COMM 493 Final Exam

When doing an industry analysis, it is important to consider contextual factors in addition to Porter's 5 Forces. What are examples of contextual factors?

- Political and legal factors - Macroeconomic factors - Social factors - Technology - Demographics - Global factors

Describe the takeaway points from the added value exercise

- To make profits we need to both create and capture value - The maximum profits you capture is the added value of what you bring to the market - Your outside option limits your minimum profits - Your ability to capture value is limited by the added value of competitors You should expect to earn: 1) At least your outside option 2) No more than your added value 3) At least the difference between total value and the sum of everyone else's added value

How does one define the industry for an industry analysis?

- don't start too broad - the industry chosen depends on the question you are trying to answer - consider demand, supply and geography Ex: for BMW - should industry be cars? - or luxury cars? - or luxury german cars?

Describe the first mover advantage How can firms capture their FMA? How can firms exploit their FMA? What are the risks of FMA?

- in tech, FMA is huge since the new product is a monopoly - but imitation can occur and cause first mover disadvantage How to exploit FMA: 1) Complementary assets - must invest in assets that allow them to respond to demand - common mistake is not having enough capacity to meet demand 2) Ensure barriers to imitation - patents help protect - but must avoid being 'invented around' 3) Determine if there are competitors who can imitate - based on R&D and ability to reverse engineer products Risk of FMA: 1) pioneering costs 2) FMs are prone to mistakes 3) misdiagnosis of market 4) FM may invest in inferior or obsolete tech

What is happening according to Ted Levitt?

- national companies are vulnerable to international companies due to scale economies - local firms are disappearing as the world's preferences become homogenized - manufactured goods are vulnerable to this, while services are less so

What are the 3 main lessons learned about value creation and capture? How does this relate to the golf ball case?

1) A product/service must provide benefits to the end user to create value 2) A firm must create value in order to capture the value as profits 3) Creating value does not guarantee profits; the firm must capture it through the price it charges In the golfball case, the technology does not benefit the buyer - it benefits the person who finds the buyer's ball. Therefore the buyer is not willing to pay a higher price since they do not benefit directly.

What are the 3 types of entry/exit industries?

1) Blockaded - incumbent does not need to take any action to deter entry - existing structural barriers are effective in deterring entry 2) Accommodated - incumbents should not bother to deter entry - typical of growing or rapidly changing markets - structural barriers are low - strategic barriers are ineffective in deterring entry 3) Deterred - entry is not blockaded - entry deterring strategies are effective - incumbents may engage in predatory acts to deter entry

Describe the 3 main structural barriers to entry

1) Control of essential resources by incumbent - e.g., rent-a-car 2) Economies of scale and scope - e.g., boeing and airbus 3) Marketing advantage of incumbents - e.g., coke and pepsi

Describe the 2 types of CA

1) Cost advantage: translates lower costs into higher profits; occurs if reduction in cost > reduction in price General cost drivers related to: - firm size/scope: economies of scale/scope, volume purchases, capacity utilization, specialization - cumulative experience: learning curve - transaction organization: vertical integration, contracts, management - technology: automation, logistics, coordination, transportation, communication 2) Benefit advantage: translates benefits to higher profits; occurs if increased price > increased cost General benefit drivers: - physical product characteristics: performance, durability, quality, features, aesthetics - quality of complementary goods: postal service, spare parts, warranty, repair services - sale or delivery: timeliness, convenience, location, staff - customer perceptions and image: reputation, networks, prestige, status

How can firms win the format war?

1) Ensure a supply of complements - jump starts demand - e.g., Tesla's charging stations - Tesla also releases technology so other firms can copy and introduce more charging stations 2) Make a killer application - tech so compelling it gets consumers to switch - e.g., email - can make your own but also endorse killer apps 3) Aggressive pricing and marketing - price one item in a complement low, and another high - e.g., printers and ink - e.g., razors and blade 4) Cooperation with competition - JVs avoid confusion 5) Licensing - VHS vs betamax - gain critical mass - exploit positive feedback loop

What are the 4 characteristics of sustainable strategies?

