Tasty Chicken Inc. is a large producer of chicken for grocery stores. It usually engages in a long-term contract with these stores to maintain demand for its product. However, Tasty Chicken is regularly plagued with rising and falling prices for its supplies: particularly chicken feed and new chicks. Should Tasty Chicken vertically integrate upstream, building or buying a hatching company and an animal feed company? What are the pluses and minuses of such a decision?
What will be an ideal response?
Market transactions are generally preferred to vertical integration. Vertical integration may reduce efficiencies (thus raising costs) in the production of the upstream input. Tasty Chicken may not be able to achieve the economies of scale that may be present in the chicken feed and new chick markets. Also the company may not have the expertise to produce these inputs efficiently. Animal feed, especially, would be an activity outside of the main line of business of Tasty Chicken. The uncertainty in input prices would be experienced by Tasty Chicken whether or not it vertically integrates. Vertical integration, however, may help to ensure supply of the inputs, and possibly reduce the costs of checking input quality. One other possibility is that vertical integration could give stronger incentives to invest in firm-specific assets such as a hatchery adjacent to the chicken coops.
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