Term
| When do economies of scope come into existence? |
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Definition
| Economies of scope exist when the cost of conducting two business activities within the same company is less than the cost of those same two businesses operated separately. |
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Term
| Explain why a learning curve is more complex than a scale curve |
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Definition
| The learning curve is more complex than a scale curve to calculate because it requires gathering data on the cumulative volume of a given product or service produced, the total amount since a company started making the product or providing the service. In contrast, the scale curve shows how costs per unit change with increases of volume of production during a given time period, such as a quarter, half-year, or year. It is easier for companies to obtain cost information from specific time periods. |
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Term
| 75. Which is an important source of proprietary knowledge? |
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Definition
| Patents are often important sources of proprietary intellectual property. |
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Term
| 76. Define economies of scale and list out its four principle sources. |
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Definition
| Economies of scale exist when there is a reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases. In other words, economies of scale exist when an increase in company size lowers the company’s average cost per unit produced. Economies of scale arise from four principle sources: the ability to spread fixed costs of production, the ability to spread nonproduction costs, specialization of equipment, and specialization of people. |
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Term
| 77. Define the cost advantage strategy and its characteristics. |
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Definition
| Some companies use the basic premise of “practice makes perfect” to help them pursue a cost advantage strategy. These companies are relying on the fact that humans can perform tasks more efficiently—more quickly, with greater dexterity—the more a task is repeated. Doing a task a lot of times also often helps people become more effective, that is, they find better ways to complete the task. Researchers and strategists measure the effects of learning and experience using the learning curve and the experience curve. |
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Term
| 78. Define learning curve, experience curve, and scale curve. Compare them with each other. |
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Definition
Scale curve is a graphic representation of the relationship between cost per unit and scale (volume) of production in a given time period. Learning curve is the concept that labor costs per unit decrease with increases in volume due to learning. New skills or knowledge can be quickly acquired initially, but subsequent learning becomes much slower. Experience curve is a representation of the relationship between cumulative volume and product cost.
The learning curve is a tool that managers can use to determine the contribution of human learning on the part of employees to reductions in costs per unit. Learning curve advantages are also relevant in service industries such as accounting, consulting, legal services, and even personal services like hair styling.
The learning curve is more complex than a scale curve to calculate because it requires gathering data on the cumulative volume of a given product or service produced, the total amount since the company started making the product or providing the service. The scale curve shows how costs per unit change with increases of volume of production during a given time period, such as a quarter, half-year, or year. It is easier for companies to obtain cost information from specific time periods.
An experience curve does a better job of capturing learning effects than a scale curve, because it is based on cumulative volume, like the learning curve. But, it also does a better job of capturing the effects of economies of scale than a learning curve does, because it includes all costs, not just labor. However, if data from the same time period are used to calculate a scale curve and experience curve, both analyses produce the same result. Like scale curves, experience curves are applicable to service, as well as manufacturing, industries. |
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Term
| 79. Explain proprietary knowledge and its important sources. |
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Definition
| In some cases companies are able to achieve a cost advantage due to proprietary knowledge that is independent of scale or output. Proprietary knowledge is information that is not public and that is viewed as the property of the holder. Patents and trade secrets are often important sources of proprietary intellectual property. |
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Term
| 80. Mention the four ways that companies achieve cost advantage through lower-cost inputs and explain bargaining power over suppliers. |
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Definition
Inputs are resources such as people, raw materials, energy, information, or financing that are put into a system (such as an economy, manufacturing plant, computer system, etc.) to obtain a desired output. There are four primary ways that companies achieve cost advantage through lower-cost inputs: (1) exercising strong bargaining power over suppliers, (2) cooperating especially well with suppliers, (3) getting inputs from low-cost locations, and (4) arranging better access to inputs than other companies have.
Perhaps the most important way that companies get lower-cost inputs is by having greater bargaining power over suppliers than their competitors do. There are two main sources of bargaining power: buying a lot from the supplier and using successful negotiating tactics.
(1) Purchasing Volume: Perhaps not surprisingly, suppliers can be expected to drop prices when buyers increase their volume of purchases. Indeed, as a rule of thumb, suppliers are known to drop prices by 5 to 10 percent with a doubling of purchased volume. At high volumes, suppliers experience economies of scale and the law of experience, so they can lower their prices.
