Firm boundaries Flashcards
What are the two ways of thinking about the scope of the firm?
Vertical and horizontal boundaries
What is meant by vertical boundaries?
This can be i.e. various production stages and this can be covered by the same or several different firms.
What is meant by horizontal boundaries?
We are staying at one stage but have to decide on how broad the scope of the product should be. e.g. covering several therapeutic areas or covering single markets.
What are benefits of vertical integration?
- Technical economies from physical integration of processes
- Avoid profit capture by powerful suppliers (demanding high prices) and distributors (insisting on lower purchase prices)
-Avoiding search, contracting, monitoring and enforcement costs - Avoiding dependencies arising from relationship-specific investments
What are costs of vertical integration?
- Units may not achieve sufficient scale to produce efficiently
- Managing structurally different business is difficult
- Specialisation may allow for better development of unique capabilities
- Incentive problems: vertical units may not remain competitive
- Negative competitive effects: competing with customers
Incentives for splitting up activities/outsourcing to other countries (veritcal):
If you don’t have the resources to have all the activities yourself. Networking effects. You can sell to many other countries rather than just yourself.
Incentives for integrating (vertical):
Making sure you are in control –> a fixed price for yourself. You are vulnerable to your own value chain - more dependent on previous steps. Another risk is that the sections do not really stay competitive bc you know you have your customer (the next in the supply chain) - cause everything is integrated.
What are the transaction costs?
1) Search costs: finding the right partners
2) Contracting costs: specifying the required parameters of a transaction (e.g. quality)
3) Monitoring and enforcement costs: monitoring partner’s compliance
The ‘make-or-buy’ decision is strongly driven by considerations of what?
Transaction costs
What can happen if you have an investment into relationship-specific assets?
This can be exploited by partner (opportunistic behaviour)
What is an ‘Hold-up’?
An action to exploit another party’s dependence
From where does hold-up arise from?
From relationship-specific investments: an asset is only useful in the context of the collaboration (sunk cost). Meaning one party imposes new, for the partner unfavourable, terms.
What is the solution if specific investments cannot be avoided (in consideration to hold-ups)?
Detailed contracts or vertical integration. Both solutions are costly and contracts may not be enforceable.
Asset specificity:
Might be necessary to engage in a specific relationship where they only have value in this agreement (i.e. input cannot come from a different supplier)
Examples of vertical boundaries hold-up:
Public procurement –> a company says ‘oh it became more expensive’ while in the middle of building - then, what does that public do? Terminate the contract or just pay much extra.
Does doing R&D in-house in pharma/biotech have a positive or negative value to the company?
POSITIVE
Can the European Union prevent M&As (in relation to horizontal boundaries)?
European union can prevent an acquisition/merger if the market power, for the aquirer, after the M&A gets too big
–> sometimes the M&A will only be allowed during some specific conditions
M&As enables a company of what (in relation to horizontal boundaries)?
1) seek ownership or increase control over a firm’s competitors through M&As among competitors
2) Economics of scale through size increase
3) Increasing market power
