MNGT-475 Chapter 8

What is opportunism?

defined as self-interest seeking with guile

What is the 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

What is restructuring?

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

What do investments in specialized assets tend to incur because of making the specialized investment opens up the threat of opportunism by one of the partners?

high opportunity costs

Why is growth important in terms of motivating management?

- growing firms afford career opportunities and professional development for employees -firms that achieve profitable growth can pay higher salaries and spend more on benefits and perks

When organizing economic activities, what are some disadvantages of firms?

-Administrative costs because of necessary bureaucracy -Low-powered incentives, such as hourly wages and salaries; these are often less attractive motivators than the entrepreneurial opportunities and rewards that can be obtained in the open market -the principal-agent problem; situation in which an agent performing activities on behalf of a principal pursues his or her own interests

When organizing economic activities, what are some advantages of markets?

-High-powered incentives; rather than work as a salaried engineer for an existing firm, for example, an individual can start a new venture offering specialized software -Increased flexibility: transacting in markets enables those who wish to purchase goods to compare prices and services among many different providers

Describe the Dog quadrant of the BCG growth-share matrix.

-Lower left quadrant -Can't turn into anything -Underperforming businesses -Hold a small market share in a low-growth market -Low and unstable earnings -Can come from a Question Mark (upper left quadrant) or a Cash Cow (lower right quadrant) Strategic Recommendations: -Divest the business or harvest it -Implies stopping investment in the business and squeezing out as much cash flow as possible before shutting it or selling it

Describe the Cash Cow quadrant of the BCG growth-share matrix.

-Lower right quadrant -Can turn into a dog (lower left quadrant) -Can come from a star (upper right quadrant) -underperforming businesses -hold a small market share in a low-growth market -low and unstable earnings -neutral or negative cash flows Strategic Recommendations: -invest enough into cash cows to hold their current position -avoid having them turn into dogs

When organizing economic activities, what are some disadvantages of markets?

-Search costs -Opportunism by other parties: opportunism is a behavior characterized by self-interest seeking with guile -Incomplete contracting: no contract covers everything which can cause future issues and information asymmetry -Enforcement of contracts: it is difficult, costly, and time-consuming to enforce legal contracts

Describe the Question Mark quadrant of the BCG growth-share matrix.

-Upper left quadrant -Can turn into a dog (lower left quadrant) or a star (upper right quadrant) -Not clear whether they will turn into dogs or stars -Earnings are low and unstable, but they might be growing -Cash flow is negative Strategic Recommendations: -Invest in question marks to increase their relative market share so they turn into stars -If market conditions change, however, or the overall market growth slows, then a question mark SBU is likely to turn into a dog (in this case, executives would want to harvest the cash flow or divest the SBU)

Describe the Star quadrant of the BCG growth-share matrix.

-Upper right quadrant -Can come from a question mark (upper left quadrant) -Can turn into a cash cow (lower right quadrant) -Hold a high market share in fast-growing market -Earnings are high and either stable or growing Strategic Recommendations: -Invest sufficient resources to hold the star's position -Or even increase investments for future growth

Describe the unrelated diversification type of diversification.

-a conglomerate: a company that combines two or more strategic business units under one overarching corporation -form derives less than 70% of its revenues from a single business and there are few, if any, linkages among its businesses

Describe the 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 in four categories (dog, cash cow, star, and question mark), each of which warrants a different investment strategy

Why is growth important in order to lower costs?

-a larger firm may benefit from economies of scale, thus driving down average costs as their output increases -firms need to grow to achieve minimum efficient scale, and thus stake out the lowest-cost position achievable through economies of scale

Describe equity alliances.

-a partnership in which at least one partner takes partial ownership in the other partner -a partner purchases an ownership share by buying stock or assets, and thus making an equity investment -the taking of equity tends to signal greater commitment to the partnership -can give one company an inside look into the other -gaining more information can be helpful if the one company decides to acquire the other in the future -built on a credible commitment

Describe joint ventures.

-a stand-along organization created and jointly owned by two or more parent companies -since the partners contribute equity, they make a long-term commitment, which in turn facilitates transaction-specific investments

What is taper integration?

-an alternative to vertical 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 -the firm sources intermediate goods and components from in-house suppliers as well as outside suppliers -a firm sells its product through company-owned retail outlets and through independent retailers -Examples: Apple and Nike

What is strategic outsourcing?

-an alternative to vertical integration -moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain -reduces the firms level of vertical integration

Describe the single business type of diversification.

-characterized by a low level of diversification, if an, because it derives more than 95% of its revenues from one business -the remainder of less than 5% of revenue is not significant to the success of the firm

What underlying strategic management concepts guide vertical integration, diversification, and geographic competition?

-core competencies -economies of scale -economies of scope -transaction costs

Describe the related diversification type of diversification.

-corporate strategy in which 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 -broken down into: (1) related-constrained diversification strategy and (2) related-linked diversification stratagey

What are internal transaction costs?

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

Describe the dominant business type of diversification.

-derives between 70-95% of its revenues from a single business, but it pursues at least one other business activity that accounts for the remainder of revenue -share competencies in products, services, technology, or distribution

Describe a parent-subsidiary relationship.