1) Heterogenous: something different from what competitors are doing - e.g. IKEA vs. west elm 2) Inimitable: something that competitors and entrants cannot replicate - if activities are replicable, then this would push prices down - complicated strategies are harder to repdroduce What do firms need to imitate us? What can we do to prevent this? - Identification: competitors must identify a strategy to imitate it; can hide strategy - Incentives for imitation: signal aggressive intentions to imitators (deterrence), or explode all available investment opportunities (preemption) - Diagnosis: rely on multiple sources of CA to create causal ambiguity - Resource acquisition: advantages based on resources which are immobile and hard to replicate Factors that protect against imitation: legal restrictions, superior access to inputs/customers, culture, network effects, reputation, switching costs, scale advantages, learning curve 3) Appropriable: something from which the firm can capture value - imperfectly mobile: another firm cannot imitate you and also cannot take you from your critical resource/capability - co-specialized resources: even if a firm could imitate one of your sources of CA, it cannot get the same benefit; the whole is greater than the sum of the parts; e.g. apple 4) Foresight: something whose value the firm has recognize before competitors - innovation, entrepreneurship

Describe: - the value creation and capture graph - how profit maximization strategies affect the graph

1) Increase revenues - increase price and increase willingness-to-pay increases value added 2) Reduce costs - lowers costs to increase value added 3) Sell more - increases quantity to increase value added

Describe the 7 strategic barriers to entry

1) Limit pricing - incumbents set prices lower than opponent entry costs - potential entrants see the price and get discouraged 2) Predatory pricing - set price below marginal cost (so you lose money) - incumbents set a reputation for 'toughness' - drives those who have entered out and deters potential entrants - illegal 3) Capacity expansion - incumbents invest in excess capacity to threaten to up capacity and lower prices upon entrance 4) Bundling - adding a substitute to the bundle may lower threat of substitutes 5) Increase cost of opponents - e.g., having high switching costs 6) Acquiring patents - legally prevents other firms from entering 7) Intensive advertising - creates brand loyalty

Describe the 4 categories of non-price competition

1) Market penetration - expand market share of existing products - heavy branding to differentiate 2) Product development - develop new products to replace old ones - ex, always 'new' laundry detergent formulas 3) Market development - find new segments for products - use brand recognition in one segment to leverage power in another - ex, Nike moving from runners to cleats 4) Product proliferation - find new markets - use brand recognition to enter - ex, Nike moving from shoes to apparel

Describe how Mcdonalds' decision to use paper straws is complicated by having heterogenous customers?

1) Mcdonalds has heterogenous customers (some care about the environment while some don't) 2) Use of paper straws will increase WTP for customers who care about the environment, but not for those don't 3) Increased costs will increase price above WTP for customers who don't care about the environment, and they will go elsewhere 4) The increased profits from customers who care about the environment must exceed the decreased profits from other customers leaving

What are some strategies for managing rivalry?

1) Price signalling - companies inc or dec prices to exchange information about their products/strategies - e.g. tit-for-tat strategy can raise prices over time and reduce price competition 2) Price leadership - one company sets the price in the industry to reduce rivalry - can charge a premium - done subtly since jointly setting prices is illegal 3) Non-price competition - compete on the basis of differentiation rather than price - does not affect price and therefore value capture - 4 categories: market penetration, product development, market development, product proliferation

What are the 3 main categories of goods? How do we communicate to customers depending on the category?

