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19ECB501 - Economics of Business Strategy > Week 1 - Horizontal Boundaries of the Firm > Flashcards

Week 1 - Horizontal Boundaries of the Firm Flashcards

1
Q

What are Horizontal Boundaries?

A

Define how of the total product market, the firm serves (scale) and what variety of products the firm offers (scope)

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2
Q

What advantages do Size and Scope have?

A
  • Market Power: Larger/Diversified firms can exercise monopoly power and set terms of competition
  • Entry Barriers:
    Once company has large position difficult to dislodge. Defers potential entrants and existing firms from attacking business core
    e.g. Only Boots and Superdrugs
  • Lower Unit Costs:
    Produce at a lower cost per unit and this becomes barrier to market entry by competitors
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3
Q

What are the determinants of Horizontal Boundaries?

A
  • Economies of Scale:
    Avg production cost down with scale of production
  • Economies of Scope:
    Cost savings when dif goods/services produced in same plant/company
  • Learning Curve:
    Cost adv from accumulated expertise and knowledge
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4
Q

What are the advantages of having a larger size?

A
  • Less vulnerable to predators

- If scale results in lower avg cost, result in better market position and comp adv relative to smaller firms

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5
Q

What are the disadvantages of having a larger size?

A
  • Loss of control (hierarchy)
  • Slow Info flows
  • Diseconomies of Scales
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6
Q

What does the firm size reflect?

A

It reflects the cost characteristics of the industry and dif across industries reflect dif cost structures and dif time periods

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7
Q

What is the relevance of mergers and diversification to corporate strategy?

A

Combined companies reduce duplicate departments/operations, lowering costs of company,better use of complementary resources (synergy), low prices via diversification etc.

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8
Q

What is Economies of Scale?

A

MC

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9
Q

What was Smith’s view on specialisation?

A

As markets increase in size, economies of scale enable specialisation

  • Larger markets lead to specialised firms
  • As markets get even bigger, specialised activity may be put in house due to EofS
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10
Q

What are the sources of Economies of Scale?

A
  • Fixed Costs
  • Physical properties of production
  • Inventories
  • Purchasing Power
  • Advertising
  • Umbrella Branding (Scope)
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11
Q

How are fixed costs a source of Economies of Scale?

A

Spreading of product-specific fixed costs through specialized inputs

e.g. specialised labour or material
cost of specialist capital to set up production (equipment and tools)
Product specific R&D required before entry into the market

  • Economies of scale can be obtained through choice of technology and related investment in capital and technology
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12
Q

How do the indivisibility of inputs lead to fixed costs?

A
  • Indivisibilities: Certain inputs can’t be scaled down below min size
  • Indivisibilities lead to fixed costs and thus EofS and scope
  • Scale and Scope economies may obtain at various lvls
    - Product Lvl
    - Plant Lvl
    - Multi plant Lvl
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13
Q

How are the physical properties of production a source of Economies of Scale?

A

Less input at larger scale of production

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14
Q

How are inventories a source of Economies of Scale

A

Bigger firms can afford to keep smaller inventories (relative to sales volume) compared with smaller firms and not have stock outs

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15
Q

How is Purchasing power a source of Economies of Scale?

A

Improves cost of inputs

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16
Q

How is advertising a source of economies of scale?

A

Larger global/national firms will have lower unit advertising costs relative to smaller national/local firms

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17
Q

How is umbrella branding a source of economies of scope?

A

Econ of scope in developing and maintaining a brand, make easier to introduce new products with established brand

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18
Q

What are the main reasons for Diseconomies of Scale?

A
  • Specialised resources stretched too thin:
    Ability to reduce fixed costs reduced or eliminated
  • Co-ordination:
    Dif to run and monitor large organisation effectively due to bureaucracy
  • Incentives:
    Inefficient managerial or labour policies (e.g. wage gap)
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19
Q

How do we measure EofS with single plant and product using elasticity of output quantity produced with respect to total cost?

A

S = (ΔQ/Q)/ (ΔC/C)

S = (C/Q)/(ΔC/ΔQ) = AC/MC

S = The percentage change in output relative to percentage change in cost

S is an output - cost elasticity

SEE NOTES FOR CLEARER VIEW AND EXAMPLE QUESTIONS

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20
Q

What statements are true following the measure of the Economies of Scales with single plant and product using elasticity of output quantity produced with respect to total cost?

