Chapter 7: Vertical Integration and Outsourcing

Question 1

Outsourcing

Answer 1

The process where a firm contracts out a business process or activity to an external supplier.

Question 2

Vertical integration (aka insourcing)

Answer 2

Bringing business processes or activities previously conducted by outside companies in-house.

Question 3

Value chain

Answer 3

The sequence of all activities that are performed by
a firm to turn raw materials into the finished product that is sold to a buyer.

Each key activity “adds value” to the prior
activity—hence the term value chain

Question 4

Companies that participate in only one

activity (such as shipping crude oil) are ___________

Answer 4

vertically specialized

Question 5

Upstream activities

Answer 5

Activities closer to the beginning

of the industry value chain, or the raw materials used to create a product

Question 6

Downstream activities

Answer 6

those toward the end, or final products that consumers purchase

Question 7

If a company wants to grow by moving forward in the value chain—that is, downstream—we
say that company engages in _________

Answer 7

forward integration

Question 8

Three Key Reasons to Vertically Integrate

Answer 8

1) Capabilities
2) Coordination
3) Control

Question 9

Capabilities

The first C of vertical integration

Answer 9

refers to the question of whether the firm has—or can build— the capabilities to perform the activity better than other firms

The firm’s leaders should ask this question: To what extent are we, or could we be, the best in the world at conducting this activity?

Question 10

Subcontractor

Answer 10

A supplier that provides an input to a local firm;
the term subcontractor is often used to describe suppliers that are contracted to create customized
inputs for a firm.

Question 11

Coordination

The second C of vertical integration

Answer 11

refers to the question of whether a firm is better able to effectively coordinate the activity with other activities in the firm when both are conducted
internally

Conduct the activity internally when effective coordination and tight integration of
the activity with other firm activities provides performance advantages—such as
speed to market or improved quality.

A firm’s leaders should ask: To what extent will we improve our ability to coordinate our business activities— and offer unique value—by conducting this activity ourselves?

Question 12

Three types of interdependence

Answer 12

1) modular
2) sequential,
3) reciprocal

Question 13

Modular Interdependence (aka pooled interdependence)

Answer 13

Some activities require low levels of coordination
because the activities are modular in nature. This means the results are pooled together, but
the individual activities can be conducted without coordinating with other activities.

Question 14

Sequential Interdependence

Answer 14

Activities are sequentially interdependent when one
firm (or set of individuals) cannot perform its (their) tasks until another firm has completed
its tasks and passed on the results.

A baseball team is an example of a team that requires a moderate amount of coordination

Question 15

Reciprocal Interdependence

Answer 15

Some activities or tasks require a high degree
of coordination because tasks are reciprocally interdependent. In these activities, good
performance is achieved through work done in a simultaneous and repetitive process in which
each individual must work in close coordination with other team members because they
can complete their tasks only through a process of iterative knowledge sharing

Question 16

Control

Last 3 C of vertical integration

Answer 16

Refers to a firm’s desire to maintain control over a valuable activity or input in the value chain.

In other words, an organization’s leaders must ask: To what extent should we maintain control over a crucial step in the value chain by conducting this activity
ourselves?

Question 17

Transaction-specific asset

Answer 17

An asset, such as equipment (oil pipeline) or a facility (bowling alley), that is customized or specialized to a particular use.

Assets are more specialized when
the value of the asset in its current
or intended use is high compared
to its next-best use.

Question 18

Two important dangers of vertical integration (two f’s)

Answer 18

1) Loss of flexibility

2) loss of focus

Question 19

Loss of Flexibility

Answer 19

First, when many activities are managed in the value chain, the flexibility to quickly make
changes to the business is lost

In fact, research has shown that companies that are more vertically integrated take a
bigger hit to performance when there is a technological change

Question 20

Loss of Focus

Answer 20

refers to the fact that the greater the number and variety of activities a firm needs to manage, the harder it is to be world class in all of those activities

It is just too difficult for managers to focus on many different activities at once and be world class at all of them

Question 21

When firms are vertically specialized, they stay

in business only when they can make profits to cover their cost of capital

Answer 21

If they can’t make enough profits, they go out of business

Question 22

Advantages of Outsourcing

Answer 22

The two F’s of vertical integration are 2 benefits to outsourcing

Question 23

Dangers of Outsourcing

There are two major dangers of
outsourcing:

Answer 23

1) a loss of capabilities (particularly the capability to innovate)
2) a lack of control over critical assets or activities.