(2) Purchasing and Negotiating Tactics: Even when two firms purchase similar volumes of inputs, one of the firms may have negotiation skills and purchasing tactics that allow it to get inputs at lower prices. |
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Term
| 58) What are the mechanisms that help companies in exploiting and/or expanding their resources and capabilities? |
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Definition
| Exploiting and/or expanding the resources and capabilities usually come through one of six mechanisms. A mnemonic device of the six Ss helps one remember these important elements: employing slack, creating synergy, leveraging shared knowledge, utilizing similar models for success, spreading human and financial capital to its best use, or providing a stepping stone for the company to a completely new business sector. |
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Term
| What does the term adjacent market mean? |
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Definition
| An adjacent market is a market or industry that is closely related to markets or industries a firm currently competes in. The adjacent market may mean selling the firm’s existing products to new customer groups, bringing new products and services to existing customers, or selling new products and services to new customers. |
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Term
| How does diversification help exploit existing customer-facing resources? |
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Definition
| Diversification allows companies to exploit their existing customer-facing resources by adding new operational resources and capabilities. |
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Term
| Explain the ways in which diversification adds value. |
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Definition
| Diversification adds value when it allows the combined businesses to deliver greater value and utility to new or existing customers than a firm could without being diversified. Diversification also adds value if the combined businesses reduce the firm’s overall cost of producing goods or services. Diversification adds value when expansion into an adjacent business either exploits the firm’s core and valuable resources and capabilities or diversification enhances and grows the resource base. Diversification allows companies to exploit their existing customer-facing resources by adding new operational resources and capabilities. Diversification also creates value when it helps a company expand its existing set of resources and capabilities or diversification enables it to prepare for the future. |
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Term
| What is a greenfield entry? When should a company use it? |
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Definition
| A greenfield entry is defined as entry into an adjacent market by a firm that opens its own operation. Greenfield entry makes sense, first and foremost, when companies have the front-end and back-end resources and capabilities they can immediately exploit to create value. Greenfield also makes sense when companies can afford to enter new arenas slowly and at small to moderate investment. |
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Term
| What are the two challenges related to acquisition premium that an acquiring firm faces when acquiring a target firm? |
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Definition
| Acquirers must pay a premium to acquire a target; the premium represents a bet by the acquirer on its ability to create value through the acquisition. The acquisition premium creates two challenges for the acquiring firm. First, the larger the premium, the more value they must actually create to justify the acquisition. Second, given the time value of money, the larger the premium, the quicker the acquirer must create that value. |
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Term
| How does a related-constrained diversification differ from a related-linked diversification? |
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Definition
| A related-constrained diversification occurs when a firm earns less than 70 percent of its revenue from its main line of business and its other lines of business share product, technological, and distribution linkages with the main business. A related-linked diversification occurs when a firm operates in related markets, but fewer linkages exist between the new and existing markets than the elements create separately. |
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Term
| Mention the factors that lead to destroying value through diversification. Explain any three of them. |
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Definition
Value usually gets destroyed in one of five ways: excessive pride; sunk cost fallacy; imitative diversification; poor governance and incentives; or the lack of resource commonality between the lines of business. (Students’ answers may vary.)
Hubris: Managers may diversify based on their own beliefs about the potential of their company’s ability to create value in the adjacent market. Hubris is an ancient Greek word for excessive pride, arrogance, or overconfidence. Managers act with hubris when they diversify or make acquisitions based on their own experience or their gut feelings rather than on solid data and research.
Sunk Cost Fallacy: Closely related to hubris as a reason why diversification fails is the sunk cost fallacy, whereby managers believe that their investment in a failed acquisition just needs more incremental investment in order to succeed. Executives are often reluctant to abandon a project in which they have already invested so much time and capital; they often move forward under the assumption that things will turn around with a little more investment.
Imitation: Managers sometimes feel pressure to diversify their corporation when a competitor diversifies first. The competitor has done due diligence and selected an attractive target for acquisition, or made a greenfield entry after careful research and planning. Caught off-guard, a firm might quickly look for a similar acquisition target or hurry to create a similar line of business. In their rush to respond, managers fail to consider how attractive the target really is, or if they have the resources and capabilities that make the new market a value adding adjacency. |
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Term
| Briefly state the difference between outsourcing and insourcing. |
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Definition
| : Outsourcing is the process where a firm contracts out a business process or activity to an external supplier, whereas, vertical integration or insourcing brings business processes or activities previously conducted by outside companies in-house. |
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Term
| What is the main difference between a company that is vertically integrated and a company that is vertically specialized? |
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Definition
| Companies that participate in many or all stages of the industry value chain from exploration to final sale are vertically integrated. Companies that participate in only one activity are vertically specialized. |
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Term
| In the context of vertical integration, when is flexibility most valuable? |
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Definition
| : Having more flexibility—that is, being less vertically integrated—is particularly valuable when new technologies are being developed or if the cost to perform an activity can change quickly. |
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Term
| In the context of coordination, what is modular interdependence? |
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Definition
| In the context of coordination, modular interdependence is one of the three types of interdependence. Some activities in a vertically integrated firm require low levels of coordination because the activities are modular in nature. This means the results are pooled together but the individual activities can be conducted without coordinating with other activities. The members of such teams may share information about the activity with each other, but in the final analysis, the activity is done by the individual performer. In this case, team performance is based on individual performances or activities that are pooled together. This is typically referred to as modular or pooled interdependence, meaning that the degree of coordination required is relatively low. |
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Term
| Explain the three Cs of vertical integration. |
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Definition
The three Cs of vertical integration—capabilities, coordination, and control—are the primary reasons that companies choose to make versus buy. The first C is capabilities, which refers to the question of whether a firm has—or can build—the capabilities to perform an activity better than other firms. The firm’s leaders should ask this question: To what extent are they, or could they be, the best in the world at conducting that activity? If the firm can be one of the best in the world, then it is probably an activity it should do. But, if it cannot be one of the best in the world, then the firm is probably better off by outsourcing the function to a company that has stronger capabilities.
