Ch8

Core Competence - Market Matric

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

Taper Integration

Alternatives 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.

Caveat Emptor

Buyer beware

Short term contracts

Closest to "buy" on make or buy scale A firm sends out request for proposals (RFPs) to several companies which initiates competitive bidding to be awarded with a short duration, generally less than a year. No incentive to make 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. Few share, if any, competencies Unrelated diversification is advantageous in emerging economies

Geographic Diversification Strategy

Corporate strategy in which a firm is active in several different countries.

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.

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.

Types of Vertical Integration

Fully Vertical Integrated: All activities are conducted within the boundaries of the firm Not all industry value chain stages are equally profitable

Human Asset Specificity

Specialized Assets Investments made in human capital to acquire unique knowledge and skills such as mastering the routines and procedures of a specific organization, not transferable to a different employer

Physical Asset Specificity

Specialized Assets physical and engineering properties are designed to satisfy a particular customer

Alternatives to Vertical Integration

Taper Integration Strategic Outsourcing

Parent Subsidiary Relationship

Most integrated alternative to performing an activity within one's own corporate family. Corporate family owns the subsidiary and can direct it via command and control.

Information Asymmetry

Situation in which one party is more informed than another because of the possession of private information Can result in the crowding out of desirable goods and services by inferior ones. Many markets

Diversification Discount

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

Restructuring

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

Increase market power

Why firms need to grow Motivated to achieve growth to increase their market share and with it their market power. Fewer companies = higher industry profitability

Make or by

anchor each end of the continuum from markets to firms.

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. Some share competencies Less than 70% of its revenues obtained Amazon, Disney

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.

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. Benefit economies of scope: Firms can pool and share resources as well as leverage competencies across different business lines. Related Constrained Diversification Related Linked Diversification

Advantages of Firms of organizing economic activity within markets

High powered incentives Increased flexibility

Licensing

Long term contract Contracting in the manufacturing sector that enables firms to commercialize intellectual property

Site Specificity

Specialized Asset Assets required to be co located such as

Vertical Market Failure

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

Increase profits

Why firms need to grow Privately held: provide a higher return for shareholders/owners Publicly traded: stock market valuation of a firm is determined to some extent by expected future revenue and profit streams. If firms fail to achieve their growth target, their stock price often falls. Lower stock price it is more costly for firms to raise the required capital to fuel growth by issuing stock

Single Business

Types of Corporate Diversification More than 95% of its revenues is from one business. The remainder is not yet significant to the success of the firm. Single businesses leverages its competencies Google, Facebook, Coca-Cola

Three Dimensions of Corporate Strategy

1) Core competencies - unique strengths embedded deep within a firm, allows to differentiate, creating higher value 2) Economies of scale - when a firm's average cost per unit decreases as its output increases 3) Transaction costs - all costs associated with an economic advantage

Corporate Strategy Executives must determine their strategy by answering these questions:

1) In what stages of the Industry value chain should the company participate (vertical integration)? 2) What range or products and services should the company offer (diversification)? 3) Where should the company compete geographically in terms of regional, national, or international markets (geographical scope)?

Internal transaction costs

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

Franchising

Long term contract 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

Long term strategic decision that is both difficult and costly to reverse

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.

Diversification Premium

Situation in which the stock price of related diversification firms is valued at greater than the sum of their individual business units For diversification to enhance firm performance it must do at least one of the following: Provide economies of scale which reduces cost Exploit economies of scope which increases value Reduce costs and increase value

Transaction Cost Economics

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 Allows us to explain which activities a firm should pursue in house (make) versus which goods and services to obtain externally (buy). These decisions help determine the boundaries of the firm. Costs of using the market such as search costs, negotiating and drafting contracts, monitoring wok, and enforcing contracts when necessary may be higher than integrating the activity within a single firm Vertically integrate by owning production of needed inputs or the channels for the distribution of outputs. When firms are more efficient in organizing economic activity than are markets, firms should vertically integrate.