-described the most integrated alternative to performing an activity in-house (closest to make) -the corporate parent owns the subsidiary and can direct it via command and control -transaction costs that arise a frequently due to political turf battles, which may include the capital budgeting process and transfer prices -other areas of potential conflict concern how centralized or decentralized a subsidiary unit should be run

Why is growth important in order to reduce risk?

-firms might be motivated to grow in order to diversify their product and service portfolio through competing in a number of different industries -falling sales and lower performance in one sector might be compensated by higher performance in another -attempting to achieve economies of scope

Why is growth important in order to increase market power?

-firms often consolidate industries through horizontal mergers and acquisitions to change the industry structure in their favor -fewer competitors generally equates to higher industry profitability -larger firms have more bargaining power with suppliers and buyers

What are the risks of vertical integration?

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

What are the benefits of vertical integration?

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

In terms of growth, why is increasing profits important?

-profitable growth allows businesses to provide higher returns for their shareholders -stock market valuation is determined by some extent by expected future revenue and profit streams -if firms fail to achieve their growth target, their stock price often falls

What are some examples of internal transaction costs?

-recruiting and retaining employees -paying salaries and benefits -setting up a shop floor -providing office space and computers -organizing, monitoring, and supervising work

When organizing economic activities, what are some advantages of firms?

-the ability to make command-and-control decisions by fiat along clear hierarchical lines -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 the firm, but of little or no use in the external market -Creation of a community knowledge, meaning employees within firms have ongoing relationships, exchanging ideas and working closely together to solve problems

What are strategic alliances and what categories does it include?

-voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services Includes: -Long-term contracts (licensing & franchising) -Equity alliances -Joint ventures

What is the Lemons Problem?

-when firms transact in the market, such unequal information can lead to this -first described by Nobel Laureate George Akerlof -described this situation using the market for cares as an example -Assume only two types of used cars are sold: good cars and bad cars (lemons) -Good cars are worth $8,000 and bad ones are worth $4,000 -Moreover, only the seller knows whether a car is good or is a lemon -Assuming the market supply is split equally between good and bad cars, the probability of buying a lemon is 50% -Buyers are aware of the general possibility of buying a lemon and thus would like to hedge against it -Therefore, they split the difference and offer $6,000 for a used car -This discounting strategy has the perverse effect of crowding out all the good cars because the sellers perceive their value to be about $6,000 -Assuming that to be the case, all used cars offered for sale will be lemons -Important take-away here is caveat emptor - buyer beware -Information asymmetries can result in the crowding out of desirable goods and services by inferior ones

Describe long term contracts.

-work much like short-term contracts but with a duration generally greater than one year -help overcome the drawback of having no incentive to making transaction-specific investments -help facilitate transaction-specific investments -includes licensing and franchising

What are the two types of vertical integration?

1. Backward vertical integration 2.Forward vertical integration

When discussing alternatives on the Make-Or-Buy continuum, list all alternatives from least integration to most integration.

1. Buy: arm's-length market transactions 2. Short-term contracts 3. Long-term contracts: licensing, franchising 4. Equity alliances 5. Joint ventures 6. Parent-subsidiary relationship 7. Make: activities performed in-house

Why do firms need to grow (five reasons)?

1. Increase profits 2. Lower costs 3. Increase market power 4. Reduce risk 5. Motivate management

What are the 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

Describe the four quadrants of the core competence-market matrix?

1. Lower left quadrant -Combines existing core competencies with existing markets -Here, managers must come up with ideas of how to leverage existing core competencies to improve the firm's current market position 2. Lower right quadrant -Comines existing core competencies with new market opportunities -Here, leaders must strategize abut how to redeploy and recombine existing core competencies to compete in future markets 3. Upper left quadrant -Combines new core competencies with existing market opportunities -Here, managers must come up with strategic initiatives to build new core competencies to protect and extend the company's current market position 4. Upper right quadrant -Combines new core competencies with new market opportunities -It is likely the most challenging diversification strategy because it requires building new core competencies to create and compete in future markets

What are the three main diversification strategies?

1. Product diversification strategy: an increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes 2. Geographic diversification strategy: corporate strategy in which a firm is active in several different countries 3. Product-market diversification strategy: corporate strategy in which a firm is active in several different product markets and several different countries

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

What are the 4 types of corporate diversification?

1. Single business 2. Dominant business 3. Related Diversification 4. Unrelated diversification: the conglomerate

What are the three types of specialized assets?

1. Site specificity: assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting 2. Physical-asset specificity: assets whose physical and engineering properties are designed to satisfy a particular customer 3. 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, which are not transferable to a different employer

What are two alternatives to vertical integration?

1. Taper integration 2. Strategic outsourcing

What are the two key variables regarding the types of corporate diversification?

1. The percentage of revenue from the dominant or primary business 2. The relationship of the core competencies across the business units

Corporate strategy determines the boundaries of the firm along what three dimensions?

1. Vertical integration along the industry value chain 2. Diversification of products and services 3. Geographic scope (regional, national, or global markets)

What are the three main questions related to corporate strategy?

