Question

If an important component of a firm's production is difficult to specify in a contract and even more difficult to enforce in its production standards, then it probable makes sense to:____________.
a) buy the component in the open market
b) use a simple short term contract
c) take the risk necessary to buy the component
d) vertically integrate upstream to build the component

Answer 1

Answer: d) vertically integrate upstream to build the component

Explanation:

Every good has a supply line from the suppliers who supply the raw  materials required to the Producers who convert it to the distributor that brings it to the final user. Vertical Integration refers to when a company such as the producers acquires another company in the supply chain to make things easier for them for instance acquiring the suppliers of a raw material that they need.  A practical example would be DeBeers acquiring rights to a diamond mine.

The company in question can engage in Vertical Integration and acquire a supplier that produces the component so that it can be able to specify how it should be made and enforcing production standards.