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Competitive Environment and the Relationship Between IT and Vertical Integration

Carlson School of Management, University of Minnesota, Minneapolis, Minnesota 55455
School of Business and Economics, Indiana University-South Bend, South Bend, Indiana 46634
The McCombs School of Business, University of Texas at Austin, Austin, Texas 78712
rayxx153{at}umn.edu
dazhwu{at}iusb.edu
pkonana{at}mail.utexas.edu

The information systems (IS) literature suggests that by lowering coordination costs, information technology (IT) will lead to an overall shift towards more use of markets. Empirical work in this area provides evidence that IT is associated with a decrease in vertical integration (VI). Economy-wide data, however, suggests that over the last 25 years the average level of VI has, in fact, increased. This paper studies this empirical anomaly by explicating the moderating impact of two measures of competitive environment, demand uncertainty, and industry concentration, on the relationship between IT and VI. We examine firms included in 1995 to 1997 InformationWeek 500 and the COMPUSTAT database. Consistent with the IS literature, the analysis suggests that IT is associated with a decrease in VI when demand uncertainty is high or industry concentration is low. However, contrary to the IS literature, IT is found to be associated with an increase in VI when industry concentration is high or demand uncertainty is low. Furthermore, as demand uncertainty increases, less vertically integrated firms invest more in IT, while as industry concentration increases, more vertically integrated firms invest more in IT. The analysis also suggests that firms' choice of the level of VI and IT investment, under different levels of demand uncertainty and industry concentration, are rational. When demand uncertainty is high or industry concentration is low, increase in VI may increase coordination and production costs. Thus, less VI is rational. However, when industry concentration is high or demand uncertainty is low, increase in VI may decrease coordination and production costs. Thus, firms' choose more VI in such industries. The implications for research and practice are discussed.

Key Words: information technology; vertical integration; coordination costs; production costs; demand uncertainty; industry concentration
History: This paper was received on January 12, 2006.