Week 2 - Vertical Boundaries of the Firm Flashcards
Why is organising the value chain an important part of business strategy? (Part 1)
- Production of any good/service requires wide range of activities organised in vertical ‘value’ chain
- Production activities said to flow from upstream suppliers to downstream manufacturers,distributors and retailers
Why is organising the value chain an important part of business strategy? (Part 2)
- Activities in the chain include activities, which are:
1. Associated directly with processing and distribution of inputs and outputs
2. Professional support activities, like accounting and planning - Understanding vertical relationships important for business strat because influence the firms composition
e. g Business must make a buy/make choice
What is the processes upstream and downstream?
- Raw inputs
- Transportation
- Good processors (mills etc.)
- Transportation
- Assemblers
- Transportation
- Retailers
Also support services such as accounting etc.
What is the make or buy decision?
Act of making a strategic choice between producing an item internally (in-house) or buying externally (out-house)
- Firm can produce in-house (vertical integration) or rely on market forces to provide the most efficient version of these products
What are the differing possibilites of the make or buy decision?
- Not a yes or no answer and is instead a spectrum
List goes from less integrated to more integrated:
Arm's length market transaction Long-term contracts Strategic Alliances and Joint Ventures Parent/Subsidiary Relationship In-house production
What are the advantages of vertical separation (buy)?
- Lower costs, due to strong market competition
- Economies of Scales in the specialised activity
- Expertise and market incentives in vertically related markets
What are the advantages of using the market? (PT 1)
- Cost savings from specialisation passed on to other phases in vertical chain (downstream) only if the market is competitive
- Specialisation limited by the size of the market. One supplier might be able to serve several buyers and rely on large market size to provide a cost advantage via economies of scale in the specialised product
What are the advantages of using the market? (PT 2)
- Reduction in agency costs:
(Slacking by employees and resulting monitoring and motivating workforce) - Higher in large companies, market firms have to reduce these costs to stay competitive
Reduction of Influence Costs:
(Time needed to influence to get resources)
What are the advantages of Vertical Integration? (Make)
- Effective control over supply chain (e.g unreliable suppliers)
- When market info critical for production schedules
- When specific assets required
- In presence of concentrated upstream and downstream markets
What are the disadvantages of using the market? (PT 1)
- Cost of co-ordinating activities in separate companies across vertical chain
- Contracts might be inadequate to deal with co-ordination problem when small errors can be costly (Better to co-ordinate internally)
- Unwillingness of suppliers/buyers to develop and share valuable info - Especially around IP’s or patents
What’s meant by the co-ordination of production flows?
- Firms make decisions that depend in part on decisions made by other firms along vertical chain
- Without good co-ordination, bottlenecks arise in vertical chain
- To ensure co-ordination, firms rely on contracts but if contracts cannot be written or transaction costs related to them are high enough co-ordination justifies vertical integration
What are the disadvantages of using the market? (PT 2)
- Limited protection via contracts
- Main costs associated with using the market are related to the costs of negotiating, writing and enforcing contracts (Transaction cost econ)
- Cost of protecting the company from potential opportunistic behaviour via complex contracts may be too high
What are the factors that prevent complete contracting?
- Bounded Rationality:
- Difficulties in specifying/measuring performance
- Asymmetric Information
What’s meant by complete contracting?
If the parties to an agreement could specify their respective rights and duties for every possible future state of the world, their contract would be complete.
-There would be no gaps in the terms of the contract.
What’s meant by bounded rationality?
- Individuals have limited capacity to process information, deal with complexity, and pursue rational aims
- Individuals cannot foresee all possible contingencies