The Flocking Strategy and Vertical Disintegration

In the industry center of lighters in Wenzhou, China, lighters are produced by a large number of small, vertically specialized, and agglomerated firms. Some firms specialize in assembling lighters, while the others specialize in producing parts. A perfect-competition model is developed to analyze this phenomenon, and four related factors are revealed to be involved. First, compared with standard factories, household workshops have the cost advantage in producing the parts of lighters. Next, lighters are produced by firms owned mostly by those transferring from peasants and other occupations. Due to the difficulty in financing, each of them focus on a specific component part of the product. Last, a large extent of market and agglomeration lead to low transaction costs. This makes it beneficial for the specialized firms to coordinate the production through the market. In the presence of the agglomeration effect in lowering the transaction costs, a perfectly competitive industry may have multiple equilibria. The ability of the industry of lighters in Wenzhou to expand to the high-level equilibrium by capturing the world market helps to explain the huge decreases in prices. JEL classification: D23; D41; L22; L25.