1) Search goods - easily comparable, often commodities, customers choose solely by price - e.g., gasoline, printer paper, batteries 2) Experience goods - hard to compare, consumers learn about quality after purchasing and using the product - e.g., cars, electronics, restaurants, hair salons 3) Credence goods - hard to evaluate quality even after purchasing and using the product - e.g., medical services, education, auto repairs Differentiation strategies are successful only if we can communicate product characteristics to the consumer - search good: simple disclosure - experience good: tests, advertisement, warranty - credence good: branding, reputation, advertisement

What are the 5 main benefits of global strategies?

1) cost advantage/economies of scale - the more places you are and the more often you do it, the better 2) global customer service - banks, audit services, advertising 3) national resources exploitation - gain access to raw materials and low cost of labor 4) learning benefits - exposing yourself to new markets can be a learning experience 5) competing strategically - can fight battles in one national market using profits from another (cross-subsidization)

What are 5 questions to consider before entering a foreign market?

1) is your CA based on firm or country-specific resources? - if firm-specific then can enter foreign market 2) is your product tradable and are there barriers to trade? - e.g., hard to do trade with china - may have to buy a plant and manufacture in china to reach the market 3) do you have resources and ability to have a CA in a foreign market? - marketing/distribution can be difficult - good to collaborate with local firms (ex, joint venture) 4) Can you capture the value you create in the foreign market? - may benefit from patents and licenses 5) What are the transaction costs? - if high exporting costs then want to enter foreign market

What is the general strategy for reading cases?

1. Identify the issues - what are they? - prioritize the most important issue(s) - is the issue immediate? 2. Identify causes of the issue - be qualitative and quantitative - use classroom material 3. Identify missing information and/or assumptions 4. Elaborate plans of action - evaluation of best/worst scenarios 5. Make a decision 6. Elaborate an implementation plan

What are the 5 elements of a Porter's 5 Forces analysis?

1. Internal rivalry 2. Threat of entrants 3. Threat of substitutes 4. Buyer bargaining power 5. Supplier bargaining power

Describe 3 reasons why strategy is hard

1. Trade-offs - firms don't directly control revenues and costs - rather, their decisions affect revenues and costs - these decisions involve tradeoffs and opportunity costs 2. Context - strategy tradeoff outcomes depend on economic context - consider buyers, cost structure, competitors, brand, etc - great strategies for one firm can be disastrous for another - ex: dog food delivery vs. amazon 3. Saying no - firms have limited resources - this may mean saying no to profitable things in order to do a better job at more profitable things - strategy requires saying no - ex: brewing company says no to exporting to maintain cult status

What are the tradeoffs of integration?

1. Using the market lowers production costs but increases transaction costs 2. VI lowers transaction costs, but decreases market efficiency 3. When the scale of production increases, VI firms enjoy better economies of scale

What is the main goal of a firm? Why? Where does social impact come in?

A firm's main goal is to maximize profits Why? - bankruptcy, fiduciary responsibility, board of directors, risk of being taken over Social impact: - environmental concerns, labor standards, social welfare, etc - if it increases profits, then it is within the profit maximization framework already - if it decreases profits, need support of policy and regulation

Describe horizontal differentiation What happens when a product is horizontally differentiated or undifferentiated? What are travel costs?

A good is horizontally differentiated if: - customers differ in their views about what the ideal product is - at equal prices, different customers choose different products - e.g., chocolate vs vanilla ice cream When products are horizontally: - Undifferentiated: price competition is intense - Differentiated: you can charge higher prices Travel costs: - high travel costs mean customers have high benefit when they obtain their ideal product, since they are willing to incur extra cost (e.g., walking 2 blocks farther to your favourite coffee shop) - low travel costs mean customers obtain similar preferences from a wide range of products

Describe vertical differentiation

A good is vertically differentiated if: - customers agree about what makes one product better than another - but differ in willingness to pay - at equal prices, customers would choose the same product - e.g., economy vs first class airline seat When products are vertically: - undifferentiated: price competition is intense - differentiated: can charge higher prices Note: - depending on competitors, customers and cost of quality, it may be more profitable to lower quality - prices must be chosen relative to what competitors can offer

What is the difference between the added value and value added?

