Abstract: In response to the increasing market uncertainty, changing environment of international competition and rising tariff barriers and labor costs over recent years, some export-oriented enterprises have adopted vertical integration to control their production costs. This paper studies an export-oriented manufacturing company that. adopts two different vertical integration modes to produce two kinds of necessary parts. The first mode is partially vertical integration, namely, one kind of parts are manufactured in house and the other by outsourcing. The second mode is completely vertical integration, namely, both kinds of parts are manufactured in house. In order to compare the different characteristics of the two production modes, this paper establishes a partially vertically integrated system dynamics model and a completely vertically integrated system dynamics model under the premise that market demand and supplier's effective output are both random. Our simulation analysis shows that at a given tariff rate, there is a unique optimal demarcation point for manufacturers to take action and at a higher tariff rate increases, the optimal demarcation point goes downward. Moreover, by factoring labor cost into the vertically integrated model, we find that labor cost has the same effect on the manufacturer's decision.

Key words: vertical integration, export-oriented manufacturing, tariff, labor cost