Vertical Scope and Location Choice

Abstract: This paper examines how firms’ choice of vertical scope influences location decisions and, in particular, the extent to which vertical integration affects a firm’s propensity to locate in dense industrial clusters. Industrial agglomeration generates a rich array of “external economies” but suffers the handicaps of congestion. This paper argues that since greater vertical scope allows firms to tap into rich internal factors and economies, and thus to be less dependent on “external economies,” more vertically-integrated firms are less likely to locate in dense industrial clusters. I test this idea drawing on a rich dataset of manufacturing plants established in Mexico by U.S. firms after NAFTA came into force. The empirical evidence provides strong support for the main prediction. The results suggest that the selection of vertical scope may also influence other complementary strategic decisions beyond governance itself.