Exam 3
Source of value creation (aka advantage) - Unrelated Diversification
Financial economies
Exhibit 8.3 - Advantages of "make" decision: Using the make decision promotes coordination of 2 things:
1. Value chain activities 2. Innovation cycles
Types of Business Diversification: What is a dominant business firm in terms of... a) % of revenues from primary business b) Relationship of the core competencies across the SBUs
a) 70-95% b) Dominant and minor businesses share competencies
Industry value chain: a) Upstream industries are involved in _______ VI b) Downstream industries are involved in _______ VI
a) Backward b) Forward
Make vs. Buy: When ETCs are greater than ITCs, what does that mean?
- Firm has a greater incentive to vertically integrate (use the make decision)
Corporate Strategy provides answers to the key question of....
- where to compete
What are specialized assets (relating to opportunity cost)?
- Unique assets with high opportunity cost - They have significantly more value in their intended use than in their next-best use.
Corporate Strategy
- The decisions made by senior management and the goal-directed actions it takes to (1) gain and (2) sustain competitive advantage in several industries and markets simultaneously
Alliance management capability: What is it + the 3 tasks involved
- A firm's ability to effectively manage 3 alliance-related tasks concurrently: (1) partner selection and alliance formation (2) alliance design and governance (3) post-formation alliance management.
Alternatives to VI: What is tapered 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.
Core competence-market matrix: What is the strategic implication of a firm with NEW competencies in a NEW market? (what do they do + why)
- Build new core competencies to create and compete in future markets
Core competence-market matrix: What is the strategic implication of a firm with NEW competencies in an EXISTING market? (what do they do + why)
- Build new core competencies to protect and extend current market position
What is an upside of related diversification? What situation do they often experience?
- Firms are more likely to improve their performance - Diversification premium: Situation in which the stock price of related-diversification firms is valued at greater than the sum of their individual business units.
What is a downside of unrelated diversification? What situation do they often experience?
- Firms are unable to create additional value - Diversification discount: situation in which the stock price of highly diversified firms is valued at less than the sum of their individual business units.
Reasons for growth - increase market power: Discuss how this is usually achieved and the logic behind it
- Firms often consolidate industries through horizontal mergers and acquisitions (aka buying their competitors) - Less competitors = higher industry profitability = more bargaining power with suppliers and buyers
BBB framework: Relating to the 4 questions, which would result in "build"?
- High relevancy
Exhibit 8.3 - Disadvantages of "buy" decision: Describe incomplete contracting
- In some way, all contracts are incomplete to some extent because not all future contingencies can be anticipated @ the time of contracting - It is also difficult to specify expectations or measure performance and outcomes - Information asymmetry is a problem w/ contracts
Corporate Strategy Dimensions: What question is asked concerning vertical integration?
- In what stages of the industry value chain should the company participate?
Core competence-market matrix: What is the strategic implication of a firm with EXISTING competencies in an EXISTING market? (what do they do + why)
- Leverage core competencies to improve current market position
BBB framework: Relating to the 4 questions, which would result in "borrow - contracting"?
- Low relevancy - High tradability
BBB framework: Relating to the 4 questions, which would result in "buy"?
- Low relevancy - Low tradability - HIGH closeness - High integration (can easily integrate/buy out partner) (if its high - buy!)
BBB framework: Relating to the 4 questions, which would result in "borrow - strategic alliance"?
- Low relevancy - Low tradability - LOW closeness
Alternatives to VI: What is strategic outsourcing?
- Moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain.
Make-or-Buy Continuum: Pros and cons of short-term contracting
- Pro: the buyer firm can demand lower prices due to the competitive bidding process - Con: firms responding to the RFP have no incentive to make any transaction-specific investments since the contract duration is short
Core competence-market matrix: What is the strategic implication of a firm with EXISTING competencies in a NEW market? (what do they do + why)
- Redeploy and recombine core competencies to compete in future markets
Make-or-Buy Continuum - strategic alliances: What is the upside of long-term contracting (non-equity alliance) rather than short-term? What are 2 main types?
