Fafco

Q1: Yes - FAFCO should vertically integrate their manufacturing in-house. Based on the Transaction Cost Theory we observe there is proof of Incomplete Contracting involved between FAFCO and Hercules Corporation who was manufacturing Panel Materials. The reason for this probably was demand and volume uncertainty as FAFCO is experiencing rapid growth. Also we observe lot of product design changes due to failures were numerous that expected in which the firm experienced technological uncertainty. Here the key discussion is how much relative benefit FAFCO receives from exercising control over the assets used for vertically integrating manufacturing (relative gain concept from Property Rights Approach).

The first major motivating factor for FAFCO to vertically integrate is Hercules Control over Price. Case facts suggest that FAFCO was always under this concern that Hercules would increase Price. In essence Hercules was saying, “What we supply to you is important for how much money you make and we want to be paid more for it.” With no target pricing programs, clearly Hercules is balking to give up profits to FAFCO. For FAFCO returns from internal operations are worth the firm’s effort to self manufacture. Second important factor is Control over Hercules investment decisions in production process for panels. This involves critical investment required for operational equipment, quality of and price of inputs to Hercules’s processes, value and cost drivers. There is total lack of information that Hercules is doing any such investments. Similarly third most important aspect is Control over Incentives. Based on the facts of degrading quality of panels – it is clear that FAFCO does not have any control over Hercules’s incentives that are tuned to support the firm’s strategy and are most likely to produce superior results. Fourth most important factor is FAFCO’s control over information that is valuable to both FAFCO and Hercules. The greatest benefit for FAFCO is that it...