Module 5: Corporate & Global Strategy

According to Piskorski, the "Better Off Test" tells us:

are business units better off working together vs. being on their own

factors that drive each test

1. quality and/or cost control 2. cost of contracting 3. relationship-specific investments (hold up) 4. downstream free-riding (possibility that service you provide could be used by rival to lower their costs --> retailer that offers much product information about the products it sells)

Vertical Integration Types

Backward integration - occurs when a firm moves into a business that is "upstream" (closer to raw materials) example: if Ducati were to begin to make more supplies forward integration - occurs when firm moves into a business that is "downstream" (closer to the end consumer) example: Ducati entering sales

2 key tests to apply to any expansion in corporate scope

1. The Better-Off Test 2. The Ownership Test

3 bad things that can happen after a contract between 2 parties expires

1. one side or the other tries to negotiate better terms (though any threatened alternative to increase bargaining leverage would be less optimal and therefore costly) 2. protracted/expensive contract renegotiations (costly) 3. failure to agree and the relationship grinds to a halt (costly)

Corporate Scopes

1. vertical integration (how much of the value chain should we own?) 2. horizontal integration (in which business area should we be active?)

example of relationship-specific investment

co-location mine & power plant

Which is an example of vertical integration?

Apple opening Apple stores is an example of vertical integration (forward integration)

Which is an example of horizontal diversification?

Ducati acquiring a consumer product company

Business Unit Strategy Key Question

How to win?

Disney Case Key Notes

Pixar- just production Disney- production & distribution ( distribution gets the highest profits, especially from sequels) Arguments that they shouldn't be working together: 1. both sides would be hesitant to make long-term investments 2. high stress and time consuming Arguments that they should be working together: 1. drive down costs 2. increase WTP

As the case went on, when the relationship between Disney and Pixar was more developed, the contracts between the two firms:

Were more complex to negotiate

bad reasons for firm diversification

diversifying risks (if shareholders wanted to diversify risks, they could do it themselves) managerial hubris (empire building, piling on bonuses) "because the #s work"

the better off test

do the business units create and capture more value if they are related than they could as separate, single-business entities without formal ties? 1 + 1 > 2? factors that matter: lower costs (shared activities, shared resources, economies of scale/scope) increased WTP

the ownership test

do the business units create more value under common ownership than they would through if they were related in other ways? are any alternative relationships superior to common ownership?

good reasons for firm diversification

efficient operations (economies of scale, economies of scope) market power (power over buyers, power over suppliers, reducing competition)

a corporation is more likely to pass the tests when it ...

has some shared resources: - that widen the gap for the chain as a whole - whose services are difficult to trade efficiently via the market (relationship-specific investments, such as specialized production facilities or a knowledge that can transfer only within hierarchies)

According to Piskorski, the "Ownership Test" tells us:

is actual ownership better than an alternative arrangement

vertical scope: benefits of market transactions

powerful incentive mechanisms informational efficiencies

hold up

situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns that they may give the other party increased bargaining power and thus reduce their own profits

vertical scope: costs of market transactions

when relationship-specific investments are needed to make a transaction work the possibility that you can renege on a 'cheat' the other person makes it difficult to have a market relationship

Corporate Strategy Key Question

Where to play?

Disney Key Takeaway

Can an integrated supply chain produce a wider gap between WTP and cost than one could attain by lining up independent entities?