rovide an extensive review of studies looking at the reasons for vertical integration and specialization at the firm level. Reasons affecting firm behavior include, for example, transaction cost analysis (TCA) and the knowledge based view of the firm (KBV), which support vertical integration of firms. Following TCA, vertical integration provides a safeguard for the possible opportunis- tic behavior of trading partners. The KBV stresses, e.g., the increased efficiency caused by the common codes of conduct within the same firm. On the other hand, a vertically integrated industry may be inflexible in adapting to new specialized activities. This may lead to an outsourcing of such activities - as they are not the core of the industry's business - and further to vertical specialization. Vertically specialized firms are seen to be better in innovating new components, whereas vertically integrated firms handle changes of the whole system more efficiently. Model for Evolution of a Vertical Software Industry Pasi Tyrväinen Phases of Evolution The interaction of the primary and secondary software industries appears to follow a common pattern, which has been described in the model for evolution of a vertical software industry (Tyrväinen et al. 2008). The evolution is seen as iterating through several phases, shown in Fig. 1 and described below. The first phase of the model is called the Innovation phase, where the vertical industry enterprises seeking to gain competitive advantage implement their core business processes with some innovative software developed in-house. In service- oriented businesses this means automating manual work with information systems and in companies developing and producing hardware products this means imple- menting most of the software needed to use their equipment by in-house R&D personnel. In both cases the vertical industry enterprise invests increasingly in ICT and the number of software personnel tends to grow gradually. In case the enter- prise has to cut back on software workforce during ec