Added value: your ability to add something unique, or better quality such that other firms want or need you in their joint ventures Value added: the difference between cost and willingness-to-pay on the value creation graph; you ability to create things customers value at a low cost

With regards to entry and exit, what are some asymmetries between incumbents and entrants?

Asymmetries: - sunk costs for incumbents are incremental costs for entrants - established relationships with customers and suppliers are hard to replicate - learning curve advantage - switching costs for customers

Compare and contrast diversification and specialization

Benefits of specialization: - shareholder value since conglomerates were underperforming - markets can adapt better to turbulence Motives for diversification: - growth - risk reduction - value creation * first 2 do not focus on shareholder value, so use Porter tests Porter tests: 1) attractiveness test: industry for diversification must be attractive 2) cost of entry test: cost of entry must not capitalize all future profits 3) better off test: will CA of firms be more profitable if they are brought together? Diversification can result in economies of scope: when multiple activities use less of a resource than when activities are carried out independently

Describe how Mcdonalds' decision to use paper straws could affect their value capture curve in a best and worst case scenario

Best-case scenario: - paper straws will increase costs - but increased customer benefit because customers value sustainability - or increased quantity sold - Inc benefits > Inc costs increases value added Worst-case scenario: - paper straws will increase costs - but customer benefits do not increase or increase very little because they do not value sustainability - or decreased quantity sold - Inc benefits < Inc costs so decrease value added

Porter's 5 Forces: Buyer Bargaining Power - what is it? - who are buyers? - what factors affect buyer power?

Buyer power: the extent to which a firm's buyers have added value and can hence capture value created Buyers are : end consumers or downstream firms Factors affecting buyer power: - substitutability - number of buyers compared to suppliers - size of buyers compared to suppliers - lumpiness of purchases

How can a firm sustain a CA in technological sectors?

CA due to technology superiority can be destroyed in 2 ways: 1) Creative destruction - isolating mechanisms that protect a firm's CA will not be permanent - shock comes to industries when new tech kills old tech - when tastes and tech are always changing, the only way to survive is to destroy yourself - e.g., cell phone changes over time 2) Disruptive innovation - destruction does not necessarily come from 'better tech' - some disruptive tech can be lower benefits and lower costs - CA is sustained by creative added value

Define competitive advantage (CA)

CA: a firm has a competitive advantage if it earns higher rates of economic profit compared to the average firm in the industry, i.e., if it can create and capture more value than its competitors - 32% of variation in profitability is due to CA

Describe comparative advantage and Porter's National Diamond

Definition: relative efficiencies of producing a product in one country compared to another - intl competitive advantage depends on internal factors but also on a company's natural environment Comparative advantage can be analyzed through Porter's National Diamond Theory: 1) Factor Conditions: material resources, human resources, knowledge resources and infrastructure - e.g. hollywood dominates the film industry thanks film schools and skilled workforce 2) Demand Conditions: domestic demand support innovation and quality in certain areas - e.g. germany and cars, switzerland and watches 3) Related and supporting industries: success of a market depends on the presence of suppliers and related industries within a region - competitive suppliers reinforce innovation and internationalization 4) Strategy, structure, rivalry: if you have high competition domestically, innovation and efficiency will increase - e.g., Canadian hockey is highly competitive so have better players To establish a an intl competitive advantage, your international strategy must align with your business strategy and your country's comparative advantage!! Must also exploit other countries' comparative advantages (e.g., by outsourcing)

What is the CAGE framework for cultural distance? What does this mean?

Defn: considers the Cultural, Administrative, Geographic and Economic differences between countries that companies should address when crafting international strategies Cultural differences: language, religion, values/norms Administrative differences: colonial ties, currency, membership in international organizations, political corruption/hostility Geographic differences: physical distance, time zones, climates/disease environments, size, remoteness, transportation Economic differences: rich/poor, cost and quality of resources, per capita income What does this mean? - must adapt to local markets - internationalization is preferable when benefits > costs of adapting to local markets

Porter's 5 Forces: Threat of Entrants - what factors affect threat of entrants? - how is entry a threat to profits? - how do profits affect entry? - how does threat of entrants affect added value?

