Final Flashcards
Transaction cost of market include information costs and costs of decision making, but usually exclude the costs incurred by monitoring and controlling.
T/F?
False because transactions cost should include all costs - ex, any, post
Porter’s “three essential tests” help to determine:
A. The likely impact of diversification upon risk. B. The potential for diversification to create shareholder value through boosting profitability. C. The impact of diversification on stakeholders. D. How the financial markets would react to a diversification.
B. The potential for diversification to create shareholder value through boosting profitability.
When a firm is diversifying through acquiring a form in another industry, the critical issue is whether the synergies that can be realized will offset the acquisition premium paid.
T/F?
True
One of the advantages of a company providing its own facilities maintenance services is that a wholly owned and directly managed maintenance unit is subject to “high powered” incentives.
T/F?
False
Bounded rationality describes individual’s limitation to foresee all possible contingencies that might arise during a contract period.
T/F?
True
In fashion clothing, one reason why mass market distributors such as H&M, outsource their production is reduced new product cycle time (the time between the initial design of a product and its delivery to a retail store).
T/F?
FALSE.
Zara doesn’t outsource and if they outsource they have to coordinate with outsourcing company and can’t respond to trend so quickly
Agency costs are due to:
A. Shirking by employees and the admin effect to deter it
B. The difficulty of measuring and rewarding individual unit’s performance
C. The difficulty of internally replication the incentives faced by market forms
D. All of the above
E. None of the above
D. All of the above
The main cause of downsizing, refocusing and outsourcing during the latter part of the 20th century was:
A. Developments in IT- especially the advent of the internet
B. A more turbulent business environment
C. both (a) and (b)
D. Neither (a) and (b)
C. both (a) and (b)
Keiretsu and similar business networks, based on relational, semi-formal contacts such as the relationships between vehicle manufacturers and their component suppliers - are superior to either pure market contracts or vertical integration because:
A. They give manufacturers immense bargaining power over their suppliers
B. They offer similar benefits of high-powered incentives and flexibility that market contracts
C. They offer similar coordination benefits as vertical integration
D. They combine the coordination benefits of vertical integration with the incentive and flexibility benefits of market contracts.
D. They combine the coordination benefits of vertical integration with the incentive and flexibility benefits of market contracts.
According to Ronald Coase, in general, firms should make rather buy.
T/F?
False
The benefits of using the market can be attributes to economies of scale rather than to the quality and efficiency advantages achieved by market firms.
T/F?
False
According to Michael Porter, industry attractiveness is a sufficient justification for diversification.
T/F?
False
Vertical boundaries of a firm determine what?
Vertical boundaries of the firm determine which tasks (of the vertical chain) are to be performed INSIDE the firm and which to be OUT-SOURCED.
The choice between using the market or using the organization is a MAKE or BUY decision
When thinking about the shifting roles of firms in the economy…
In the 20th century, what occurred?
During the 20th century: Expanding Size and Scope of Corporations
Administrative efficiency increased by:
*New techniques of strategic, financial, operational and human resource management
*New organizational forms
*Technology
When thinking about the shifting roles of firms in the economy in the mid 1970s, what occurred?
Around the mid-1970s: Reverse trend of Restructuring,Refocusing and Downsizing among Large Corporations
Market efficiency due to:
* Environment Uncertainty – Turbulent business environment reduces the efficiency of large, hierarchical firms
* Digital technologies and internet increase efficiency of markets
What does the vertical chain start & end with?
What is an important part of a business strategy?
The vertical chain
* begins with the acquisition of raw materials and,
* ends with the sale of finished goods/services
Organizing the vertical chain is an important part of business strategy
Explain Upstream & Downstream.
Upstream : Early steps in the production process are upstream (Timber for furniture)
Downstream : Later steps are downstream (finished goods in showrooms) i.e., sales
Define Market firms.
Outside specialists who can perform vertical chain tasks
- Market firms are often recognized leaders in their field (Example: UPS)
Explain Transaction Cost Theory (TCT).
Oliver Williamson – TCT’s founder and best-known representative
TCT is the optimum organizational structure to achieve economic efficiency by minimizing the costs of exchange.
The theory suggests that each type of transaction produces coordination costs of monitoring, controlling, and managing transactions.
What are the benefits of vertical integration?
- Avoids transactions costs of market contracts in situations where there are:
– small numbers of firms
– transaction-specific investments
– opportunism and strategic misrepresentation
– taxes and regulations on market transactions - Superior coordination
What are the costs of vertical integration?
- Differences in optimal scale of operation between different stages of production prevent balanced vertical integration
- Inhibits development of distinctive capabilities
- Difficulties of managing strategically different businesses
- Incentive problems: lack of “high-powered” incentives
- Limits flexibility:
* in responding to demand fluctuations
* in responding to changes in technology, customer preferences, etc.
