Session 6: Corporate Strategy (Vertical Integration & Diversification) Flashcards
(23 cards)
What is the central question of corporate strategy? (What/Where/How)
Where to compete.
Why do firms need to grow?
- To increase profitability and shareholder returns
- Lower costs via economies of scale
- Increase market power
- Reduce risk through diversification
- Motivate management and employees.
What are transaction costs?
Costs associated with an economic exchange
e.g.
- searching for contractors
- negotiating
- monitoring
- enforcing contracts.
What are internal transaction costs?
Internal transaction costs involve managing activities within the firm
- e.g. recruiting employees.
What are external transaction costs?
External transaction costs involve dealing with outside firms
- e.g. outsourcing
When should a firm make (vertically integrate) rather than buy?
When the cost of producing in-house is less than the cost of using the market.
What are the advantages of organising economic activity within firms?
- Command and control
- Coordination
- Transaction-specific investments (you can specialise investments to your transactions)
- Community of knowledge.
What is the principal-agent problem?
When managers (agents) may act in their own interests rather than those of the owners (principals), creating a conflict.
How can firms try to solve the principal-agent problem?
By offering stock options to align agents’ interests with those of the owners.
What are disadvantages of using markets for economic activity?
- Search costs
- Risk of Opportunism by Market (markets might fight for their own self-interest)
- Hold-up (lead-time)
- Incomplete contracting
- Information asymmetries
- Contract enforcement issues.
What is vertical integration?
When a firm owns its inputs (backward integration) or distribution channels (forward integration).
What is backward vertical integration?
Ownership of suppliers of inputs along the value chain, such as raw materials or components.
What is forward vertical integration?
Ownership of activities closer to the customer, such as distribution, sales or after-sales service.
Give an example of backward and forward vertical integration in the cell phone industry.
Backward: Owning raw materials or component manufacturing; Forward: Owning marketing and sales channels.
What are risks of vertical integration?
- Increasing costs
- Reducing quality or flexibility
- Legal risks.
What is a vertical market failure?
When transactions are too risky or costly to be efficiently handled by the market.
What are the 3 types of diversification?
- Product diversification
- Increase products
- Geographic diversification
- Increase regions
- Product-market diversification
- Both product and geog
What are the types of corporate diversification?
- Single business
- Dominant business
- Related diversification (constrained or linked)
- Unrelated diversification (conglomerate).
What is unrelated diversification?
A conglomerate strategy where businesses do not share competencies.
How does diversification enhance firm performance?
Provides economies of scale (reducing costs)
Exploits economies of scope (increasing value)
Spreads risk.
What is Single-Business Diversification?
A low level of diversification, e.g. deriving more than 95% of revenue from one business and less than 5% from another
What is dominant business diversification?
Same as Single Business but to a higher extent, e.g. 75% to 90% from one business and remaining from another
What is related diversification?
All or some of your business sharing competencies.
Note: With unrelated, no businesses share any.
