Agglomeration, related variety and vertical integration

Several recent studies investigate the relation between geographic concentration of production and vertical integration based on the hypothesis that spatial agglomeration of firms in the same industry facilitates input procurement thereby reducing the degree of vertical integration. The present paper contributes to this debate. We are interested specifically in assessing the effect of specialization compared to variety, in local production systems, in these decisions. Using a dataset of 24,663 Italian business groups for 2001, we estimate Tobit models to investigate the influence of these forces on the degree of vertical integration. Following a methodology developed by Fan et al. (2009), we construct an index of vertical integration in business groups using information on the activities of firms belonging to the same group, and information from input-output tables on the exchanges between industries. Our evidence supports the hypothesis that vertical integration choices are influenced by agglomeration forces. Moreover, we find that the higher the variety in the local system the lower the need for firms to integrate activities since they can acquire intermediate goods and services from within the local system. Finally, we show that it is not variety ‘per se’ that matters for vertical integration choices, but the presence of technologically related activities.