According to the Wall Street Journal, Apple has acquired start-up chip technology firm Intrinsity. The article explains that, "Some analysts believe that Intrinsity's technology is used in the A4, the Apple-designed chip used in the new iPad." As my students have learned, such an acquisition represents an example of backward integration, i.e. a firm choosing to produce its own components.
In general, I'm skeptical of vertical integration because I believe firms should pursue focused strategies and allow other companies to specialize at points of the value chain in which they have unique and superior capabilities. Moreover, I believe the transaction costs of using the market often are low enough that contracting with outside parties for component manufacturing makes more sense than in-house production.
However, this particular acquisition may have great benefits for Apple. Let's step back and look at several valid reasons to backward integrate. First, firms may do so to enhance the differentiation of their finished product. Apple certainly may want to own a chip technology firm for this reason. Second, firms may backward integrate so as to foreclose access to key inputs for key rivals. Apple may choose to keep certain innovations in chip technology away from competitors. Third, firms can benefit from backward integration if they find themselves in a situation in which asset specificity exists. What does that mean? Well, suppose that Intrinsity has to invest in assets and capabilities completely specific to Apple in order to supply parts for the iPad. Moreover, suppose Apple cannot secure that technology from any other supplier. Both firms would be beholden to each other because of assets specific to each other. That mutual dependence creates the potential for contracting difficulties if they remain independent. A solution to such challenges would be to bring the two firms together, i.e. an acquisition or merger. Thus, we have a potentially very strong rationale for backward integration in this instance.