Jones, Kierzkowski and Lurong (2005) provide a useful conceptual framework
for studying the determinants of vertical fragmentation. Suppose a firm produces
a particular final good in a vertically integrated process, in which all activity
takes place in one location. As the scale of production increases, the firm may
find it optimal to divide the production line into different fragments that may be
located elsewhere. The total cost of production may be lowered by outsourcing,
for example, a stage that makes relatively high use of unskilled labour, to another
location in which the unit labour costs of unskilled labour are relatively low. But the fragmentation of production is costly as it also requires services that link each
production stage, such as transportation and communication activities.