Lecture 2 - Boundaries of the Firm Flashcards
1
Q
Explain transaction costs theory.
A
- The transaction cost theory supposes that companies try to minimize the costs of exchanging resources with the environment, and that companies try to minimize the bureaucratic costs of exchanges within the company.
- Companies are therefore weighing the costs of exchanging resources with the environment, against the bureaucratic costs of performing activities in-house.
2
Q
Activities are undertaken by the firm or market depending on what relative costs?
A
- Transaction costs - Search costs, contract negotiation and monitoring etc.
- Administrative costs - Management coordination, employments contracts etc.
If transcation costs > administrative costs then coordination of productive activities will be internalised within firms.
3
Q
What are the two forms of economic organisation that capitalist economy comprises of?
A
- Market mechanism - Prices determine the production and resource allocation.
- Administrative mechanism - Production and resource allocation made by managers and imposed through hierarchies.
4
Q
What is vertical integration?
A
- Vertical integration is a strategy where a company expands its business operations into different steps on the same production path, such as when a manufacturer owns its supplier and/or distributor.
- Vertical integration can help companies reduce costs and improve efficiencies by decreasing transportation expenses and reducing turnaroundtime, among other advantages.
- However, sometimes it is more effective for a company to rely on the established expertise and economies of scale of other vendors rather than trying to become vertically integrated.
5
Q
What is horizontal scope/integration?
A
- Horizontal integration is the acquisition of additional business activities that are at the same level of the value chain in similar or different industries.
- This can be achieved by internal expansion through a reinvestment of operating profits or by external expansion through a merger or acquisition (M&A).
- Since the different firms integrating are involved in the same stage of production, horizontal integration allows them to share resources at that level.
6
Q
Illustrate the differences of:
[A] single integrated firm
[B] Several Specialised Firms linked by Markets
(in both a vertical scope and horizontal scope)
A
- Situation [A] businesses 1, 2 & 3 are integrated within a single firm.
- Situation [B] businesses 1, 2 & 3 are independent firms linked by markets.
7
Q
Explain how economies of scale/diseconomies of scale with in terms of average cost.
A
8
Q
What are the effects of economies of scale?
A
- create cost advantages
- determine market structure and entry/exit - makes it hard for new entrants to join market since existing firms products at low cost.
- affect the internal organisation of firms
- determine the vertical and horizontal boundaries of firms.
9
Q
What does the U-shaped AC curve say about the optimum size for a firm?
A
- Average cost decilnes as fixed costs are spread over larger volumes.
- Average cost eventually starts increasing as capacity constraints kick in.
- U-shape implies cost disadvantage for very small and very large firms.
- Optimum size for a firm inbetween extremes.
10
Q
Explain the L-Shaped cost curve and what the MES is.
A
- In reality, cost curves are closer to being L-shaped than U-shaped.
- Large firms are rarely at a cost disadvantage relative to smaller firms.
- A minimum efficient size (MES) beyond which average costs are identical across firms.
11
Q
Describe sources of economies of scale
A
-
Spreading of fixed costs
- R&D
- Specialised equipment or building/stores
- Training and HR
- Marketing (Advertising and Brands)
- Purchasing and distribution costs
- IT costs
-
Digitalisation
- Use of digital technologies to provide new means of value creation and improve processes/business models
- production and distribution which are separate activities (e.g., for books and music) could be coupled into a single business model when transformed into a digital format
- saving on inventories (e.g., Amazon vs Borders, Apple iTunes vs HMV Records)
12
Q
What are sources of diseconomies?
A
- Increasing labour costs
- Spreading specialised resources to thinly - e.g. having someone specialised in a task doing more work over a range of things - takes away from what hes good at/efficiency.
- Incentive and coordination effects
- “Conflicting out” - (competitor already a client; informal sensitivity, reputation damage)
13
Q
Explain why larger firms might exit an industry first.
A
- Larger firms will experience loss in profits more if demand goes down because their costs are higher. Hence will be first to exit industry.
- High fixed cost - Larger factory, larger plant etc.
14
Q
Explain the maths in economies of scope.
A
- It is cheaper for one firm to produce both X and Y than for two different firms to specialise in X and T each.
15
Q
What are some sources of economies of scope?
A
-
Scope economies might arise from:
- Sharing tangible resources (research labs, distribution systems) across multiple businesses.
- Sharing intangible resources (brands, technology) across multiple businesses
- Transferring functional capabilities (marketing, product development) across businesses.
- Applying common general management capabilities to different businesses.
- Cross sales and complementarity.
17
Q
Describe the Hub and Spoke model and explain how it drives both scale and scope economies in the airline business.
A
- The small number of routes may also lead to more efficient use of transportation resources. For a same number of aircraft, having less routes to fly means each route can be flown more frequently and with higher capacity because the demand for passengers can be resourced from more than just one city.
- Complicated operations, such as package sorting and accounting, can be carried out at the hub rather than at every node, and this leads to economies of scale. As a result of this, spokes are simpler to operate and so new routes can easily be created.
-
Downfalls:
- because the model is centralised, day-to-day operations may be relatively inflexible, and changes at the hub, even in a single route, may have unexpected consequences throughout the network
18
Q
Explain the low cost airline business model and how it drives scale and scope.
A
- Only flies into regional airports, no landing fees
- Guarantees airport certain number of passengers in their terminal
- Airport provides low cost airlines (LCA) a percentage of the revenues from customer facilities.
34
Q
Draw BCG’s growth/Share matrix.
A
- Use the cash generated by “cash cows” to exploit the learning economies of “rising stars” and “problem children”.
- Dog - want to get rid of it but still have it.
37
Q
What are sources of strategic relatedness between business?
A
38
Q
What is the layered modular architecture in the digital economy?
A
