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Flashcards in Competitive Strategy 2 Deck (64):

Vertical Integration and Outsourcing: Control

- firms want to control investment decisions in supplier resources and capabilities that are STRATEGICALLY IMPORTANT
- therefore, these activities are more likely to be specialized within the firm


Types of Control Problems

1. Suppliers price - can alleviate by dividing and conquering (don't rely on just one supplier)
2. Supplier investment in the asset or activity that produce the input - firm wants to make sure its own value and cost drivers increase as much as possible from its suppliers investment
3. Supplier incentives - alignment with buyer strategy
4. Supplier handling of sensitive information - firm is exposing itself to risk - can they trust the supplier?


The Efficient Boundaries Model

- model compares in-house and market costs as supplier specialization to the buyer increases
- examines both transaction and production costs
- assumes market supply is always more attractive when the input is not customized to the buyer (as pieces get more complicated, supplier will charge more)
- assumes in-house production is more attractive when the cost advantage declines due to customization or a lower volume of purchases


Patterns of Vertical Integration

1. Initial Market purchase - low buyer competence/low strategic competence
2. Strategic importance rises, the supplier can't give the firm the control it needs, partnership fails
3. The firm vertically integrates as it invests in building capabilities to increase its competence - high buyer competence/high strategic importance
KEY: the firm has a strong incentive to continue investing in the activity since it is strategically important
ALSO: the opposite could be true


Patterns of Outsourcing

1. Initial vertical integration of a strategically important activity - high buyer competence/high strategic competence
2. the firm's competence lowers relative to its competitors - low buyer competence/high strategic importance (firm's partnership with supplier gives it control over investment decisions)
3. The partner may fail to cooperate effectively so the firm invests in new capabilities to increase its competence OR reduces the strategic importance of the activity and buys from a standard market supplier


Key Points re: Vertical Integration/Outsourcing

1. Control needs to dominate vertical integration decisions (e.g. Unilever and horsemeat as well as Nestle- traceability)
2. Control and buyer competence affect outsourcing
3. Vertical Integration almost always involves a change in the way the activity is executed (not frozen in time)
4. Vertical Integration and outsourcing decisions are ALWAYS made for an activity or for an asset with associated activities NOT for a product or input i.e. not for the final product


Volume and Technological Uncertainty

volume uncertainty = the higher it is, leads to higher levels of vertical integration (ESPECIALLY when competition is weak)

technological uncertainty = the higher it is, leads to lower levels of vertical integration (ESPECIALLY when competition is strong)...changing so often, don't want to be married to a particular, pass the risk on to the suppliers


The Problem of Consistency

- gains from consistency among activities determine in part the firm's need for control over them
- system-wide benefits from coordination inhibit the outsourcing of a single activity


Strategic Boundaries over the Industry Life Cycle

- in early stages of industry development, firms are integrated bc demand for inputs is too small to attract entry of suppliers
- as it grows, suppliers enter and produce inputs for many firms
- as demand drops due to the introduction of substitutes, suppliers exit and firms re-integrate production


Strategic Sourcing Framework

- derived from the importance of both control needs and relative competence
- high strategic value/high relative competence = make
- low strategic value/low competence = buy
- high strategic value/low competence = process innovation (control as much as possible)
- low strategic value/high competence = make or buy

e.g. Drax's new technology from biomass was important enough to spend $ to set-up a system to produce themselves


Conditions that Foster Partnerships (2)

1. The activity has high strategic value to the firm
2. The firm has a low competency to perform the activity


Trends in Partnership Foundation (7)

1. Global integration of manufacturing and service industries
2. Diffusion of Japanese partnering practices
3. Diffusion of partnerships with suppliers (formed in response to competition by Japanese durable goods)
4. Rise of outsourcing
5. Rise of supply chain management practices
6. Growth of technology intensive industries
7. Emergence of regional networks


Global Integration and Partnering

- partnering is the preferred mode of entry into foreign markets
- opportunities for foreign expansion are increasing as the developed world expands
- partnering enables control over up-or-downstream activities


