Vertical Integration and Supply Chains

Vertical integration is central to understanding patterns of economic activity, but there has been limited empirical work measuring the extent to which firms own and utilize direct upstream and downstream production links for sourcing physical inputs. We use administrative data from Karnataka, India on the movement of goods, both within and outside the firm, and find that 13% of input value can be sourced from vertically integrated upstream establishments. Of this potential 13%, somewhere between 30 40% of trade actually materializes. This suggests that the supply of physical goods along the production chain is an important rationale for vertical integration. Notably, within the set of vertically integrated firms, firms which source at least one product from within account for over three-quarters of economic activity. We look at factors associated with the decision to source a given product from within, and find that firm size, distance to outside and within firm suppliers, frequency of input requirement, product relationship specificity, volume, R&D requirements and competition both upstream and downstream are important factors. Finally, we look at factors associated with the ownership of an vertically integrated establishment and find that firm size, product specificity, R&D requirements and competition matter.