What are two benefits of using market firms?
What are the 3 disadvantages of using market firms?
Benefits of using market firms:
* Economies of scale achieved by market firms
* Value of market discipline; quality & efficiency
Disadvantages of using market firms:
* problems coordinating production flows
* transaction costs
* possible leak of private data
Explain economies of scale.
When the marginal cost is less than average cost, there are economies of scale
- Average cost declines with output, due to indivisibilities
- If average cost increases with output, we have diseconomies of scale
- As markets increase in size, economies of scale enables specialization and automation
- Larger markets support an array of specialized activities
- Market firms are likely to exploit learning economies
Who said “The division of labor is limited to the extent of the market”?
Adam Smith: Wealth of Nations, 1776
Explain Agency costs.
- Agency costs are due to shirking by employees and the administrative effort to deter shirking
- Measuring and rewarding individual unit’s performance is difficult
- It is difficult to internally replicate the incentives faced by market firms
Explain Influence Costs.
Performing a task in-house will lead to influence costs
- Internal capital markets allocates scarce capital within the firm
- Allocations can be favorably affected by influence activities
- Resources consumed by influence activities represent influence costs
Value chain reconfiguration through Vertical Integration means what?
High orientation: constantly changing product range
&&
Core competence: Speed and design flexibility
What are 4 reason to make products in-house?
- Costs imposed by poor coordination
- Reluctance of partners to develop and share private information
- Transactions cost that can be avoided by performing the task in-house
- These problems can be traced to difficulties in contracting
What do contracts list? What is the purpose of contracts?
Contracts list:
* the set of tasks that need to be performed,
* the remedies if one party fails to fulfill its
obligation and, the cost to perform the tasks
- Contracts protect each party to a transaction from the opportunistic behavior of the other party
- Contracts provide this protection by
* the “completeness” of the contract
* the body of contract law
If the market mechanism improves efficiency, why do so many of the activities take place outside the price system?
Said by Coase 1937
- Costs of using the market that are saved by centralized direction – TRANSACTIONS COSTS.
- Outsourcing entails costs of negotiating, writing and enforcing contracts
Holdup Effect on Transactions Costs.
The holdup problem raises the cost of transacting exchanges:
* Contract negotiations become more difficult
* Investments may have to be made to improve the ex-post bargaining position, hence safeguarding costs rise
* Potential holdup can cause distrust
* There could be underinvestment in relationship-specific assets
The Holdup Problem: Summary
- Relation-specific assets support a particular transaction
- Redeploying to other uses is costly
- Quasi-rents become available to one party and there is incentive for a holdup
- Potential for holdups lead to
* Underinvestment in these assets
* Investment in safeguards
* Reduced trust
The dimensions of the SCOPE OF THE FIRM are?
- Vertical scope (vertical boundaries)
- Geographical scope –> diversification across markets
- Product (horizontal) scope –> diversification across products
Horizontal vs vertical boundaries.
The HORIZONTAL BOUNDARIES of the firm refer to the size/scale (how much of the total product market will the firm serve) and scope (what variety of products and services does the firm produce)
The VERTICAL BOUNDARIES of the firm illustrate which activities the firm would perform itself and which it would leave to the market
Define Diversification Strategy.
What are the 2 basic issues when it comes to diversification?
Product diversification is a strategy employed by a
company to increase profitability and achieve higher sales volume from new products.
2 issues:
1. How attractive is the industry to be entered?
- Can the firm establish a competitive advantage within the industry to be entered? —> What synergies exist between the core business and the new business?
What is considered one of the easiest ways to measure diversifying activity?
3 motives for diversification.
Mergers and acquisitions/takeovers are
broadly considered one of the easiest ways to measure diversifying activity.
3 motives are:
*Growth
*Risk Spreading
*Value Creation
Why do Firms Diversify?
To make use of surplus cash flows (internal capital market), but influence costs!
To more fully utilize existing resources and capabilities (exploitation of economies of scale and scope; dominant general management logic)
What are Porter’s Three Essential Tests?