Rise of Outsourcing

- trend first began in the US and rapidly spread through EU
- need for additional cost reduction in the face of rising competition
- entry of firms designed to induce customers to outsource (e.g. IT, HR, logistics)
- viability of firms offering alliances as type of supply relationship


Rise of Supply Chain Management Practices

- focus on delivery as a value driver and on cost reduction through improved practices in logistics
- involves establishment of close relationships btw producers and distributors as well as btw producers and suppliers (e.g. often with logistics providers such as UPS)


Disadvantages of Partnerships (4)

1. Reduced control over decision-making
2. Strategic Inflexibility (conflicting interests, committing to each other's resources)
3. Weaker organization identity (start-ups may lose control over investment and other types of decisions)
4. Anti-trust issues (to mitigate, demonstrate the partnership provides significant benefits)


Partner Selection Considerations

*overall, need to be good enough to know what you can and can't do before you can find a partner
1. Current capabilities of the potential partner (contribution to value and cost drivers)
2. Projections of the partner's future capabilities
3. Comparison and assessment of alternative partners


Managing Partnerships

1. Maintaining a convergence of purpose between partners
2. Ensuring a consistency of positioning across the partners
3. Managing the interface between the partners


Ensuring a Consistency of Positioning Across the Partners

- partnerships are managed at various levels in each firm and each level (CEO, tech staff, operating managers, etc.) will have its own perspective
- managing these differences in perspective is critical to achieving partnership goals


Framework for Global Competition

1. The economic logic of global competition depends on the costs and benefits of geographical location (regional advantages and national advantages) - e.g. Heinz is going against food trends in the US so expanding globally
2. Global strategy is beyond leveraging benefits of the firm's country of origin (includes leveraging firm's capabilities and resources across national markets)
3. Successfully competing as a global firm means achieving higher economic performance that indigenous rivals ("how am I doing?" is relative to the locals)


Framework for Global Competition

1. The economic logic of global competition depends on the costs and benefits of geographical location (regional advantages and national advantages)
2. Global strategy is beyond leveraging benefits of the firm's country of origin (includes leveraging firm's capabilities and resources across national markets)
3. Successfully competing as a global firm means achieving higher economic performance that indigenous rivals ("how am I doing?" is relative to the locals)


Motivations for Partnerships (5)

1. Technology transfer and development (common btw start-ups and established companies in the tech industry or coalitions of standard firms for dominance - includes patent sharing, etc.)
2. Market access (partnering with local firm to gain access to new geographic market including local regulation) - e.g. CARMAKERS need to form partnerships to compete in the industry
3. Cost Reduction (economies of scope, learning curve)
4. Risk reduction (esp. in firms with high growth rates and large projects like telecommunications where resources are limited)
5. Change in industry structure (alliances separates competitors into clusters that compete with each other, firms not allied must be able to match combined capabilities of cluster)


Maintaining a Convergence of Purpose Between Partners

- partners are likely to have multiple dimensions and they will differ on their goals on each
- mutual understanding of these goals improves inter-firm coordination over the coarse of a relationship
e.g. McDonalds in India - clash of business culture and expectations


Managing the Interface Between the Partners

- the interface between partners should be designed to achieve the partnership's goals
- interface may include: a separate unit to manage the partnership (joint venture), a separate unit in each firm to manage, Ad Hoc relationships between the firms, function by function
e.g. pharma industry - adult discussion vs. hostile takeover


Why do Regions Matter?

1. Labor force pooling among firms
2. Use of specialized local suppliers
3. Technological spillovers in the region

- overall, a win-win atmosphere
- regional incubators


Why do Countries Matter?