- Since the duration is longer, firms DO have an incentive to make transaction specific investments. (opposite of ST) - Types: Licensing (manufacturing) & Franchising (services)
Learning races
- Situations in which both partners in a strategic alliance are motivated to form an alliance for learning, but the rate at which the firms learn may vary. - Can be a result of co-opetition
Make-or-Buy Continuum: What are strategic alliances? What are the 3 main different governance mechanisms?
- Voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services. - 3 gov mechanisms: Long-term contracts (non-equity alliance), equity alliances, joint ventures
Corporate Strategy Dimensions: What question is asked concerning diversification?
- What range of products/services should the company offer?
When do economies of scale occur?
- When a firms average cost per unit decreases as the volume of output increases - Usually easier for large firms with large market share to achieve
Corporate Strategy Dimensions: What question is asked concerning geographic scope?
- Where should the company compete geographically in terms of regional, national, or international markets?
Vertical integration can be measured by...
- a firm's value added - the degree of VI corresponds to the # of industry value chain stages in which a firm directly participates
Make-or-Buy Continuum - strategic alliances: What is an equity alliance?
- a partnership in which at least 1 partner takes partial ownership in the other partner by buying stock or assets (equity investment)
What are transaction costs?
- all internal and external costs associated with an economic exchange, whether it takes place within the boundaries of a firm of in markets
Exhibit 8.3 - Disadvantages of "buy" decision: What is opportunism? What other "problem" does this relate to?
- behavior characterized by self-interest seeking with guile - Relates to the hold-up problem: outside parties (like a supplier) may make decisions in their own self-interest, not the interest of the buyer. Buyer firm can get held-up by this
How do firms accomplish effective alliance management?
- by creating a dedicated alliance function (usually led by a VP or director and endowed with its own resources and support staff)
Reasons for growth - reduce risk: How do firms reduce risk? What is the logic behind doing this?
- by diversifying their product/service portfolio thru competing in a number of different industries - logic: falling sales & lower performance in one sector/product may be compensated by higher performance in another
Make-or-Buy Continuum: What is a parent-subsidiary relationship?
- corporate parent owns the subsidiary and can direct it via command and control - this is the most integrated alternative to the complete "make" decision - transaction costs arise due to turf battles
Types of Business Diversification: What is a related diversification strategy? Rationale behind it (what benefits does this strategy provide)?
- derives less than 70% of revenues from a single business activity and obtains rev from other lines of business linked to the primary biz - rationale: benefit from economies of scale and scope
What is the key insight of transaction cost economics?
- different institutional arrangements (markets vs. firms) have different costs attached
Reasons for growth - reduce risk: In general, companies who diversify often attempt to achieve...
- economies of scope
Make-or-Buy Continuum: What occurs when engaging in short-term contracting?
- firm sends out requests for proposals (RFPs) to several companies - this initiates competitive bidding for contracts to be awarded within a short duration (usually less than a year)
Principal-agent problem: What is one potential way to overcome this problem?
- give stock options to strategic leaders, transforming them from agents into owners
Types of Business Diversification: How can an unrelated diversification strategy be advantageous in emerging economies?
- helps firms gain and sustain CA because it allows the conglomerate to overcome institutional weaknesses in emerging economies such as lack of capital markets and well-defined legal systems
An alliance is only considered "strategic" if...
- if it has the potential to help a firm gain and sustain competitive advantage - this occurs when knowledge and resources combine in a way that obeys the VRIO principles
Alliance management capability - alliance design and governance: What is a critical dimension of alliance success?
- interorganizational trust: trust between alliance partners
Reasons for growth - lower costs: Firms need to grow to achieve __________, and thus stake out the _________ through _________.
- need to grow to acheive *minimum efficient scale*, and thus stake out the *lowest-cost position* through *economies of scale*
Exhibit 8.3 - Disadvantages of "make" decision: What is the principal-agent problem?
- occurs when an agent (such as a manager) who performs activities on behalf of the principal (owner of firm) pursues his or her own interests, not the interest of the whole firm
What are economies of scope?