For diversification to create shareholder value, it must meet three tests:
1. The Attractiveness Test: Diversification must be directed towards attractive industries (or those with the potential to become attractive)
2. The Cost of Entry Test: The cost of entry must not capitalize all future profits (acquisition premium or entry barriers)
3. The Better-Off Test: Either the new unit must gain competitive advantage from its link with the company, or vice-versa (i.e., some form of ‘synergy’ must be present)
- Aim of diversification should be to create value or wealth in excess of what firms would enjoy without diversification
- Synergy: The value of the combined firm after acquisition should be greater than the value of the two firms prior to acquisition
What are intangible, tangible resources? (economies of scope)
- Sharing TANGIBLE resources (e.g., research labs, IT systems, sales force, distribution systems) across
multiple businesses - Sharing INTANGIBLE resources (e.g., brands, reputation, technology) across multiple businesses
- Transferring functional capabilities (e.g., marketing, product development) across businesses
- Applying common GENERAL MANAGEMENT CAPABILITIES to different businesses
Describe the Crucial Role of Corporate Management
Successful diversification strategies result from the ability of managers to develop skill and competency at MANAGING diversification
Managers must develop two important types of mental models:
* Must have well-developed understandings of their firm’s diversity and relatedness that define their companies
* Must also have well-developed beliefs about how diversification should be managed in order to achieve synergies
For each step in the vertical chain the firm has to decide between
market exchange and vertical integration. Describe the tradeoff in Vertical Integration.
- Using the market improves technical efficiency (least-cost
production, achieved by scale economies). - Vertical integration improves agency efficiency (coordination,
transactions costs). - Firms should “economize” – choose the best possible
combination of technical and agency efficiencies.
Technical efficiency & assets Specificity
- Using the market leads to higher technical efficiency compared
to vertical integration (power of market discipline). - The difference in technical efficiency of market over vertical
integration (DT) depends on the nature of the assets involved in
production. - As the assets become more SPECIALIZED the market firm’s
advantage becomes weaker (REDUCTION IN SCALE AND SCOPE
ADVANTAGES). - The difference in TECHNICAL EFFICIENCY OF MARKET over vertical integration (DT) DECLINES with greater asset specificity.
At LOW LEVELS OF ASSET SPECIFICITY, differential AGENCY EFFICIENCY OF MARKET over vertical integration is likely to be ?
At high levels of asset specificity, differential AGENCY EFFICIENCY OF MARKET OVER vertical integration is ??
When specialized assets are involved, what is likely to happen?
positive
negative
potential for a holdup is
high and the transactions costs are higher.
The COMBINED (MARKET over vertical integration) differential EFFICIENCY will ?
With increased scale, the differential TECHNICAL EFFICIENCY OF MARKET over vertical integration, does what FOR EVERY LEVEL OF ASSET SPECIFICITY?
be NEGATIVELY related to asset specificity
- At high levels of assets specificity vertical integration is more
efficient - At low levels of assets specificity market firms have an edge.
DECREASES for every level pf asset specificity.
What are 3 Alternatives to Vertical Integration?
- Tapered integration (making some and buying the rest)
- Strategic alliances and joint ventures
- Semi-formal collaborative relationships based on long-term implicit contracts between firms
Strategic alliances have developed rapidly as one of the most common ways companies get involved in INTERNATIONAL OPERATIONS. It typically includes: ?
- Licensing and franchising – allowing another firm to market your brands or use the technology = NON-EQUITY MODE
- Joint Ventures – separate entity of two or more firms. Joint ventures may be with either customers or competitors who share R&D, production and/or distribution costs = EQUITY MODE
Define Join Venture & Tapered Integration
TAPERED INTEGRATION is a mixture of vertical integration and market exchange.
* A firm may produce part of its input on its own and purchase the rest (upstream)
JOINT VENTURE – Firm A and Firm B form a new, independent Firm C, jointly owned by a binding contract by A and B.
Real authority and control is determined by daily operational management
What is an implicit contract?
Implicit contracts are unstated understanding between firms in a
business relationship.
Members of a keiretsu work with each other through implicit
contracts.
Longstanding relationship between firms can make them behave
cooperatively towards each other without any formal contracts.
TC Hypothesis.
Define Firm-specififc assets,
Complementary assets &
First-mover advantages.
Firm-specififc assets -
H1: The greater the MNC‘s research and development intensity, the
higher the probability it will enter through a greenfield investment.
Complementary assets -
H2: The lesser the MNC‘s experience of the host market, the greater the likelihood it will enter through acquisitions.
First-mover advantages -
H3: The higher the rate of growth of demand in the target market, the
greater the MNC‘s incentive to enter through acquisition.
Resource-based Hypotheses. Define Managerial constraints on H4 & H5.
a) Managerial constraints
H4: The lower the MNC‘s endowment in HUMAN RESOURCES, the more likely it will enter through acquisition.
H5: The larger the SIZE OF THE SUBSIDIARY RELATIVE to the MNC, the greater the probability of an entry through acquisition.
Define Acquisition, Brownfield & Greenfield resources
Acquisition :
resources held by local firms, e.g. technology assets, market
power/entry barriers
Brownfield :
acquisition replace a large part of the resources, e.g. transferrable knowledge, managerial services, financial capital
Greenfield :
resources are available on markets, e.g. real estate, labour skills, access to utilities transfer of own resources