1. laws and regulations (e.g. taxes, subsidies, etc.)
2. national cultures (e.g. sensitivity in cultural ads such as starbucks logo and burger king ads in Saudi Arabia)
3. Natural resources and geography
4. Factors in Porter's diamond model


Porter's Diamond Model (Global Strategy)

1. Firm's Strategy, Structure and Rivalry
2. Demand Conditions
3. Related and Supporting Industries
4. Factor Conditions


Country and Firm Specific Advantage

- country (comparative) advantage = nation-specific resources that provide local firms with competitive advantage in global markets (e.g. Japan's capability for quality, natural resources producing diamonds in South Africa
- firm-specific (competitive advantage) = capabilities within the firm itself


Modes of Foreign Market Entry

1. Pattern of investment reflects need for increased control over operations in the host country
a. first export
b. then, licensing
c. joint venture
d. then wholly owned production activities

2. The process of internalization - need for control, relative competence to perform the activity (like vertical integration)


Potential Risks of International Investments (4)

1. potential government appropriation of firm's assets
2. removal of price guarantees
3. removal of guarantees related to shifts in currency and exchange rates
4. Favoritism towards competition


Types of Organization Structure of Global Firms (3)

1. Global = centralized by function and implement parent company strategies
2. Multi-domestic = decentralized by geography and exploiting local opportunities
3. Transnational = dispersed, independent and specialized - knowledge dispersed across regions



- when a business develops a new, autonomous unit, as opposed to an extension of a current product line (in one business into another
- each unit in the firm competes in a unique product market, can control the resources and capabilities required to compete effectively, can develop a strategic plan for the unit (including a unique mission for the business within the firm)


New Business Development Process

1. New business ideas
2. top management assessment
3. the concept of corporate strategy (look for synergies)
4. strategy execution (control and coordination, compensation and incentives, learning and culture, consistency of activities)


Motivations for Diversification

Two questions:
1. What is the new business going to do for the firm (value add)? Can't be a financial decision - has to be strategic (e.g. GE going into healthcare to take advantage of synergies)
2. What is the parent company going to do for the new business?

Common motivations:
- reduce earnings volatility
- acquire new source of revenues
- reposition current business
- employ current resources/capabilities in new markets


Contributions of Venture to Parent Company

1. Reduce Risk w/lower earning volatility, reduce cost of equity (shouldn't be a primary motivation)
2. Add to corporate growth in revenues and earnings
3. Help to reposition other businesses in the parent firm (include risks of lower benefits than expected, isolating mechanisms being weak, decline of market position over time)


Contributions of Parent Company to New Venture

1. Financial Capital
2. Resources
3. Capabilities
4. Management Skills
a. entrepreneurial (coming up with new ideas)
b. general management (day-to-day operations)


Financial Capital (new ventures)

- firms, on average, cannot be more efficient than external capital markets in allocating financial resources to businesses
- the disadvantage is reduced when a) value chains of the business are highly related b) firm invests in small businesses and they have high growth potential


Resources (new venture)

- firms share resources among business units in order to improve their market positions (improve value, lower cost)
- contribution should be benchmarked against market alternatives


Capabilities (new venture)

- capabilities transferred to a business unit should contribute to its market position (through higher value or lower cost)
- a paradox: codified capabilities (written and well-defined) are easier to transfer but also more observable and imitable (this problem is more acute for firms diversifying for the first time


Entrepreneurial Management (new venture)

- firms can transfer managerial expertise in innovation and growth to a new business (e.g. Best Buy - brick and mortar as well as online)
- includes knowledge about how to manage the unit as it grows


Core Competence (new venture)

- in contract to common usage, the original meaning of core competence of
a) a technology platform from which many applications could be developed
b) an entrepreneurial capability to commercialize applications
BOTH are necessary, neither sufficient


General Management

- existing management expertise helps new business units achieve a sustainable competitive advantage during shakeout and maturity

(e.g. Bud carrying craft brews or J&J buying those stints from outsourcing - defects in products)


New Market Characteristics

- characteristics of industries that are attractive to firms seeking diversity
1. large ultimate size of new market
2. high growth rate in demand
3. future industry structure in which the startup will have favorable position
EVERY diversification event is an entry event (requires special attention)


Managing New Ventures - 2 Major Challenges

1. Differentiation - separating new ventures from existing businesses so it can tailor investments more closely to its market's requirements
2. Integration - trying the new venture to existing businesses so that it can benefit from their resources and capabilities


New Venture Governance

- multiple perspectives on business unit valuation across the firm
- separate resource allocation mechanisms for existing startup business units
- different management incentive schemes for existing and startup businesses
- alternative mechanisms for inter-unit coordination and control

