 The issue of vertical firm boundaries continues to attract interest both for economics and management research. The transaction cost economics approach, emphasizing transaction-specific assets and opportunism in order to explain discrete 'make-or-buy' decisions, dominates the literature. Nevertheless, alternative perspectives, developed under the guise of the capabilities, competence or knowledge-based theories of the firm, have gained attention recently. They focus on the evolutionary dynamics of boundaries in the context of the division of labour among firms in an industry and on what is to be divided and co-ordinated -i.e. productive knowledge. The conceptual links between this line of research, which some refer to as neo-Marshallian, and the Industrial Networks approach are explored in this paper. The paper emphasizes both a vision of firms as sets of direct and indirect capabilities, developed and combined in different ways over time, and the connectedness between inter-firm relationships. The discussion is illustrated with the cases of two firms, which are contrasted in terms of the dynamic evolution of their boundaries. The analysis made supports the argument that firms' vertical boundaries reflect their relationships with specific counterparts and the way they address through time the division and integration of knowledge through the configuration of direct and indirect, counterpart specific, capabilities.

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IntroductionDespite the growth in transport and communication infrastructure and the possibilities it has opened, there has been a renewed interest in industrial agglomerations or the spatial clustering of firms operating in the same or closely related industries. The vast literature on the subject has emphasised almost obsessively as Hudson (1999) notes, access to and generation of knowledge when firms are spatially close to each other

Franchising, Business relationships, Firms’ capabilities,