Question

Question:18. Argyle is a large, vertically integrated firm that manufactures sweaters from a rare type of wool produced on its sheep farms. Argyle has adopted a strategy of selling wool to companies that compete against it in the market forsweaters. Explain why this strategy may, in fact, be rational. Also, identify at least two other strategies that might permit Argyle to earn higher profits.

Short answer

Answer:

The relevant strategy can be much more aggressive than the Vertical Foreclosure strategy.

Argyle will take action on the prices of the final products (sweaters) and on the input costs of the production companies that purchase wool.

Step-by-step solution

Control Competition

Argyle, a vertically integrated firm's decision to sell its wool, its raw material for making sweaters, to other manufacturing companies is consistent with the nature of the company's integration and may be rational as it may earn additional income from the sale of wool and the sale of sweaters. This structure allows Argyle to have control over the competitionas, if the income from the sale of the sweater were to be reduced due to a price strategy on the part of the competition, it may decide to increase the costs of the wool to return to an equilibrium situation where they get higher income.

Two Strategies to increase profits

More specifically, two strategies that Argyle can adopt to increase its profits according to its integrated vertical system can be the following:

Vertical Foreclosure:This strategy briefly mentioned above, pretends to make Argyle take advantage of its vertical integrated system and decide to increase the costs of its raw material, in this case, wool, and make the costs of the competition increase to the point where they decide to exit the market.However, this decision must be taken with care since part of Argyle's income comes from the sale of inputs to sweater manufacturers, therefore increasing the price of wool will decrease the demand for wool and reduce income and may affect to Argyle revenue. Therefore, the Argyle manager must consider this situation and analyze whether the increase in market power that it will have (and the future sales of sweater) generated by the exits of the competition is greater than the income that will not be obtained by the sale of wool.

Price-Cost Squeeze: This strategy can be much more aggressive than the Vertical Foreclosure strategy since Argyle will take action on the prices of the final products (sweaters) and on the input costs of the production companies that purchase wool.On the one hand, Argyle will seek to lower the prices of its sweaters below their costs to attract a greater market share while it will seek to increase the price of the wool that the manufacturer companies acquire, causing them to eventually be forced out of the market. This measure is risky for Argyle since it reduces its income through the sale of final products (sweaters) and sale of inputs (wool). However, it will be more effective, and once removed from the market to the competition of companies producing sweaters it will be in a situation of greater control of market share, which will mean higher profits from the sale of sweaters, which will allow it to compensate for the price-cost strategy carried out.