Basically, identify cash cows versus cash hogs


Diversification through Acquisition

- about 40% of acquisitions occur in a merger wave
Why? shifts in the rules of competition in some industries, stock market booms, top management optimism


Empirics on Acquisition Performance

- target firm shareholders typically benefit from being acquired
- acquiring a firm shareholders are likely to benefit when a) deals are made with cash, b) targets are private
- acquiring a firm shareholders are less likely to benefit when the acquiring firm is large
Overall, usually the company that gets acquired benefits


Stages of Acquisition

Stage 1 - Transaction
Stage 2 - turnaround and integration
Stage 3 - Ongoing operation



- spinning off part of the equity in a startup to outside investors
1. improves estimates of venture's value
2. allows the entrepreneur and management team to own shares in venture
3. allows parent firm to benefit from owning shares


Diversification in Different Nations

- industry-to-industry diversification patterns differ significantly across countries (regulation, labor laws, etc.)


Corporate Governance

the institutions that design and monitor the rules used to make decisions in a firm especially those involving compliance


Agency Theory

- focuses on the relationship between the principal (i.e. shareholder) and the agent (e.g. firm's management)
- principal tries to ensure the agent acts in the principal's interest via incentives and monitoring


Berle and Means (1932)

- argued the control of the modern corporation passed from owners to managers because managers had become too dispersed for control
- managers were positioned to pay themselves more


Separation of Control and Ownership

Management: Project Initiation (i.e. proposals)
Board: Project Ratification (i.e. chooses a proposal)
Management: Project Implementation (i.e. executes proposal chosen)
Board: Project Monitoring (i.e. measures and rewards project and firm performance)


Board of Directors

- shareholders exercise influence over managerial decision-making primarily via election of board whose then primary responsibility is corporate governance
- project details received by board depend on firm
- legal responsibilities of board:
a) duty of care
b) duty of loyalty
c) business judgment rule


Board Compensation

- inside directors = upper management/family members (may be conflict of interest)
- outside directors = persons not employed by firm or to related by blood or commercial transactions


Committees and Lead Director

- committees (composed of independent directors) = audit, compensation and nominations
- other committees deal with various issues = finance, executive, risk, etc.
- lead director = chief independent director who chairs executive sessions of independent directors at board meetings


Duty of Care

- the care that an ordinary prudent person would reasonably be expected to exercise in a like position and under similar circumstances (director should be active, not passive)
- carries with it a requirement to develop knowledge related to the firm's business
- implies the duty to inquire into and remain informed about the firm's ongoing activities
e.g. BP chief claimed he didn't know about chemicals in mud being used to stop a leak


Duty of Loyalty

- duty in good faith to act in the best interest of the corporation
- the firm's interest must dominate conflicts between the interests of a director and the firm
- the firm's interest is congruent with but not identical with shareholders (other stakeholders are also considered)


Business Judgment Rule

- underlies the Duty of Care obligation
- acts as a safe harbor or protection when the duty of care is being questioned
- shields directors from liability for taking reasonable actions on behalf of the firm that consequently turn out badly
- preserves directors' willingness to take risks in investments in new products or markets



- overly aggressive growth goals (firm diversified into risky ventures with low earnings growth)
- questionable standards of accounting practices (e.g. removal of high risk projects from the balance sheet)
- the response:
1) public outcry
2) Sarbanes-Oxley Act which establishes CEO and CFO must attest to effectiveness of firm's financial controls, strict audit rules, etc.
3) redesign of rules of major stock exchanges (e.g. new prescriptions of the NYSE and NASDAQ


Are Better Governed Firms Higher Performers?

- studies show investing in better governed firms resulted in a better return
- better firms have fewer policies that impede a takeover while worse governed firms have more of them


CEO Compensation

- possible determinants of compensation:
a) firm size (primary)
b) higher returns to shareholders (weakly related)
c) CEO influence on the board

research indicates that each is valid to some degree


Governance in Different Countries

- governance rules, practices and legal practices vary across countries
- the key is the combined effects of these institutional components on management behavior