Vertical (Dis-)Integration and Firm Performance: A Management Paradigm Revisited

Vertical disintegration in manufacturing industries has been an increasing trend since the 1990s in many countries. According to a prevailing management paradigm of focusing on core competencies, firms should have vertically disintegrated (i.e. outsourced non-core competencies) to achieve cost savings, enhance competitiveness and improve firm performance. In line with this management paradigm, most empirical studies therefore hypothesized a negative linear relationship between the degree of vertical integration and firm performance, expecting performance to rise when vertical integration decreases.In contrast to previous studies, finding mixed results, we assume an inverted u-shaped relationship, theoretically based on transaction cost economics and the resource-based view of the firm, and by considering advantages and disadvantages of vertical integration, with an optimal level of vertical integration, where firms with a too low degree of vertical integration could achieve higher performance by vertical integration, while firms with too broad vertical integration could achieve higher performance by vertical disintegration.With respect to our data based on a sample of 434 German manufacturing firms between 1993 and 2013 we find a decreasing trend of vertical integration over time. Applying multiple regression analysis, our findings suggest a positive, but diminishing relationship between the degree of vertical integration and financial performance. These two findings describe a paradox of vertical disintegration. The decreasing trend mainly emerges because lower performing firms outsourced their activities significantly whereas high performing firms do not show such a development. Overall, our results indicate that German manufacturing firms might have gone too far in in their vertical disintegration strategy by following a management paradigm which needs much more critical reflection.