Social Networks and Vertical Integration

Josh Wright —  1 February 2006

My friend and co-author, Wes Hartmann (Stanford Graduate School of Business) has posted a very interesting paper with Ricard Gil (UC Santa Cruz Economics) entitled, “Airing your Dirty Laundry: Social Networks, Reputational Capital, and Vertical Integration.” As the title implies, Hartmann and Gil examine the role of social networks (ethnic-based networks in this case) on the “make or buy” decision. The abstract is here:

This paper explores the relationship between an ethnic-based social network and the decision to vertically integrate. We find that stores which are members of a social network in the laundry services industry are less likely to vertically integrate than non-members. This has three primary implications. First, the social network may be lowering costs of using the market more than it facilitates in-house production. Therefore better oursourcing opportunities in a social network may help explain a documented relationship between social networks and economic performance. Second, in the context of our empirical example, the estimated relationship suggests a role for opportunism and reputation as determinants of the boundaries of the firm. While these have typically been associated with vertical integration in the presence of asset specificity, the laundry services industry lacks this feature. Finally, while much of the existing literature on social networks has focused on the network’s ability to increase access to credit, our evidence shows that the network’s effect on credit in our empirical application is relatively small, if existent at all.

Check it out!