A

S> 1: MCAC:

- Diseconomies of Scale - Avg costs increase with more output

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21
Q

What does the U-Shaped cost function look like?

A

SEE GRAPH IN NOTES

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22
Q

What does the U-Shaped cost function explain?

A
  • Avg cost declines as fixed costs spread over large volumes
  • Avg cost eventually start increasing as capacity constraints kick in
  • U-shape implies cost disadv for very small and very large firms
  • Unique optimum size for a firm
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23
Q

What does the L- shaped cost function look like and what does it display?

A

SEE GRAPH IN NOTES

Demonstrates alternatives in which min efficient size exists beyond which avg costs are identical across firms

24
Q

What is the truth behind the cost curves?

A
  • Often cost curves closer to L-shaped curves than to U-shaped curves
  • In L- shaped can identify level of output, called min efficient size beyond which avg costs identical across the firm
25
Q

What does the trade off between technologies look like?

A

SEE GRAPH IN NOTES

26
Q

When do technology trade offs occur?

A
  • If output needs to be increased beyond a point capital intensive tech may need to be subbed for labour intensive tech
  • Greater scale allow further capital investment that improves productivity
  • Lower envelope of the two cost curves is LR Avg Cost curve
27
Q

What is the dif between short run and long run Economies of Scale?

A
  • Cost reduction via better capacity utilisation (SR)

- Cost reduction by switching to higher fixed cost (more capital intensive) tech (LR)

28
Q

What does the Long Run Avg cost curve look like?

A

SEE GRAPH IN NOTES

29
Q

What can we see from the Long Run Avg cost curve?

A

The long-run average cost curve, LRAC, traces the lowest attainable average total cost of production.

30
Q

How do we estimate Econ of Scale?

A

When economies of scale are present larger firms tend to have a cost advantage over smaller firms.

Internal strategies for growth – new product development and geographical expansion
.
External strategies for growth involve mergers aimed at exploiting inter-firm synergies.

Accounting data is used for the analysis of the financial and managerial impact of a merger, based on balance sheet, income statement and managerial accounting data (internal costing of department) to assess potential cost savings.

31
Q

What is the econometric analysis of the potential EofS?

A

Based on cross-section info about avg cost and output level:

AC = β0 + β1 Y + β2 Y squared + β3W + e

Where:
W = Identifies cost factors other than output driven ones and e is the residual

SEE NOTES FOR BETTER DISPLAY

32
Q

What the most common epressions describing strategies that exploit econ of scope?

A
  • Leveraging core competencies
  • Competing on capabilities
  • Mobilizing invisible assets
  • Diversification into related products

Managers may cite EofS and scope (even if not exist) to justify investment in growth (usually by merger)

33
Q

What are economies of scope?

A

the long-run average and marginal cost of a company, decreases, due to the production of some complementary goods and service

34
Q

When are economies of scope present?

A

Present if costs lower than outputs are produced together rather than separately, because it’s possible to effectively share resources in joint production

35
Q

What economies of scope do to economies of scale?

A

Presence of economies of scope reduce overall costs of production and increase EofS when integrated production carried out instead of separate production

36
Q

When are economies of scope present mathematically?

A

C(y1,y2) < C(y1, 0) + C(0,y2)

Y1 and Y2 are dif outputs assumed to be produced jointly by same firm (LHS) or seperately (RHS)

37
Q

What is the measure of potential scope economy savings?

A

Measures percentage cost associated with integrated production:

SC(y1,y2) = C(y1,0) + C(0,y2) - C(y1,y2) / C( y1,y2)

SEE NOTES FOR CLEARER VIEW AND EXAMPLES

38
Q

What does the measure of potential scope economy savings display?

A

If >0 : Separated costs exceed integrated costs of production indicating presence of scope economies

If <0: Integrated costs exceed separated costs indicating diseconomies of scope

39
Q

What is the statistical analysis of cost functions with multiple output production?

A

Cannot be based on average costs which cannot be defined with multiple outputs

Cost = β0 + β1 Y1 + β2 Y1 squared + β4 Y2 + β5 Y2 squared + β6 Y1Y2 + β3W + e

Where:
W = Identifies cost factors other than output driven ones and e residual (noise)

SEE NOTES FOR CLEARER VIEW

40
Q

SLIDE 39 ON LECTURE

A

I REALLY DUNNO CHECK WITH LECTURER

41
Q

What does the learning curve effect and experience curve express?