The second C is coordination, which refers to the question of whether a firm is better able to effectively coordinate an activity with other activities in the firm when both are conducted internally. In this case, the firm isn’t necessarily more capable at performing a particular activity, but it lowers the coordination costs associated with two interdependent activities. A firm’s leaders should ask: To what extent will they improve their ability to coordinate their business activities—and offer unique value—by conducting this activity themselves? The fact of the matter is that some activities or tasks require more coordination than others to be successful because of greater interdependence with other activities. The greater the interdependence between activities, the more it makes sense to vertically integrate and have these done within a company where the team members can effectively coordinate their work.
The third C is control, which refers to a firm’s desire to maintain control over a valuable activity or input in the value chain. In other words, an organization’s leaders must ask: to what extent should they maintain control over a crucial step in the value chain by conducting that activity themselves? A company may want to vertically integrate in order to control some scarce and valuable resource, particularly if it is a differentiator of its final product. The choice to backward integrate may be made in order to control access to important raw materials or inputs that are highly customized to downstream activities. In a similar vein, it might make sense to maintain control over investments in assets or equipment that provide key inputs at lower cost. |
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Term
| What are the dangers of vertical integration? |
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Definition
There are two important dangers—a loss of flexibility and loss of focus—the two Fs.
First, when many activities are managed in a value chain, the flexibility to quickly make changes to the business is lost. This might be important when there are major technological changes. In fact, research has shown that companies that are more vertically integrated take a bigger hit to performance when there is a technological change. Having more flexibility—that is, being less vertically integrated—is particularly valuable when new technologies are being developed or if the cost to perform an activity can change quickly.
A loss of focus refers to the fact that the more different types of activities a firm needs to manage, the harder it is to be world class in all of those activities. It is just too difficult for managers to focus on many different activities at once and be world class at all of them. There is one more dimension to focus that is worth mentioning. When firms are vertically specialized, they only stay in business when they can focus on making profits. If they can’t make enough profits, they go out of business |
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Term
| What are some of the advantages of outsourcing? |
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Definition
| Outsourcing does give firms more flexibility to quickly move activities to whatever company is the best at performing that particular activity. When there is high technological uncertainty in an industry with lots of new leapfrog technologies being developed, flexibility is valuable, and outsourcing is often preferred to vertical integration. Outsourcing also allows firms to focus their attention on being good at a narrower range of activities. Along with this benefit, outsourcing also minimizes the capital investment required to grow. Also, outside suppliers can often produce at much greater scale than in-house suppliers because in-house suppliers often have difficulty getting outside customers. |
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Term
| What are the disadvantages to outsourcing? |
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Definition
| There are two major dangers of outsourcing: a loss of capabilities (particularly the capability to innovate) and a lack of control over critical assets or activities. In addition to leading to a loss of innovation capabilities, outsourcing can lead to a loss of control as suppliers that provide key inputs gain bargaining power. |
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Term
| What are the ways in which strategic partners can build trust in alliance relationships? |
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Definition
| There are four primary ways that partners build trust in alliance relationships: (1) personal trust, (2) legal contracts, (3) shared equity/financial collateral bonds, or (4) reputation. |
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Term
| Companies have three choices—make, buy, or ally—when it comes to conducting any particular activity that needs to be done to offer a product or service to a customer. Explain the three choices and the process involved in each. |
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Definition
| First, firms can make, or conduct the activity themselves within the firm. Second, they can buy, or purchase, the activity or input from another firm, using an arm’s-length relationship, in which the buyer purchases an input with no obligation to have a long-term relationship with the supplier. Companies that send out a bid to numerous suppliers and then buy from the supplier that offers the lowest price have an arm’s-length relationship with those suppliers. The winner of the bid this month may lose next month. Finally, they can ally, or acquire, the activity or input from another firm, using an exclusive partnership relationship with that firm. |
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Term
| What are the four kinds of inputs and activities that might qualify as strategic inputs, which merit forming an alliance relationship? Explain the four inputs with suitable examples. |
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Definition
i) Inputs that can differentiate a firm’s product in the minds of customers. Automakers are much more likely to want to partner with a supplier that provides important engine or drivetrain components that influence engine performance or reliability than one that provides fasteners. For example, truck manufacturers often partner with Cummins, a respected maker of truck engines and components, in the manufacture of their trucks.
