move from high-cost production base (China & Vietnam) to low-cost production base (Bangladesh). Below is the summary on 5-years strategic production capacity allocation plan.
Crystal Group Production Capacity Allocation
Vertical integration from fabric to garment
With the incentive plan offer by the Bangladesh government, Crystal Group has an opportunity to set up an integrated (from fabrics to garment) manufacturing plant with its partner, Pacific Textile (one of major fabric vendors), which is also supported by Japan customer Fast Retailing (FR). In addition, the new set-up company can also buy yarns locally which can help our customer, FR, enjoying duty-free status in Japan when importing garments with yarns sourcing in Bangladesh.
In and , the term vertical integration describes a style of . Vertically integrated companies in a are united through a common owner. Usually each member of the supply chain produces a different or (market-specific) service, and the products combine to satisfy a common .
Vertical integration is one method of avoiding the . A produced through vertical integration is called a , although it might be more appropriate to speak of this as some form of .
Make or buy
In Crystal Group’s case, vertical integration (upstream) is typified by one firm engaged in different parts of production (e.g. growing raw materials manufacturing). It is intended to create a stable supply and ensure a consistent quality in their final product. It is to minimize costs by the production of garment and fabrics.
In normal business environment, suppliers are often contractors, not legally owned subsidiaries. Still, Crystal Group may effectively control a supplier if their contract solely assures the supplier's profitability. To make this complex analysis of “make or buy”, I use the following issue tree to elaborate the cost and benefit. Should they form a vertical integration by explicit ownership e.g. Joint Ventures between Crystal Group, Pacific Textile and FR?
Issue tree for vertical integration
The following issue tree could help to analyze the cost-benefit factors of the above-mentioned vertical integration, as follows:
Per the above issue tree analysis, Crystal Group’s management proposed Joint Venture holding structure to mitigate potential risk.
According to the management, the vertically integrated model allows the new set-up company for dyeing, finishing, designing, cutting and sewing in Bangladesh. Since the new company controls both fabric and garment production, there is ability to market throughout the chain by . In the mean time, it could increase market shares in Garment industry. The monopolies minimize cost and maximize profit. Improved price discrimination allows a monopolist to gain more profit by charging more to those who want or need the product more or who have a greater ability to pay.
Conclusion
Crystal group uses vertical integration for improving its business environment through well control of raw material, economics of scale, increase market share, monopolies in garment OEM market. The original founder Lo (Chairman of Crystal Group) has remained the majority shareholder (51%) and CEO in joint venture of which is a good strategy to keep the control of the new company and accomplish Crystal Group’s 2015 plan as one of the most productive enterprises in garment OEM industry.
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