GBS ch 8

When does vertical integration make sense?

-When there are shortages of raw materials -To enhance the customer's experience * Ford experienced Diseconomies of scale when tried to have full-integrated plants.

4 Risks of Vertical Integration

1) increasing costs: .In-house suppliers not exposed to market competition. .By knowing there will always be a buyer = no incentives to lower costs. .Administrative costs go up .Open market suppliers can achieve economies of scale 2) reducing quality: .By knowing there will always be a buyer = no incentives to increase quality and innovation. .External suppliers reap higher learning, experiences = higher capabilities. 3) reducing flexibility: .Vertical integration demand investments. But when there is change in the external environment and technology, it makes it difficult to change biz model. Ex: Steel company bankrupted bc tech changed and they didn't bc of full investment in vertical integration. 4) increasing the potential for legal repercussions; Monopoly concerns. EX: Pepsi Co trying to buy 2 of its biggest bottlers to control distribution.

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 recombine existing core competencies to compete in markets of the future. 4.Build new core competencies to create and compete in markets of the future.

MARKETS (vs firms): Disadvantages

1. Search costs: costs involved with searching for products, services, and suppliers. 2. Opportunism by other parties: when self-interest comes first 3. Incomplete contracting: A possible flaw in the contract. EX: not specifying the quality of the product expected from supplier. 4. Enforcement of contracts: Legal exposure is a threat

Alternatives to Vertical Integration

1. Taper Integration 2. Strategic Outsourcing

Concepts that will guide discussion of vertical integration, diversification, and geographic competition

1. core competencies: unique strengths embedded in a firm. The resourced based view admits that a firm's boundaries are delineated (outlined) by its knowledge and core competences. 2. Economies of scale: when cost per unit decreases as its output increases. 3. Economies of scope: savings that come from producing two or more outputs at less cost than producing each individually. 4. Transaction Costs: All costs associated with doing business

Benefits of Vertical Integration

1. lowering costs 2. improving quality 3. facilitating scheduling and planning 4. facilitating investments in specialized assets 5. securing critical supplies and distribution channels *Can increase differentiation and reduces costs, thus strengthening a firm's strategic position as gap between value creation and costs widens

joint venture

A stand-alone organization created and jointly owned by two or more parent companies. -Two or more partners create and jointly own a new organization -Facilitates transaction-specific investments

unrelated diversification strategy

Corporate strategy in which a firm derives less than 70 percent of its revenues from a single business and there are few, if any, linkages among its businesses. *conglomerate: 2+ SBUs under one corporation.

related diversification strategy

Corporate strategy in which a firm derives less than 70% of its revenues from a single business activity and obtains revenues from other lines of business that are linked to the primary business activity. .related-constrained diversification .related-linked diversification 2 types of costs = -coordination costs: function of the number, size, and types of businesses that are linked -influence costs: occur due to political maneuvering by managers to influence capital and resource allocation and the resulting inefficiencies stemming from suboptimal allocation of scarce resources.

external transaction costs

Costs of searching for a firm or individual with whom to contract, and then negotiating, monitoring, and enforcing the contract. - When companies transact in the open market

internal transaction costs

Costs pertaining to organizing an economic exchange within a hierarchy; also called ADMINISTRATIVE COSTS. - ex: costs of recruiting, retaining employees, paying salaries, providing office space and computers, etc.

FIRMS (vs market): Advantages

FIRMS ADVANTAGES: 1. Command-and-control decisions: - fiat (official order issued by legal authority) -hierarchical lines of authority 2. Coordination: of complex tasks to allow specialized division of labor 3. Transaction-specific investments: specialized resources valuable to the firm, but not much for the external market. EX: robots. 4. Community of knowledge: employees within firms tend to resolve problems together and creates a sense of group knowledge and routines.

FIRMS (vs market): Disadvantages

FIRMS DISADVANTAGES: 1. Administrative costs: AKA INTERNAL TRANSACTION COSTS - due to necessary bureaucracy. 2. Low-powered incentives: Like hourly wages and salary 3. Principal-agent problem: When an individual pursues her/his own interests opposed to the firm's. -to avoid: give shares to managers so they become partial owners and act on firm's best interest - separation of ownership and control when shareholders do not have access to managerial decisions.

institutional arrangements - key insight of transaction cost economics

Markets VS Firms - have different costs attached.

parent-subsidiary relationship

The most-integrated alternative to performing an activity within one's own corporate family. The corporate parent owns the subsidiary and can direct it via command and control. Ex: GM owns german carmaker Opel, but has trouble bringing the European knowhow to the US car market

Make vs Buy

Transaction cost economics allows us to decide if firm should make it in house or obtain externally. - When the costs of pursuing activity in house are the lowest, the firm should vertically integrate by owning the needed resource for input and/or output.

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, . human-asset specificity.

internal capital market

When company does a better job of allocating capital through its budgeting process than in external capital market. - allows managers to access private information and discover which unit will provide higher returns on invested capital. - allows access to capital at a lower cost. *source of value creation in a diversification strategy

Lemons Problem

With asymmetric information, low-quality goods can drive high-quality goods out of the market.

conglomerate

a company that combines two or more strategic business units under one overarching corporation; follows an unrelated diversification strategy -can be advantageous in emerging economies because they lack capital market and well-defined legal system and property rights. Ex: Yamaha and LG

core competence-market matrix

a framework to guide corporate diversification strategy by analyzing possible combinations of existing/new core competencies and existing/new markets -lower-left quadrant: leverage existing core competencies with existing market position. -lower-right quadrant: strategize how to us existing core competencies to compete in future markets. -upper-left quadrant: strategize how to build new core competencies to protect and extend existing market position. -upper-right quadrant: combines new core competencies with new market opportunities - "mega opportunities"

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 Ex: ExxonMobil leveraged its core competency in the exploration and commercialization of oil into natural gas.