- savings that come from producing 2+ outputs at less cost than producing each individually, through using the same resources and tech
Relational view of competitive advantage
- says the sources of competitive advantage are usually not found within each individual firm, but within a strategic partnership - proposes that critical resources and capabilities frequently are embedded in strategic alliances that span firm boundaries.
Reasons for growth - increase profitability: What happens if a firm fails to achieve their growth target?
- stock price falls which reduces overall market capitalization and exposes the firm to the risk of a hostile takeover - Note: with a lower stock price, it is more costly for firms to raise the required capital to fuel future growth by issuing stock
Exhibit 8.3 - Disadvantages of "buy" decision: What are search costs? What makes these a large cost?
- the costs incurred while searching the market to find reliable suppliers, specific products/inputs needed, etc. - when there are many suppliers, these costs can be huge - if unable to find a supplier who makes the product you need, you'll have to make transaction specific investments (an advantage of make decision)
Principal-agent problem: Why is this problem almost inevitable for publicly traded companies?
- these types of companies have separation of ownership and control, so the principal (owner) must rely on an agent to make decisions, increasing risk of this problem
Exhibit 8.3 - Advantages of "make" decision: What are transaction specific investments? Ex?
- things the firm invests in that are highly valuable within the firm, but of little or no use in the external market -ex: AI; specialized robotics equipment
How do firms build alliance management capability? (what is the approach used)
- through the learning-by-doing approach - as firms move down the learning curve, they become better at managing alliances thru repeated alliance exposure
What are core competencies?
- unique strengths embedded deep within a firm that allow the firm to either (a) differentiate its products, creating higher value for customer, or (b) offering products of comparative value at lower cost
What is information asymmetry? In the market, who usually has more info?
- when one party is more informed than another because of the possession of private information - sellers often have more info than buyers - can lead to the lemon problem
With relevancy, what 2 sub-questions are asked ab existing resources?
1) Are they *similar* to the ones we need to develop AND 2) Are they *superior* to those of competitors
Corporate Strategy determines the boundaries of the firm along 3 dimensions:
1. *Vertical integration* along the industry value chain 2. *Diversification* of products and services 3. *Geographic scope* - regional, national, or global markets
Exhibit 8.3: What are the 6 advantages of using the "make" decision (aka FIRM is organizing economic activity)?
1. Ability to make *command and control decisions* by fiat along hierarchical lines of authority (aka formal ownership) 2. Coordination of value chain activities and innovation cycles 3. Transaction-specific investments 4. Community of knowledge between employees in the firm 5. Reduce BP suppliers/buyers; reduce hold up problem 6. Reduce ETCs
3-person alliance team (name + describe)
1. Alliance champion: senior level exec responsible for high-level support, oversight, and making sure alliance fits within the firm's existing portfolio and strategy 2. Alliance leader: has tech expertise and knowledge needed; also responsible for day-to-day mgmt of alliance 3. Alliance manager: serves as an alliance process resoucrce and biz integrator btwn the partners; provides training, development, and diagnostic tools
2 types of costs incurred with a related-diversification strategy (explain each)
1. Coordination costs: function of the number, size, and types of business that are linked 2. Influence costs: occur due to political maneuvering by managers to influence capital and resource allocation and the resulting inefficiencies stemming from suboptimal allocation of scarce resources
List the 4 strategic concepts relating to the 3 dimensions of corporate strategy:
1. Core competencies 2. Economies of scale 3. Economies of scope 4. Transaction costs
3 Sources of value creation (aka advantages) - Related Diversification
1. Economies of scope 2. Economies of scale 3. Financial economies
Alternatives to VI: 3 benefits of tapered integration
1. Exposes in-house suppliers/distributors to market comp. so that performance comparisons are possible (retain/fine-tune competencies) 2. Enhances flexibility since you have options 3. Paves path for innovation by combining internal and external knowledge
Exhibit 8.3: What are the 3 advantages of using the "buy" decision (aka MARKET is organizing economic activity)? Describe each briefly
1. High-powered incentives: instead of just salaried at existing firm, market offers new ventures -> capture profit -> create another venture or be acquired by existing firm. 2. Increased flexibility: can compare prices across firms before purchasing 3. Reduced ITCs
Exhibit 8.3: What are the 3 disadvantages of using the "make" decision (aka FIRM is organizing economic activity)?
