Session 7 Flashcards
(17 cards)
What are the key differences between Business Strategy and Corporate Strategy and how do they relate to scope?
- Business Strategy: Focuses on how a firm competes within a specific market. It involves decisions on competitive advantage, differentiation, cost leadership, and market positioning.
- Corporate Strategy: Focuses on where a firm competes, determining the firm’s overall scope across industries, markets, or geographic areas.
Dimensions of Scope:
* Vertical: Degree of control over production stages (e.g., vertical integration).
* Geographical: Expansion across different regions or countries.
* Product: Range of products or services a firm offers.
What are the key differences between specialization and integration in firm scope?
- Vertical scope: Specialization relies on multiple specialized firms for different stages of production, while integration keeps all stages in-house.
- Product scope: Specialization focuses on specific product categories, whereas integration diversifies products under one firm.
- Geographical scope: Specialized firms operate in single regions, while integrated firms expand globally.
Strategic trade-offs:
* Specialization offers focused expertise and flexibility.
* Integration provides control, synergies, and reduced dependency.
What has been a key trend in the scale and scope of large U.S. companies since the 2000s?
- Recent Trends (2000s–Present): Growth through mergers and acquisitions.
- Aim: Market domination, particularly in tech and mature industries.
What prevents firms from growing enormous?
Transaction Costs:
- Costs related to contracting, monitoring, and enforcement.
- Growth increases transaction complexity and costs.
- Misalignment between principals (owners) and agents (managers) can cause inefficiencies.
Agency Problems:
- Managers may prioritize personal interests over company goals.
- Difficulties in monitoring and enforcing contracts lead to inefficiencies.
What are the types of directions in vertical integration, when should a firm use them, and how do they impact competition?
Backward Integration: A company acquires or controls its suppliers (e.g., Ford owning a steel plant).
- When to integrate backward?
- Suppliers have high costs or low reliability.
- To control critical inputs and reduce dependency.
- To improve cost efficiency and quality.
Forward Integration: A company controls distribution or retail (e.g., Ford owning automobile sales).
- When to integrate forward?
- Distributors/retailers capture too much value.
- To enhance customer experience and branding.
- To secure direct market access.
Impact on Competitive Landscape
- Backward integration strengthens cost control and supply chain security.
- Forward integration enhances market power and customer relationships.
- Creates barriers for competitors but increases operational complexity.
What prevents principals and agents from recognizing contract violations?
- Information asymmetry: Agents may withhold or distort information.
- Monitoring limitations: Hard to track every decision in large firms.
- Incentive misalignment: Agents may lack motivation to report violations.
What are the benefits of vertical integration?
- Superior coordination between different stages of production.
- Economies of scale from integrating technical processes.
Avoids transaction costs in cases where:
* Few firms exist in the market.
* Investments are transaction-specific.
* There is a risk of opportunism or strategic misrepresentation.
* Taxes and regulations make market transactions costly.
What are the costs of vertical integration?
- Mismatch in scale between production stages can prevent balanced integration.
- Reduces specialization, inhibiting the development of distinctive capabilities.
- Complex management, making multi-business operations difficult.
- Lower incentives for efficiency due to internalization.
- Limits flexibility in adapting to demand fluctuations or technological changes.
- However, it may enhance system-wide flexibility in some cases.
Vertical integration improves coordination and reduces transaction costs but can lead to inefficiencies, complexity, and reduced adaptability.
When is vertical integration (VI) better than outsourcing?
- Few suppliers → Less competition, better to integrate.
- High investment in specialized assets → Reduces reliance on outsiders.
- Information asymmetry → More control over processes.
- Long-term uncertainty → Contracts may be risky; owning helps.
- Similar scale & strategy → Easier to manage together.
When is outsourcing better than vertical integration?
- Independent processes → No need for internal control.
- Generic tasks → Easier to outsource.
- High-powered incentives needed → External suppliers work harder.
- Uncertain demand → More flexible to adjust.
- High risk → Avoid unnecessary exposure.
What are some alternatives to vertical integration and outsourcing?
- Strategic alliances → Work with suppliers without owning them.
- Licensing → Use external expertise without full control.
- Franchising → Let others operate under your brand.
What are the motives for diversification (horizontal integration)?
Growth:
- Helps escape stagnant industries (e.g., tobacco, oil, newspapers).
- Often benefits managers more than shareholders.
- Acquisitions for growth can destroy shareholder value if not strategic.
Risk-Spreading:
- Diversification stabilizes profit flows.
- Shareholders can diversify their own portfolios, so corporate risk-spreading may not add value.
- CAPM theory: Diversification only lowers unsystematic risk, not systematic risk.
Value Creation:
- Combining businesses can increase profitability through synergies.
- If done right, diversification enhances shareholder value.
What are Porter’s 3 essential tests for successful diversification?
For diversification to increase shareholder value, it must pass these tests:
- Attractiveness Test: The new industry must be (or become) attractive.
- Cost of Entry Test: The cost of entering must not eliminate future profits.
- Better-Off Test: The new unit must create synergy or gain a competitive advantage.
Diversification is only valuable if it improves profitability and passes these tests. Otherwise, it may destroy shareholder value.
What are the sources of competitive advantage from diversification?
Economies of Scope
- Sharing resources: Common distribution, branding, and procurement across businesses.
- Leveraging capabilities: Applying management expertise and operational skills to multiple units.
Economies from Internalizing Transactions
- Reduces external transaction costs by using internal capital and labor markets.
- Firms gain better resource information than external markets.
- However, economies of scope alone aren’t enough—strong market transaction benefits are needed to justify diversification.
Key Considerations:
- Moderate diversification can improve firm performance, but excessive diversification may be detrimental.
- Related diversification tends to outperform unrelated diversification.
What are the types of relatedness between businesses in diversification?
- Operational Relatedness → Synergies arise from sharing resources, such as common distribution facilities.
- Strategic Relatedness → Synergies occur at the corporate level by applying common management capabilities across different businesses.
- Issue with Operational Relatedness → Although economies of scope can offer benefits, administrative costs may reduce or eliminate these gains.
What are the three corporate management tasks that determine strategic relatedness?
Resource Allocation
- Similarities in capital investment size and time spans.
- Similar risk sources and management skills needed.
Strategy Formulation
- Common key success factors and industry life cycle stages.
- Comparable competitive positions within industries.
Performance Management & Control
- Similar performance targets and time horizons.
Businesses benefit from strategic similarity in these areas when engaging in horizontal integration.
When should a business split up (divestment), and what are the key reasons for doing so?
Example:
The Abbott-AbbVie split (2013): Abbott Laboratories spun off its pharmaceutical division into AbbVie, while keeping medical devices, diagnostics, and nutrition under Abbott.
Reasons for Business Splits (Divestment):
- Focus on Core Competencies → Separate companies can specialize in their respective markets.
- Financial Performance → Unlocks shareholder value by allowing each business to operate independently.
- Regulatory or Strategic Needs → Different industries may require different compliance and strategic approaches.
- Market Positioning → Enables distinct branding and investment strategies for each segment.
Key Takeaway: Business splits help optimize focus, financial performance, compliance, and branding.