ii) Inputs that influence a firm’s brand or reputation. Volvo, a Swedish manufacturer of cars and trucks, has tried to develop a reputation on the safety of its cars. Consequently, it has worked closely with key suppliers, including Autoliv, a Swedish supplier of seat belts and airbags, to put pioneering safety technology into its vehicles.
iii) High value inputs or activities that make up a high percentage of a firm’s total costs. Companies that make refrigerators are more likely to partner with the supplier who provides the compressor—the component that costs the most and cools the refrigerator—than with the suppliers of plastic trays or fixtures.
iv) Inputs or activities that require significant coordination in order to achieve the desired fit, quality, or performance. Whenever one needs to coordinate closely with another firm to get the desired performance from their input or activity, he or she probably wants a partnership relationship. |
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Term
| What are the three types of strategic alliances based on governance arrangement? Also, briefly explain how alliances can also be categorized based on the stages of the value chain. |
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Definition
The following are the three types of strategic alliance based on governance arrangement.
i) A contractual or nonequity alliance: This is a type of strategic alliance in which two or more firms write a contract to govern their relationship. There is ownership shared between the companies.
ii) An equity alliance: In this type of alliance, the collaborating firms often supplement contracts with equity holdings in their alliance partners.
iii) A joint venture: This is an alliance in which collaborating firms create and jointly own a legally independent company. The new company is created from resources and assets contributed by the parent firms.
In addition to distinguishing alliances by the type of governance arrangement (e.g., nonequity, equity, joint venture), alliances are sometimes categorized as either vertical alliances or horizontal alliances. A vertical alliance is an alliance between firms who are positioned at different stages along the value chain, such as a supplier and a buyer. A horizontal alliance is between two firms that do not have a supplier-buyer relationship and are typically positioned at a common stage of the value chain. |
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Term
| What are the different types of nonequity alliances? |
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Definition
Different types of nonequity alliances include:
i) Licensing agreement: It is an alliance in which one firm receives a license, or permission to use a resource, such as a brand or a patent, from another firm in return for a percentage of the revenues or profits.
ii) Supply agreement: It is a type of alliance in which a supplier may agree to develop certain customized inputs for a customer.
iii) Distribution agreement: It is the agreement in which a distributor or retailer may agree to provide certain customized services in order to help sell a product. |
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Term
| Explain the different ways through which a firm can create value in an alliance. Support your answer with suitable examples. |
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Definition
i) Combine unique resources: Pixar contributed computer-generated animation (CGA) and story-writing skills that brought to life unique stories in films such as Toy Story, Finding Nemo, Cars, and The Incredibles. Disney contributed worldwide film distribution to the partnership and sold products involving Pixar’s movie characters—such as Woody and Buzz Lightyear—at its Disney stores and theme parks.
ii) Pool similar resources: Intel and Micron wanted to manufacture flash memory—a business that required billions of dollars of investment in plant and equipment. So they decided to create IMFlash, a joint venture designed to produce flash memory products. By splitting the cost of the plant and equipment, the two companies were able to build a much larger plant and, through economies of scale, produce flash memory at a lower cost per unit.
iii) Create new alliance-specific resources: The alliance between Toyota Boshoku and Toyota is an example of building new resources in order to improve efficiency, the ability of the partners to coordinate their joint work. Toyota Boshoku, which supplies automobile seats to Toyota, built its factory next door to Toyota’s assembly factory. Because seats are bulky and costly to ship, building the plant nearby lowered Toyota Boshoku’s costs of inventory and shipping to Toyota. Then, to further reduce shipping costs, Boshoku decided to build a conveyer belt to take seats directly from its factory into Toyota’s. The factory plant and the conveyor belt were both new resources that were created to support Boshoku’s transactions with Toyota. These investments substantially lowered transportation costs, inventory costs, and the costs associated with having face-to-face meetings.
iv) Lower transaction costs: General Motors and its suppliers had higher transaction costs because they did not trust each other; so they spent a lot of time negotiating agreements and writing legal contracts. In contrast, Toyota had developed relationships with its supplier partners that were based on mutual trust. One thing that Toyota did to build trusting relationships with some suppliers was to purchase a minority stock ownership stake in the supplier. Because Toyota owned part of the suppliers’ stock, suppliers felt that Toyota would behave in a trustworthy manner. |
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