1. Increase of ITCs (admin/bureaucratic costs) 2. Low-powered incentives such as hourly wages and salaries (employees may have more opportunities in open market) 3. Principal-agent problem
5 reasons why firms need to grow
1. Increase profitability 2. Lower costs 3. Increase market power 4. Reduce risk 5. Motivate management
What are 4 risks of vertical integration?
1. Increasing costs 2. Reducing quality 3. Reducing strategic flexibility 4. Increasing the potential for legal repercussions
What are the key words/outcomes associated with... 1. Build 2. Borrow 3. Buy
1. Internal development 2. (a) contracting/licensing and (b) equity alliance/joint venture 3. Acquisition
3 disadvantages of joint ventures
1. Long term solution: can entail long negotiations (time) and significant investments ($$) 2. JV managers have double reporting lines (2 bosses) 3. Rewards must be shared among partners
What are 5 benefits of vertical integration?
1. Lowering costs 2. Improving quality 3. Facilitating scheduling and planning 4. Facilitating investments in specialized assets 5. Securing critical supplies and distribution channels
2 key variables of diversification:
1. Percentage of revenue from the primary business 2. Relationship of the core competencies across the SBUs
What are the 3 general diversification strategies? Explain each.
1. Product diversification strategy: firm is active in several different product markets 2. Geographic diversification strategy: firm is active in several different countries 3. Product-market diversification strategy: firm is active in several different product markets and several different countries (combo of 1 and 2)
Types of Business Diversification: 2 subtypes of related diversification strategy (& describe each)
1. Related-constrained: executives only pursue businesses where they can apply the resources/competencies already available in the primary biz (many competencies shared) 2. Related-linked: executives pursue various businesses opportunities that share only a limited number of linkages (~some~ competencies shared)
Alliance management capability - alliance design and governance: What 3 things help alliance partners accomplish effective alliance governance?
1. Relation-specific investments 2. Interfirm trust 3. Knowledge-sharing routines
What are the 4 questions that are asked in determining whether to build, borrow, or buy?
1. Relevancy: how relevant are the firm's existing resources to solving the critical resource gap? 2. Tradability: how tradable are the targeted resources that may be available externally? 3. Closeness: how close do you need to be with your external resource partner? 4. Integration: how well can you integrate the targeted firm if you decide you need to acquire the resource partner?
Sources of value creation - Diversification: What are the 2 types of financial economies? Explain each
1. Restructuring: process of reorganizing and divesting business units & activities to refocus a company to leverage its core competencies more fully 2. Internal capital markets: occurs when a conglomerate's HQ does a more efficient job of allocating capital thru its budgeting process than what could be achieved in external capital markets
Exhibit 8.3: What are the 5 disadvantages of using the "buy" decision (aka MARKET is organizing economic activity)?
1. Search costs (biggest disadvantage!!) 2. Opportunism by other parties 3. Incomplete contracting 4. Enforcement of contracts (legal fees) 5. Increased ETCs
Make-or-Buy Continuum: Other than being fully "make" or fully "buy", what are the 3 categories of alternatives? (in order of closer to buy -> closer to make)
1. Short-term contracts 2. Strategic alliances (3 subtypes) 3. Parent-subsidiary relationships
4 main types of business diversification
1. Single business 2. Dominant business 3. Related diversification 4. Unrelated diversification: the conglomerate
What are the 3 types of specialized assets? Describe each.
1. Site specificity: assets required to be co-located/shared 2. Physical-asset specificity: asset 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 & skills; not transferrable
5 reasons firms enter into strategic alliances
1. Strengthen competitive position & reduce rivalry 2. Enter new markets 3. Hedge against uncertainty 4. Access critical complementary assets 5. Learn new capabilities
2 advantages of joint ventures
1. Strongest tie 2. Trust and commitment likely to emerge
What are the 2 alternatives to vertical integration?