Factors affecting entry: - capital requirements - economies of scale - learning curve - absolute cost advantage - brand loyalty - access to resources and distribution channels - government/legal barriers - retaliation by established firms Entry is a threat to profits because: - the market and profits must be split among more players - it can destabilize pricing if entrants aggressively try to gain market share - the possibility of entry can affect prices (contestable markets) Profits and entry: - attractive profits can encourage entry and imitation - as output expands, the demand curve dictates that prices must fall - entry will continue until prices have fallen to a 'normal' rate of return If entry is not costly, incumbents have low added value because they could easily be replaced if they disappear.

Describe the AAA framework

Idea: ASSETS allow firms to undertake ACTIVITIES that support their competitive ADVANTAGE Assets: - Resources: equipment, brand, intellectual property, human capital, experience - Capabilities: developing products, managing relationships, procuring inputs, controlling inventory, promoting sales... Activities: - Strategy, actions, decisions, choices, trade-offs Advantage: - Consistently higher profits: low turnover, loyal customers, lower prices, supplier relationships, brand image, etc

What are the implications of internationalization? How does internationalization occur? What are the 4 types of industries?

Implications: - more competition and less profitability - directly affects rivalry, threat of entry, and buyer power Internationalization occurs through: - Trade - Direct investment 4 types of industries: 1) Sheltered industries (local services) 2) Trade industries (import/export) 3) Multidomestic industries 4) Global industries

Describe how the supply chain is structured and support services

Industries face the question as to how this vertical chain should be organized. Must answer two questions to find out: 1) what assets/activities do we need to coordinate to create and capture value? 2) what is the most profitable way of combining/coordinating these activities? Single firm or different firms? Make or buy?

Describe the learning curve advantage How is it different from economies of scale?

Learning curve: a firm's average cost of production falls as cumulative product increases - the more you do, the better you get - helps prevent imitation of CA Learning curve is different from economies of scale: - LC: cost falls as CUMULATIVE production inc - EOS: cost falls as CURRENT production inc Characteristics: - a firm with little total production experiences produce at high avg cost - as the firm accumulates more experience, avg costs fall - entrants come into the market at a cost disadvantage - even as the entrant acquires experience, the incumbent retains a cost advantage - firms that learn better will benefit more from LC effects (i.e., different slope) - technological change shifts the curve (may cause a disadvantage at first, but outweighed by cost advantage in the future)

Describe how coalitions affect added value

Mergers, unions, and coalitions can change added value calculations Ex: - merge B and C into D - D's added value is 100-15 = 85 (must larger than the sum of their added values alone) - before, A had the most power, but now A needs D more than D needs A - A can now get no more than 15

What are the important main tools to remember?

Most important tools to remember: 1. Porter's 5 Forces a. Threat of entrants i. Structural barriers to entry: access to critical resources, economies of scale/scope, marketing advantage ii. Strategic barriers to entry: limit pricing, predatory pricing, capacity expansion, bundling, acquiring patents, advertising b. Threat of substitutes c. Buyer bargaining power d. Supplier bargaining power e. Internal rivalry i. Strategies for managing rivalry: price signaling, price leadership, non-price competition 2. AAA Framework a. Assets, activities, advantages b. Cost vs. benefit advantage 3. Sustaining a competitive advantage a. Heterogeneous, inimitable, appropriable, foresight b. Learning curve 4. Vertical and horizontal differentiation 5. Vertical integration a. Transaction costs: opportunism, incentives/monitoring, information, uncertainty b. Synergy 6. International expansion a. Poter's national diamond b. Benefits of global strategies c. CAGE framework 7. Technology a. Network effects b. How to win a format war: i. Ensure a supply of complements ii. Licensing iii. Working with competitors iv. Killer applications v. Aggressive pricing and marketing c. First mover advantage

What are paradigm shifts? When do they occur?