A

They express the relationship between experience and efficiency (Practise makes perfect)

  • Existence of learning economies encourages aggressive fight for market share
  • Learning happens over time and has cumulative effects
  • Cost of producing a given level of output decreases with past experience
42
Q

What does the learning curve look like?

A

SEE GRAPH IN NOTES

43
Q

What is the relation between the learning curve and the economies of scale?

A
  • Learning reduces unit cost via experience
  • Capital Intensive tech can offer scale economies even if no learning
  • Complex labour intensive processes may offer learning economies without scale economies
44
Q

What does the Learning Curve and Economies of Scale graph look like?

A

SEE GRAPH IN NOTES

45
Q

What are the determinants of learning effects?

A
  • Labour Efficiency: Workers become more skillful
  • Standardisation, Specialisation and methods improvement: Gaining exp via specialisation
  • Tech driven learning: IT and automated production tech introduce efficiencies
  • Better use of equipment: Increase in total production leads to full exploitation of manufacturing equipment
46
Q

What are the roles of firms in Learning Economies?

A
  • If firms objective SR then learning economies might not be fully exploited
  • Organisations can promote or hinder development of learning processes (e.g. Unions)
  • Learning curve strats involve output expansion above SR optimal level in order to acquire experience
47
Q

What is the Boston Consulting Groups Growth/Share paradigm?

A
  • Product life cycle model combined with an internal capital market with the firm serving as a banker
  • Use the cash generated by ‘cash cows’ to exploit the learning economies of ‘stars’ and ‘question marks’

SEE GRAPH IN NOTES

48
Q

What are the differing elements of the BCG growth/share matrix?

A

Stars - Lots of growth, Lots of Market share

Question Marks - Lots of growth, low market share, can go into star

Cash Cow - Not growing, Large Share in the market

Dogs - They just suck

49
Q

What are the 2 types of diversification that can be identified?

A

Related Diversification:
Multi-product firm where their products have some commonality

Unrelated Diversification:
Multi-product firm whose products display little or no commonality (AKA a congolmerate)

50
Q

What does Diversification tend to be associated with?

A

Tends to be associated with large scale firms and the motivations to diversify are widespread, including attempts to capture econ of scale or scope

51
Q

What are the common justications for diversification and mergers?

A

Efficiency based Diversifications:

  • Econ of Scale and Scope
  • Economising on transaction costs and sharing skills and systems
  • Internal Capital Markets

Problematic Justifications for Diversification:

  • Shareholder’s diversification of risk
  • Identifying undervalued firms
52
Q

Explanation of Econ of Scale and Scope as justification for Diversification and Mergers

A

Mergers that legitimately capture economies of Scale and Scope across products and markets will by definition improve costs and competitiveness of firms

SEE EOS AND DIVERSIFICATION GRAPH IN NOTES

53
Q

How do firms economise on transactions costs and sharing skills and systems?

A
  • Applying a dominant general management logic
  • Managers develop specific skills (e.g. Finance)
  • Seemingly unrelated business may need these skills and benefit from sharing them
  • The logic can be misapplied when skills not useful in the business the firm diversifies in
54
Q

What is the relation between diversification and risk?

A
  • Diversification reduce firms risk and smoothes earnings stream
  • Shareholders may not really benefit from this as they can diversify their portfolio at near zero cost, via stock markets.

-When shareholders are unable to diversify (Example: owners of a large fraction of the firm) they may benefit from such risk reduction

55
Q

What is the cost of diversification?

A
  • Diversified Firms may need elaborate control system to reward/punish managers
  • Internal capital markets may not function well in practise
56
Q

What are the managerial reasons for diversification? (PT 1)

A

Managers may prefer growth even when it is unprofitable since it adds to their social prominence, prestige and political power.

Managers may be able to enhance their compensation by increasing the size of their firm

57
Q

What are the managerial reasons for Diversification? (PT 2)

A

Managers may feel secure if the performance of the firm mirrors the performance of the economy (which will happen with diversification)

Manager controlled firms tend to engage in more conglomerate diversification than owner-controlled firms.

19ECB501 - Economics of Business Strategy (8 decks)

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