1. Vertical integration: In what stages of the industry value chain participate? 2. Product diversification: What range of products and services should the firm offer? 3. Geographic diversification: Where should the firm compete in terms of regional, national, or international markets?

What are the benefits of taper integration?

1.It exposes in-house suppliers and distributors to market competition so that performance comparisons are impossible -Rather than hollowing out its competencies by relying too much on outsourcing, allows a firm to retain and fine-tune its competencies in upstream and downstream value chain activities 2. Enhances a firm's flexibility -For example, when adjusting to fluctuations in demand, a firm could cut back on the finished goods it delivers to external retailers while continuing to stock its own stores 3. Firms can combine internal and external knowledge, possibly paving the path for innovation

What is licensing?

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

What are benefits and drawbacks of short-term contracts?

Benefits: -allows a somewhat longer planning period than individual market transactions -the buying firm can often demand lower prices due to the competitive bidding process Drawback: -firms responding to the REP have no incentive to make any transaction-specific investments (e.g., buy new machinery to improve product quality) due to the short duration of the contract

What is the core competence-market matrix?

a framework to guide corporate diversification strategy by analyzing possible combinations of existing/new core competencies and existing/new markets

To gain and sustain competitive advantage, therefore, any corporate strategy must align with and strengthen a firm's what?

Business strategy

Firms that pursue unrelated diversification are often unable to create additional value which causes what?

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

Firms that pursue related diversification are more likely to improve their performance and in turn they create what?

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

Who advanced the core competence-market matrix?

Gary Hamel and C.K. Prahalad

What is the first key question when formulating corporate strategy?

In what stages of the industry value chain should the firm participate?

Internal transaction costs tend to ___________________ with organizational size and complexity.

Increase

Summarize vertical integration in terms of sources of value creation and sources of costs.

Sources of Value Creation: -Can lower costs -Can improve quality -Can facilitate scheduling and planning -Facilitating investments in specialized assets -Securing critical supplies and distribution channels Sources of Costs: -Can increase costs -Can reduce quality -Can reduce flexibility -Increasing potential for legal repercussions

Summarize related diversification in terms of sources of value creation and sources of costs.

Sources of Value Creation: -Economies of scope -Economies of scale -Financial economies --Restructuring --Internal capital markets Sources of Costs: -Coordination costs -Influence costs

Summarize unrelated diversification in terms of sources of value creation and sources of costs.

Sources of Value Creation: -Financial economies --Restructuring --Internal capital markets Sources of Costs -Influence costs

Can a firm fail even if it is achieving growth?

Yes - a promising business can fail because they grow unwisely - usually too fast too soon, and based on shaky assumptions about the future

What are short-term contracts?

a firm sends out requests for proposals (REPs) to several companies, which initiates competitive bidding for contracts to be awarded with a short duration, generally less than one year

What is a 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

What is a related-linked diversification strategy?

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

What is franchising?

a long-term contact 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

What is a credible commitment?

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

What is 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

What are transaction costs?

all costs associated with an economic exchange

What is diversification?

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

What is the principal-agent problem?

an issue created when firms grow in order to achieve goals that benefit managers more than stockholders

Which vertical integration is often undertaken to overcome the threat of opportunism and to secure raw materials?

backwards vertical integration

How is corporate strategy different from business strategy?

business strategy concerns the question of how to compete in a single product market

What is forward vertical integraiton?

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

What is backward vertical integration?

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

What are external transaction costs?

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

What does transaction cost economics help strategic leaders do?

decide what activities to do in-house versus what service and product to obtain from the external market

High (unrelated diversification) and low (single business) levels of diversification are generally associated with ____________ overall performance.

lower

What are economies of scale?

occur when a firm's average cost per unit decreases as its output increases

Because shareholders expect continuous growth from public companies, strategic leaders turn to _____________________ and _____________________ diversification to achieve it.

product and geographic diversification

What is information asymmetry?

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

What is corporate strategy?

the decisions that senior management makes and the goal-directed actions it takes to gain and sustain competitive advantage

What is vertical integration?

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

What are economies of scope?

the savings the come from producing two (or more) outputs or providing different services at less cost than producing each individually, though using the same resources and technology

What does applying the logic of transaction cost economics allow managers to do?

to answer the question of whether it is cost-effective for their firm to expand its boundaries through vertical integration or diversification

Why do corporate managers pursue diversification?

to gain and sustain competitive advantage

Why must strategic leaders formulate a corporate strategy?

to guide continued growth

A cumulative body of research indicates an inverted ________________ relationship between the type of diversification and overall performance.

u-shaped

What are specialized assets?

unique assets with high opportunity cost: they have significantly more value in their intended use than in their next best use

When the costs of pursuing an activity in-house are less than the costs of transacting for that activity in the market, the firm should ______________ ______________ by owning production of the needed inputs or the channels for the distribution of outputs.

vertically integrate

What is vertical market failure?

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

What key question does corporate strategy answer?

where to compete

When managers are considering to pursue diversification, what is the one critical question to ask?

whether the individual businesses are worth more under the company's management than if each were managed individually