Integrative Capabilities, Vertical Integration, and Innovation Over Successive Technology Lifecycles

The analysis presented here provides a new explanation for why vertically integrated and specialized firms may continue to coexist as industries evolve, especially during time periods when conditions unequivocally favor lower cost specialized firms. In contrast to the common view that firms should match their organizational form to the prevailing nature of technology, vertically integrated firms may rationally choose to stay integrated and bear the sunk costs of developing integrative capabilities as well as the ongoing costs of maintaining them, even when they lose money during some time periods due to competition from lower cost specialized firms. In particular, in industries characterized by successive systemic innovations, which entail interdependence across stages of production, some firms may remain vertically integrated to maintain their capability to innovate over multiple cycles of technological innovation. The results hinge on the sunk costs of long-lived investments in integrative capabilities. An extension to the analysis suggests that vertically integrated firms may retain their organizational form to pioneer systemic innovations in other industries, including industries not subject to frequent technology lifecycles—providing another explanation of product-market diversification and market entry over time.