Quality, Vertical Integration and Adaptability

As global competition increasingly focuses on product quality, firms need to ensure the quality of their inputs. A central question is then which organizational structure best enables them to achieve this objective. Numerous papers have found that firms that produce higher quality are more likely to integrate with their suppliers. However, their focus so far has been placed on quality unobservability as the driver of integration. In this paper, we confirm the empirical relationship between quality and vertical integration but uncover an alternative mechanism in a set up where quality unobservability is not relevant: a stronger need for high quality producers to adapt efficiently to uncertain events. Based on a survey of 688 Spanish wineries and using the probability of hail as a proxy measure of uncertainty and need for adaptation, we find that the relationship between product quality and vertical integration is stronger for wineries in locations subject to more climatic uncertainty. In those cases, vertical integration comes out as an organizational form that provides high quality producers with more adaptability to preserve input quality in response to unforeseen events