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 Ex: Amazon, started by selling books, then added CD's, then gradually leveraged its online retailing capabilities into a wide array of product offerings.

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. BENEFITS: 1. exposes in-house suppliers and distributors to market competition. 2. enhances a firm's flexibility like when adjusting to fluctuations in demand. 3. it combines internal and external knowledge, allowing for innovation

Transaction costs

all internal and external costs associated with an economic exchange (doing business), whether its within the firm or market.

Diversification

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

site specificity

assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting

physical asset specificity

assets whose physical and engineering properties are designed to satisfy a particular customer Ex: bottling machinery for Pepsi (bottles have specific shape, even trademarked shapes, except for cans that are generic)

caveat emptor

buyer beware (associated with lemons problem)

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 DOWNSTREAM

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

product-market diversification strategy

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

equity alliance

partnership in which at least one partner takes partial ownership in the other (by buying stocks or assets in private companies) - helps company to gain information on a firm - helps buy time to decide if an acquisition is good

restructuring

reorganizing and divesting business units and activities to refocus a company in order to leverage its core competencies more fully. *Boston Consulting Group (BCG) growth-share matrix

Principle-Agent Problem

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

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

information asymmetries

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

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

Backward vertical integration

changes in an industry value chain that involve moving ownership of activities UPSTREAM to the originating inputs of the value chain

Vertical Integration

the firm's ownership of its production of needed inputs or of the channels by which it distributes its outputs .Can be measure by: what percentage of a firm's sales is generated within firm's boundaries? -Stages in which a firm participates

opportunity cost

the loss of potential gain from other alternatives when one alternative is chosen.

vertical market failure

when the markets along the industry value chain are too risky, and alternatives too costly in time or money *when a firm vertically integrates 2+ steps away from its core competency, it fails 2/3 of the time.

Single Business Diversification Strategy

- 95% or more of sales revenue comes from a single business - The remainder 5% is yet not significant to the success of the firm. Ex: Google has many different businesses but more than 95% of revenue is from Online Advertising

Long-term contracts

- Duration is more than a year - Helps overcome short-term contract downside of investments

the diversification-performance relationship

- High and low levels of diversification usually = lower level of overall performance - Moderate levels of diversification = higher firm performance Implying that - single business and unrelated diversification often fail to achieve ADDITIONAL VALUE CREATION. . single business: could potentially benefit from economies of scope by leveraging their core competencies into adjacent markets. . unrelated diversification: can get rid of some unrelated biz to focus on most important ones.

Dominant Business Diversification Strategy

- the firm generates between 70 and 95% of its total revenue within a single business area - pursues the remainder revenue through at least one other biz activity (usually SBU--strategic business unit-- within the firm)

Corporate strategy boundaries

.Degree of vertical integration = what stages of the value chain to participate .Type of diversification = what ranges of product and service to offer .Geographic scope = where to compete

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.

3 questions of corporate strategy

.what stages of the industry value chain should the company participate? .What range of products and services should the company offer? .Where should the company compete geographically?

4 Types of Corporate Diversification

1) single business 2) dominant business 3) related diversification 4) unrelated diversification *Derived from 2 variables: 1- percentage of revenue from dominant/primary biz 2- relationship of the core competencies across biz units

MARKETS (vs firms): Advantages

1. High-powered incentives: A person who instead of working for google, launches its own software into the market and can profit more. 2. Increased flexibility: For who wants to purchase goods/services, the market allows flexibility on comparing prices amongst different providers.

5 reasons for companies to grow

1. Increase Profits 2. Lower Costs 3. Increase market power 4.Reduce Risk 5. Motivate Management

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

1. Provide economies of scale, which reduces costs. 2. Exploit economies of scope, which increases value. 3. Reduce costs and increase value. *Other potential benefits to firm performance when following a diversification strategy include financial economies, resulting from restructuring and using internal capital markets.

Alternatives on the Make-or-Buy Continuum

1. short term contracts 2. strategic alliances *long term contracts (licensing, franchising) *equity alliances *joint ventures 3. Parent-subsidiary relationships

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.

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 .help managers decide to produce in house or obtain products/services from the external market

short-term contract

Firms send out RFPs (request for proposals) to several companies and initiates competition for the contract. BENEFITS: . Allows longer planning period than individual market transaction. . Buying firm can demand lower prices since companies are competing to get contract. DOWNSIDE: . Companies responding to RFPs have no incentive to make any investments to improve quality due to short-term contract. .EX: GM made small contracts and suppliers had to lower quality to control costs.

strategic alliance

a voluntary arrangement between firms that involves the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services. - facilitate investments in transaction-specific assets without having internal transaction costs. 1. Long-term contracts 2. Licensing 3. Equity alliances 4. Joint Ventures

Licensing

a form of long-term contracting in the manufacturing sector that enables firms to commercialize intellectual property such as a patent. Ex: A drug firm can create a product and share its secrets with another firm that will sell it through LICENSING

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. EX: Monster and Coca Cola having an equity alliance.

human asset specificity

investments made in human capital to acquire unique knowledge and skills, such as mastering the routines and procedures of a specific organization - not transferrable to a different employer.

Strategic Outsourcing

moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain *if it's outside of the country = offshoring or offshore outsourcing