Week 9 & 10 Flashcards
Forward vertical integration
Move to the customer in the value chain
Backwards vertical integration
Move to the raw material in the value chain
Horizontal integration
Remain within the boundaries of an industry but expands via, for instance geographical expansion or versions of products
Product diversification
A compamy operates in multiple industries at the same time
Can be related or unrelated
Advantages of Horizontal expansion
- Economies of scale: The per unit cost of products decreases with higher production levels
- Reduction of competition: Larger firm within an industry industry concentration is increased Competition is reduced Higher expected profitability
Disadvantages of product diversification:
By focusing on industy x, opportunities in y might be overlooked.
Can Vertical integration and product diversification overlap?
Yes! The overlap will generate outside sales and sits in a different stage in same value chain
If the vertical integration is focussed only internal sales, and sits in a different stage in the same value chain & Product diversification is part of a different value chain and generate outside sales
Why is Disney a great example of both vertical integration and product diversification?
Theme parks: Different value chain wich generates outside sales (product diversification)
ICT System: Different stage in same value chain
Generates no outside sales (vertical integration)
Overlapping area: Script preparation
- Different stage in same value chain
- Generates outside sales
What means economies of scope
Costs of P1 and P2 within a firm is lower compared than producing both in different firms
Advantages product diversification: What means Economies of scope
Economies of scope:
-Costs of performing research on both “oncology” and “immunoscience” might be cheaper that two firms researching seperately
Advantages product diversification: Internal capital market (volksbank)
- More information
- More control and monitoring possible
Advantages product diversification. Competition reduction: predatory pricing/ deep pockets
Transferring funds from another market to start offering products in another market to make prices low, and let competitors fall out
Advantages product diversification: Competition reduction: Mutual forbearance
Refraining from competition in a market because of retaliation of competitor in another market
Explain the advantages product diversification: Risk reductions
It can reduce overall risk, depending on the correlation of the cash flows of different businesses. (core has to be -1 or so, why?)
Risk reduction- portfolio management
Maximize expected return for a given level of risk
Disadvantages of product diversification
Increased management cost
Monitoring costs
Losing focus on the firm’s core competence(s)
Advantages and disadvantages of the product diversification
Depends on Related or Unrelated diversification
How to kwantitative determine the relatedness between business units
Resources and Capabilities
Dominant logic
Corporate coherence
Multimarket contact
Industry codes
What means “resources and capabilities?” in the relatedness between firms?
Does a firm use the same resource for two or more of its businesses? (Yes? Related)
What means Dominant logic in the relatedness between firms?
Do businesses have common strategic characteristics? (Yes? Related)
What means Corporate coherence in the relatedness between firms?
Because competitors have created similar portfolios, we conclude that the businesses somehow must be related.
What means Multimarket contact in the relatedness between firms?
We are active in businesses A and B, but so is our competitor. A strategic move in A can have consequences in business B
Industry codes (SIC)
First two digits of the SIC codes are identical.
How to categorize businesses Wrigley/Rumelt
Single Businesses > 95% revenue of one business
Dominant Businesses: 70-95% revenues from one business
Related Business < 70% of revenues from one business
Unrelated Business: < 70% of revenues from one business without relationships between the businesses. (active or passive role)
Measure Product Count (Varadarajan & Ramanujam)
BSD = Number of unique codes (first two numbers)
MNSD = Total of companies in the list
MNSD/BSD=…(look at the plot)
Measure: Weighted product count (Palepu). Explain
Takes into account the relative size of each of the businesses
Entropy measure
Aims at the share of the certain business (i) in the total sales of the firm.
ln(1/revenue%)*revenue%+ idem.
Advantage of product diversification of: Economies of scope
Related: Large
Unrelated: Small
Give the advantage of product diversification in the Internal capital market when related and/or unrelated
Related: Large
Unrelated: Large
How high is the advantage of product diversification to reduce competition when related or not
Related: Large
Unrelated: Medium
Advantage of product diversification to reduce Risk when related/unrelated
Related: Small
Unrelated: Large
Disadvantages of product diversification: Management costs
Related: Large
Unrelated: Small
Disadvantages of product diversification: Lost focus
Related: Small
Unrelated: Large
Performance of Corporate- level strategies. Paluch, Cardinal and Miller. Explain their research.
> Researched the relationship between level of diversification between businesses, and overall firm performance.
Diversification is measured in different ways.
Should we diversify (porters 3 test)
> The attractiveness test: we expect to make a healthy profit in that market
The cost of entry test ( Cost of entry 100m, profit 50m, don’t do it)
The better off test (new business must be able to gain a competitive advantage for the firm or visa versa
How to rate a portfolio of businesses?
> Market Growth Rate
Relative Market Share
Dogs, ?, Star, Cash Cow
Why are family firms often more diversified than non-family firms?
Conglomerate discount (Shareholders will punish diversified behaviour of firms, because they can do it themselves.)
In a family firm, the family is the shareholder.
Organisational form (M-form) Explain and give the pro’s and cons
> Activities aimed at either product or geographic regions are grouped in divisions
Pro’s:
- Clear focus on specific areas
-Reduced overload top management
Cons:
-Loss of efficiency and synergie
Management controls in an M-form organisation. Give 3 questions.
How to evaluate divisional performance
How to allocate corporate capital
How to transfer intermediate products
Compensation between firms. Give 2 difficulties
> Managers (agents) may not act in the best interest
Same rationale applies to product diversification
- Equity holders: make sense if it increases the performance of the firm
- Managers: Compensation packages are often tied to firm size, so might make individual sense for managers to expand. at the expense of equity holders
