Friday, September 9, 2016
Organization and transaction costs
Transaction costs are the necessary expenses your organization has to pay in order to participate in the market. When organizations decide to merge it will always have transaction costs to complete the move. This summer, I had a job with a food distribution company and halfway through the summer our company merged with a company called Rouquette that was the producer of the food we shipped. This merger allowed our company to expand but had transaction costs involved in it. We had to buy another warehouse to be able to hold all the inventory they were going to be providing us which was very expensive. The new warehouse we bought also needed some renovations in order to meet FDA standards which required us to hire people to do the labor and had to buy all the necessary equipment to meet the standards. All of this took just over a month which set the company's profits back in the short term due to the transaction costs but now the company is doing better than ever due to the expansion the merger allowed. The company is now the main sugar distributer for all Wrigley Gum products. It was a great experience being able to be apart of two organizations merging because it let me see first hand how effective transaction costs can be and it was interesting to see the micromanagement of each company when the merger was occurring.
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This post is rather skimpy and is surely under the 600 word minimum requirement that is stated in the syllabus. What I suggest here is that in response to my comment you write quite an extensive comment. In the future please put in the requisite effort to produce a post of the required length.
ReplyDeleteThe merger you described would be referred to as vertical integration, a subject we will consider at some length in our course. Vertical integration happens when an upstream firm, which produces an intermediate product, merges with a downstream firm that uses the intermediate product as input and then sells its product to the market. The underlying economic question is when does vertical integration make sense and when is it preferable for the two firms to remain separate?
An obvious question to ask in the case you mention is whether prior to merger your food distribution company had other suppliers of food it dealt with or was Rouquette the sole supplier? Likewise, from Roquette's point of view, did it deal with other distributors prior to the merger or only with your company?
When there are many suppliers of the intermediate product and they produce products that are reasonably good substitutes for one another, vertical integration is not preferred. It is better to let competition between these various suppliers play out. Similarly if there are many different downstream firms that all demand that same intermediate product competition between them is preferred to vertical integration.
The type of merger you describes makes the most sense in the case of bilateral monopoly. So in your response to my comment, you might spend some time discussing the pre-merger environment and characterizing what that situation looked like.
I apologize professor about the shortness of the post, will not happen again.
ReplyDeleteRegarding your comments, the company originally started as a small trucking company that would distribute local diary products. Being located in a rural area it was easy to obtain fresh diary products and deliver them to local grocery stores in the area. Essentially our only supplier was local farmers that wanted to sell their product beyond their local farmers market. Rouquette relocated right outside of our warehouse 6 years ago and offered us to be their sole distributor of their product. Accepting the offer, the company immediately grew and Rouquette doubled our warehouse size even before we had to buy the new warehouse that I touched upon in the original post. Through being Rouquette’s distributor we began to move from local grocery stores to having contracts such as Wrigley, Colgate, Mondelez, and other large corporations that purchased Rouquette’s sweetener products. We had to part ways with the local farmers in order to be able to suffice the demands of Rouquette’s output and continue to grow because this was a much better business opportunity than dealing with farmers. Through this we vertically integrated with Rouquette and it was beneficiary for both parties. We provided Rouquette the warehouse space and distribution methods so they could keep expanding production while they provided us multiple contracts and the product needed to fulfill those contracts. I do not believe it is a bilateral monopoly as you said because we do only receive product from Rouquette but we have multiple corporations that we distribute to. I appreciate your comments on my blog as they have opened my mind towards a new side of the merger and I would like to hear your thoughts on this additional information I added.