1. Tapered integration 2. Strategic outsourcing
What is a conglomerate?
A company that combines 2 or more SBUs under one overarching corporation & follows an unrelated diversification strategy
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.
Make-or-Buy Continuum - strategic alliances: What is a credible commitment?
A long-term strategic decision that is both difficult and costly to reverse.
Make-or-Buy Continuum - strategic alliances: What is a joint venture?
A standalone organization created and jointly owned by two or more parent companies (long-term commitment = transaction-specific investments made)
What is a hostile takeover?
Acquisition in which the target company does not wish to be acquired.
What is diversification?
An increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes.
What is the "build-borrow-or buy" framework?
Conceptual model that aids firms in deciding whether to pursue internal development (build), enter a contractual arrangement or strategic alliance (borrow), or acquire new resources, capabilities, and competencies (buy).
Co-opetition
Cooperation by competitors to achieve a strategic objective.
What is an 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 vertical integration?
The firm's ownership of (a) its production of needed inputs or (b) of the channels by which it distributes its outputs.
What is a strategic alliance?
Voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services
Vertical market failure
When the markets along the industry value chain are too risky, and alternatives too costly in time or money
Alliance management capability - partner selection and alliance formation: a) What is partner compatibility? b) What is partner commitment?
a) Captures aspects of cultural fit between different firms b) Concerns the willingness to make available necessary resources and to accept short-term sacrifices to ensure long-term rewards
a) What are real options? b) What is the real-options perspective?
a) Choices that afford managers the right but not the obligation to make further investments b) Approach that breaks down a larger investment decision into a set of smaller decisions that are staged sequentially over time (allows firm to obtain additional info at predetermined stages)
Strategic alliances - Joint venture: a) What is it (govt mechanism)? b) How common? c) What type of knowledge is exchanged?
a) Creation of new entity by 2+ parent firms b) Least common c) Both tacit and explicit knowledge
Make vs. Buy: a) ITCs are the costs of using the ______ decision b) ETCs are the costs of using the _____ decision
a) Make b) Buy
Transaction cost economics: a) What does it help a firm to decide? b) Why is it used?
a) decide what activities to do in-house vs. what products/services to obtain from the external market (aka make vs buy) b) does this to explain and predict the boundaries of the firm
External transaction costs (ETC): a) Where do they come from? b) Main type of ETC? Ex?
a) external parties in the open market b) Contracting costs: costs of finding the right parter, costs of negotiating contract, cost of enforcing contract, etc.
Core competencies & the RBV: a) RBV says ___________ determines a firm's boundaries. b) Which types of activities should be done in-house? c) Which types of activities should be outsourced?
a) internally held knowledge underlying a core competency b) activities that draw on what the firm does well - their core competencies (ex: formulas & algorithms) c) noncore activities (ex: payroll and maintenance)
Types of Business Diversification: What is an unrelated diversification strategy in terms of... a) % of revenues from primary business b) Relationship of the core competencies across the SBUs
a) less than 70% b) few, if any, competencies shared among businesses
Types of Business Diversification: What is a single business firm in terms of... a) % of revenues from primary business b) Relationship of the core competencies across the SBUs
a) more than 95% b) Single business leverages its competencies
Strategic alliances - Joint venture: Tacit vs. explicit knowledge
a) tacit knowledge: concerns knowing *how* to do a certain task and can be acquired only through active participation in that task (cannot be codified) b) explicit knowledge: concerns knowing *about* a process or product (can be codified)
Internal transaction costs (ITC): a) Where do they come from? b) Main type of ITC? c) 3 things affecting ITC? Ex for each?
a) within the firm b) Bureaucratic & admin costs c) 3 things affecting: 1. Complexity (more complex firm = more costly) 2. Value chain activities (coordinating SBU activities) 3. People and location (salaries, benefits, office space rent)
Information asymmetries can result in...
the crowding out of desirable goods/services by inferior ones (lemon problem)
The benefits of vertical integration are a source of...
value creation