Paradigm shift: shifts in technology where companies must adopt new strategies to survive - e.g. Kodak and digital cameras Occur when: - the industry is reaching its 'natural limit' - a disruptive technology has entered the market and is serving niches previously ignored by the incumbent

What is the profit maximization formula? What are the 4 ways to make profit?

Profit = (Revenue/unit - Cost/unit) x Quantity sold Four ways to increase profit: 1) Increase willingness-to-pay and price 2) Cut costs 3) Find more customers to increase quantity 4) Sell more to existing customers to increase quantity

Why is 'profit maximization' not a strategy?

Profits are the eventual goal, but we must focus on the decisions that lead to long-term profitability! Ex: what inputs, processes, products, customers, and prices do we use?

What are 6 key ways to get your ideas to stick?

Simple Unexpected Concrete Credible Emotional Story Acronym: SUCCES

Describe the vertical integration decision tree

Step 1: Determine synergy - Synergy: when cooperation b/w firms produces combined effects greater than the sum of their separate effects - Synergy comes complementary assets, activities and customers Q1 - How big are the potential gains of coordination? Q2 - How achievable are these gains? Q3 - How costly will coordination be? Synergy = (Q1xQ2) - Q3 Step 2: What is the best way to coordinate? Option 1: Through market - BUY IT - Pros: preserves options, maximum flexibility, market price incentives - Cons: control of assets by different parties, each party has their own bottom line Option 2: Through integration - MAKE IT - Pros: control of assets, centralized direction, incentive alignment via shared bottom line - Cons: maximum commitment, minimum flexibility, no price incentives of market

Porter's 5 Forces: Substitutes and Complements

Substitutes decrease the added value of a firm, while complements boost it Force of substitutes/complements can be assessed by: - availability - relative levels of price-value characteristics - price elasticity of demand

Porter's 5 Forces: Supplier Bargaining Power - what is it? - what factors impact supplier power?

Supplier power: describes the extent to which a firm's suppliers can capture added value What factors impact supplier power? - number of suppliers relative to buyers - size of suppliers relative to buyers - number of substitutes - price rivalry threat of entry into suppliers' industry - extent of relationships with buyers - lumpiness of sales

Describe: - the nature of the technology industry - standards and the format war - network effects

Technology industry: - can be a "winner take all" industry - ownership of standards by tech firms is important for CA Format war: - firms that determine standards win the format war - standardization and compatibility benefits users and reduces cost of production - once a standard is chosen, alternative standards are locked out - e.g., USB, DVD drive, shipping containers, keyboards Network effects: - networks are primary determinants of how standards are set - the more people use a product, the more valuable it becomes to them - this is a positive feedback loop - e.g., JVC licensed the VHS to anyone so it became the standard, even though the Betamax was better tech

In what ways is the line between market and coordination blurred?

The contrast isn't actually so stark! Ways to mitigate issues... On the market end: - long-term contracts - profit-sharing agreements - repeated interactions build trust and reputation On the integration end: - individual divisions with profit and loss responsibility/incentives - explicit incentive and bonus payments for individuals - internal transfer of pricing or bidding arrangements

Porter's 5 Forces: Internal Rivalry - what factors affect internal rivalry? - price rivalry vs. non-price rivalry - when is price rivalry high in an industry? - how does rivalry affect added value?

The intensity of rivalry depends on: - Number and concentration of sellers - Product homogeneity or differentiation - Buyer switching costs - Size and frequency of sales (lumpiness) - Cost structure (fixed vs. marginal costs) - Industry capacity/demand Price vs. non-price rivalry: - price rivalry hugely threatens profits by driving prices towards marginal costs - non-price rivalry (branding, differentiation, technology races) can be made up by charging customers higher prices for better products Price rivalry is high when: - the economic structure of an industry means that small decreases in price lead to big increases in sales - i.e., a highly price elastic industry If rivalry is high, then the added value of any one firm is low.

