Chapter 8

advantages of firms

- the ability to make command and control decisions by fiat along clear hierarchical lines of authority -coordination of highly complex tasks to allow for specialized division of labor -transaction specific investments, such as specialized robotics equipment that is highly valuable within he firm, but of little ornouse in the external market -creation of community of knowledge

disadvantages of organizing economic activity within a firm

-administrative costs because of necessary bureaucrazy -low powered incentives, such as hourly wages and salaires -the principal agent problem

advantages of markets

-high powered incentives -increased flexibility

Risks of Vertical Integration

-increasing costs -reducing quality -reducing flexibility -increasing the potential for legal repercussions

benefits of vertical integration

-lowering costs -improving quality -facilitating scheduling and planning -facilitating investments in specialized assets -securing critical supplies and distribution channels

for diversification to enhance firm performance, it must do at least one of the following:

-provide economies of scale, which reduces costs -exploit economies of scope, which increases value -reduce costs and increase value

Disadvatages of markets

-search costs -opportunism by other parties -incomplete contracting -enforcement of contracts

what is the classification scheme developed by Richard Rumelt that identifies four main types of diversification by looking at two variables

-the percentage of revenue from he dominant or primary business -the relationship of the core competencies across the business units

Executives must determine their corporate strategy by answering three questions:

1. in what stages of the industry value chain should the company participate?(vertical integration) 2. what range of products and services should the company offer ?(diversification) 3. where should the company compete geographically in terms of regional, national, or international markets?(geographic scope)

Reasons why firms need to grow

1.increase profits 2.lower costs 3.increase market power 4.reduce risk 5.motivate management

four options to formulate corporate strategy via core competencies

1.leverage existing core competencies to improve current market position 2.build new core competencies to protect and extend current market position 3.redeploy and combine existing core competencies to compete in markets of the future 4.build new core competencies to create and compete in markets of the future

single business

95% or more of revenue comes from a single business

Boston Consulting Group (BCG) growth-share matrix

A corporate planning tool in which the corporation is viewed as a portfolio of business units, which are represented graphically along relative market share (horizontal axis) and speed of market growth (vertical axis). SBUs are plotted into four categories (dog, cash cow, star, and question mark), each of which warrants a different investment strategy.

joint venture

A stand-alone organization created and jointly owned by two or more parent companies.

related diversification

Corporate strategy in which a firm derives less than 70 percent of its revenues from a single business activity and obtains revenues from other lines of business that are linked to the primary business activity.

specialized assets

Unique assets with high opportunity cost: They have significantly more value in their intended use than in their next best use. They come in three types: site specificity, physical asset specificity, and human-asset specificity.

conglomerate

a company that combines two or more strategic business units under one overarching corporation; follows an unrelated diversification strategy

equity alliances

a partnership in which at least one partner takes partial ownership in the other partner

transaction cost economics

a theoretical framework in strategic management to explain and predict the boundaries of the firm, which is central to formulating a corporate strategy that is more likely to lead to competitive advantage

taper integration

a way of orchestrating value activities in which a firm is backwardly integrated but also relies on outside market firms for some of its supplies, and/or is forwardly integrated but also relies on outside market firms for some of its distribution

transaction costs

all internal and external costs associated with an economic exchange, whether within firm or in markets

Diversification

an increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes

types of vertical integration

backward vertical integration and forward vertical integration

Dominant Business

between 70% and 95% of revenue comes from a single business, but pursues at least one other business activity that accounts for the remainder of the revenue

Forward vertical integration

changes in an industry value chain that involve moving ownership of activities closer to the end (customer) point of the value chain

Backward vertical integration

changes in an industry value chain that involve moving ownership of activities upstream to the originating (inputs) point of the value chain

unrelated diversification

corporate strategy in which a firm derives less than 70 percent of its revenues form a single business and there are few if any linkages among its businesses

geographic diversification strategy

corporate strategy in which a firm is active in several different countries

product diversification strategy

corporate strategy in which a firm is active in several different product markets

reduce risk

firms might be motivated to grow in order to diversity their product and service portfolio through competing in number of different industries

degree of vertical integration

in what stages of the industry value chain to participate

what are the three dimensions of corporate strategy

vertical integration, diversification, and geographic scope

product-market diversification strategy

corporate strategy in which a firm is active in several different product markets and several different countries

external transaction costs

costs of searching for a firm or an individual with whom to contract, and then negotiating, monitoring, and enforcing the contract

internal transaction costs

costs pertaining to organizing an economic exchange within a hierarchy; also called administrative costs

examples of core competencies

-walmarts ability to effectively orchestrate a globally distributed supply chain at low cost -infoys ability to provide high-quality information technology services at a low cost by leveraging its global delivery model. This implies taking work to the location where it makes the best economic sense, based on the available talent and the least amount of acceptable risk and lowest cost

what are the four main types of diversification

1.single business 2.dominant business 3.related diversification 4.unrelated diversification: the conglomerate

industry value chain

depiction of the transformation of raw materials into finished goods and services along distinct vertical stages, each of which typically represents a distinct industry in which a number of different firms are competing

Licensing

a form of long-term contracting in the manufacturing sector that enables firms to commercialize intellectual property

related constrained diversification strategy

a kind of related diversification strategy in which executives pursue only businesses where they can apply the resources and core competencies already available in the primary business

related linked diversification strategy

a kind of related diversification strategy in which executives pursue various businesses opportunities that share only a limited number of linkages

Franchising

a long-term contract in which a franchisor grants a franchisee the right to use the franchisor's trademark and business processes to offer goods and services that carry the franchisor's brand name

credible commitment

a long-term strategic decision that is both difficult and costly to reverse

Internal capital markets

can be a source of value creation in a diversification strategy if the conglomerate's headquarters does a more efficient job of allocating capital through its budgeting process than what could be achieved in external capital markets

restructuring

describes the process of reorganizing and divesting business units and activities to refocus a company in order to leverage its core competencies more fully

lower costs

firms are also motived to grow ignorer to lower their ost

managerial motives

firms may grow to achieve goals that benefit its managers more tan their stockholders

increase market power

firms might be motivated to achieve growth to increase their market share and with it their market power

strategic outsourcing

moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain

increase profits

profitable growth allows businesses to provide higher return for their shareholders, or owners, if privately held

principal-agent problem

situation in which an agent performing activities on behalf of a principal pursues his or her own interests

information asymmetries

situation in which one party is more informed than another because of the possession of private information

diversification discount

situation in which the stock price of highly diversified firms is valued at less than the sum of their individual business units

diversification premium

situation in which the stock price of related-diversification firms is valued at greater than the sum of their individual business units

Corporate Strategy

the decisions that senior management makes and the goal-directed actions it takes to gain and sustain competitive advantage in several industries and markets simultaneously

Vertical Integration

the firm's ownership of its production of needed inputs or of the channels by which it distributes its outputs

strategic alliance

voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services

The type of diversification

what range of products and services to offer

vertical market failure

when the markets along the industry value chain are too risky, and alternatives too costly in time or money

the geographic scope

where to compete