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. Site Specificity Physical Asset Specificity Human Asset Specificity

Conglomerate

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

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. Generally share competencies Less than 70% of its revenues from a single business activity and obtains revenues from other lines of business related to the primary business activity Nike, Johnson&Johnson

Advantages of Firms of organizing economic activity within firms

Ability to make command and control decisions by flat along clear hierarchical lines of authority Coordination of highly complex tasks to allow for specialized division of labor Transaction specific investments high valuable within firms, but little or no use in external market Creation of a community of knowledge meaning employees within firms have ongoing relationships, exchanging ideas and working closely together to solve problems.

Disadvantages of Firms of organizing economic activity within firms

Administrative costs because of necessary bureaucracy Lower powered incentives, hourly wages and salaries Principal agent problem

Transaction costs

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

Strategic Outsourcing

Alternatives 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 its level of vertical integration. Rather than developing their own human resource management systems, firms outsource these non core activites which can leverage their deep competencies and produce scale efects

Diversification

An increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes. Competes in several different markets simultaneously. Product Diversification Strategy Geographic Diversification Strategy Product - Market Diversification Strategy

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.

Product Diversification Strategy

Corporate strategy in which a firm is active in several different product markets.

Business Stratety

How to compete in a single product market

Why firms need to grow

Increase profits Lower costs Increase market power Reduce risk Motivate management

Risks of Vertical Integration

Increasing costs Reducing quality Reducing flexibility Increasing the potential for legal repercussions

Four Options to Formulate Corporate Strategy vis Core Competencies

Leverage existing core competencies to improve current market position Build new 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

Benefits of Vertical Integration

Lowering costs Improving quality Facilitating scheduling and planning Facilitating investments and specialized assets Securing critical supplies and distribution channels Allows firms to increase operational efficiencies through improved coordination and the fine tuning of adjacent value chain activities

Types of Corporate Diversification

Percentage of revenue from the dominant or primary business Relationship of the core competencies across the business units 1) Single Business (more than 95%) 2) Dominant Business (70-95%) 3) Related Diversification (less than 70%) 4) Unrelated diversification: conglomerate

Disadvantages of Firms of organizing economic activity within markets

Search costs Opportunism by other parties Incomplete contracting Enforcement of contracts

Internal Capital Markets

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.

Equity Alliances

Strategic Alliances A partnership in which at least one partner takes partial ownership in the other partner. Partner purchases an ownership share by buying stock or assets and making an equity investment.

Joint Venture

Strategic Alliances A stand alone organization owned by two or more parent companies They make a long term commitment which facilitates transaction specific investments.

Long Term Contracts

Strategic Alliances Work like short term contracts but with a duration of longer than one year. Help facilitate transaction specific investments

Corporate Strategy

The decisions that senior management makes and the goal directed actions it takes in the quest for competitive advantage in several industries and markets simultaneously. Provides answers to the key questions of where to compete. Determines the boundaries of the firm along three dimensions: Vertical Integration (along industry value chain) Diversification (of products and services) Geographic Scope (regional, national, or global markets)

Vertical Integration

The firm's ownership of its production of needed inputs or of the channels by which it distributes its outputs. Measured by a firm's value added: What percentage of a firm's sales is generated within the firm's boundaries?

Dominant Buisness

Types of Corporate Diversification 70-95% of its revenues from a single business, but pursues at least one other business activity that accounts for the remainder of the revenue. Dominant and minor businesses share competencies Harley-Davidson, UPS

Strategic Alliances

Voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, and services. Umbrella term that denotes different hybrid organizational forms: long term contracts Equity alliances joint ventures

Reduce Risk

Why firms need to grow Motivated to grow in order to diversify their product and service portfolio through competing in an umber of different industries. Rationale: falling sales and lower performance in one sector might be compensated by higher performance in another Achieve economies of scope

Lower Costs

Why firms need to grow Motivated to grow in order to lower their cost. Larger firm may benefit from economies of scale, driving down average costs as their output increases. Need to achieve minimum efficient scale and stake out the lowest cost position achievable through economies of scale

Managerial Motives

Why firms need to grow Research in behavioral economics suggests that firms may grow to achieve goals that benefits its managers more than their stockholders. Principal agent problem -managers ay be more interested in pursing their own interests