How do we incorporate strategic interactions into our analysis?

Think of interactions as a 'business game' with: - players - actions: what the players do - rules: structure of the game - tactics: strategies of players - scope: boundaries of the game - context By predicting how your opponents will react to your actions, you can incorporate their rations into your design strategy. - required for a successful strategy

Describe the joint venture added value exercise: - if A, B and C work together they earn 100M total - A and B earn 80M total - B and C earn 40M total - A and C earn 70M total - Firms earn 15M total if they work alone

Three main principles 1) You have feet - should not agree on a deal where you make <15M (outside option = lower bound on return) - improving outside option improves negotiating position 2) They have feet too - your counterparts can make 15M if they walk away - they should not accept a deal where they make <15M (outside option) 3) You cannot take more than your added value - If you make more than your added value, then remaining players earn less than they could without you - Added value = value with player - value if player leaves - Added val, A: 100M-40M = 60M - Added val, B: 100M-70M = 30M - Added val, C: 100M-80M = 20M - Inc your added value improves your negotiating position, since you can increase the amount you demand before others opt out Prediction: - A should get 50-60M - B should get 20-30M - C should get 15-20M - note: added values can sum to >100 Amt predicted is b/w (Total-sum of max of opponent claims) and added val Know thyself - A and B's lower bound is determined by max share minus the claims of others - C's lower bound is determined by the outside option

What is the purpose/relevance of an industry analysis?

To identify key actors, the relations among them, and the attractiveness of an industry to help formulate strategy. - Where is value created and captured? - Potential partners? - Should we stay, enter or leave the industry? - How should we compete? Industry analysis is important because industries are relevant to profits! - ex, household products have very high ROE - ex, airline industry has very low/negative ROE

Entry and exist of new players into markets is a common 'game changing' event. - what are the two forms of entry? - what have studies shown? - what are the implications of these studies?

Two forms of entry: 1) An entrant may be a brand new firm 2) An entrant may be an established firm that is diversifying into a new product/market Studies found that: - conditions fostering entry also foster exist - industries have 30-40% turnover over 5 years (mostly new firms) - diversifying firms built same sized plants as incumbents and rarely closed plants - diversifying firm plants were 2x the size of new firm plants Implications of studies: - managers should account for unknown future competitors - diversifying firms pose a greater threats to incumbents

Define vertical integration How is the degree of VI defined?

VI: combination in one company of >2 stages of production normally operated by companies occupying different levels of the supply chain - e.g. Tesla - e.g. Steel can making - the degree of VI is defined by the ratio of value added to sales revenue - the more a firm makes rather than buys, the greater the value added to sales revenue and greater VI

Describe the value chain method

Value chain: looks at a firm as a set of value-creating activities Includes: - primary activities: production, sales - secondary activities: HR, finance About: - each activity has perceived benefits AND costs - allows us to identify core business areas and weaknesses - firms can reconfigure the value chain or perform activities more efficiently than rivals to create more value

What are costs of the market?

a) Opportunism - relationship-specific investments: when firms that are necessary in an interaction, they can act opportunistically - e.g. coal processors depend on coal mining plants, so coal miners can demand high prices b) Incentives and monitoring - contracts with outside firms specify product and price - gives outside suppliers incentives to produce at low cost - this is hard to monitor - e.g., toy stores selling toys made with lead paint c) Information - outside suppliers need to know produce specifications - could encroach trade secrets/intellectual property and compromise CA - coordination controls dissemination of information d) Uncertainty - contracts can be 'incomplete' since firms cannot predict everything - vertical integrations mean that everyone has the same objective and prevents problems from arising