MNGT 475 -- Chapter 10 Vertical Integration

application of TCE: make or buy?

TCE suggests: if the cost to produce something in house is less than the cost to produce it in the market then vertically integrate - when firms are more efficient than the market, vertically integrate - example: google in-house programmers

transaction costs of markets include search costs and costs of negotiating contracts, but usually exclude the costs incurred in enforcing contracts

false

McDonalds franchises most other fast-food chains prefer to franchise rather than directly operate their retail outlets. an advantage of franchising over vertical integration is

franchising subjects the operators of retail outlets to "high powered" incentives

McDonalds -- like most other fast-food chains -- prefers to franchise rather than directly operate its retail outlets. an advantage of franchising over vertical integration is:

franchising subjects the operators of retail outlets to "high-powered" incentives

the growth in the scope of business enterprises for most of the 19th and 20th centuries can be attributed to a drop in administrative costs of firms relative to the transaction costs of market: this resulted from

innovations in information and communications technologies and in management

in order for a manufacturer of consumer goods to maximize responsiveness to changes in consumer demand for its products

it depends upon the type of flexibility that is desired

external transaction costs

two main external costs: - searching for a firm/individual to contract with - negotiating, monitoring, and enforcing the contract

transaction costs

- any cost in marking an economic transaction - two main types: internal transaction costs and external transaction costs

long-term contracts and quasi-vertical integration

- choices not limited to vertical integration or arms-length market contracts: several intermediate types of vertical relationship (these may combine benefits of both market transactions and internalization) - key issues in designing vertical relationships: no generic solution (depends upon the resources, capabilities, and strategy of the individual firm), how is risk to be allocated between the parties, are the incentives appropriate?

internal transaction costs

- costs to organize an exchange within a firm - examples: recruiting and retaining employees, paying salaries and benefits, setting up a shop floor, providing office space and computers, etc

trends in vertical integration

- from competitive contracting to supplier partnerships (ex: in autos) - from vertical integration to outsourcing (not just components, also IT, distribution, and administrative services) - diffusion of franchising - technology partnerships - inter-firm networks - general conclusion: boundaries between firms and markets are becoming increasingly blurred

when to vertically integrate? transaction cost economics (TCE)

- helps explain and predict boundaries of the firm - helps managers decide which activities to perform in-house vs obtain from the external market

vertical integration risks

- increase in costs: in house suppliers not exposed to market competition - reduction in quality: know there is always a buyer - reduction in flexibility: example -- bethlehem steel - potential for legal repercussions: monopoly concerns

forward vertical integration

- moving ownership of activities closer to the end customer - firms enter buyer's business

backward vertical integration

- moving ownership of activities upstream to the originating inputs of the value chain - firms enter supplier's business

benefits of vertical integration

- technical economies from integrating processes e.g. iron and steel production. but doesn't necessarily require common ownership - avoids transactions costs of market contracts in situation where there are: smaller numbers of firms, transaction-specific investments, opportunism and strategic mis-represenatation, taxes and regulations on market transactions - superior coordination

when amazon.com founded amazon studios to create content for its amazon prime video streaming service, this represented:

backward integration

business strategy

concerned with how a firm competes within a particular market

corporate strategy

concerned with where a firm competes; i.e. the scope of its activities

during the final decades of the 20th century, large corporations reduced their vertical and product scope through outsourcing and refocusing, this was encouraged by

developments in IT - especially the advent of the internal and greater turbulence of the business environmet

which of the following factors is not conducive to vertical integration between two adjacent stages of production

each stage of production requiring different organizational capabilities

after an examination of how to best procure raw materials, Lincoln Corp has determined that it would cost 1 million dollars to mine for the materials themselves or 750,000 dollars to obtain these materials from Mine Co. Transaction cost economics (TCE) would thus suggest that Lincoln Corp should vertically integrate and mine for these materials.

false

vertical integration by industrial firms during the major part of the 20th century was motivated primarily by firms' desire for:

reducing risk and improving coordination

industry value chain

representation of all the various processes involved in producing goods or services

vertical integration

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

vertical integration by zara, the main division and brand of the spanish clothing firm inditex, illustrates:

the potential for vertical integration to offer flexibility in responding to rapid changes in customers product preferences

the main lesson to be drawn from the delays to the launch of Boeing's 787 Dreamliner is that, when developing complex products that embody diverse new technologies:

the principal firm must possess well-developed integration capabilities

corporate strategy decisions are primarily concerned with

the scope of the firm's activities

vendor partnerships based on relational contacts—such as the relationships between vehicle manufacturers and their component suppliers—are superior to either pure market contracts or vertical integration because:

they combine the coordination benefits of vertical integration with the incentive and flexibility benefits of market contracts

the main reason that the producers of wood pulp have often forward integrated into the production of paper is

to exploit technical economies of co-locating pulp and paper making plants while avoiding transaction costs caused by transaction-specific investments

when a farmer operates a stall in a local farmers' market; this is a form of forward integration

true

dimensions of scope

- vertical scope - geographical scope - product scope

corporate strategy is concerned with how a firm competes in a particular industry, whereas business strategy is concerned with the choice of which industries the firm competes in

false

long-term contracts involve a higher degree of commitment than vertical integration

false

the main business of the coca-cola company is manufacturing, marketing and distributing concentrate for soda drinks to bottlers in over 200 countries of the world. the corporate scope of the coca-cola company is best described as:

a broad geographical scope and narrow product and vertical scope

vertical integration is

a firm's ownership of vertically related activities

which of these activities would be considered the most forward in the value chain?

after sales service

which of the following are alternatives to vertical integration?

all: agency agreements, spot purchases, joint ventures