Vertical Chain

- Process that begins with purchasing raw material and ends with distribution of finished goods

Value Chain

- Identifying steps in vertical chain where more value is added 

Purchasing/Inventory Handling

l

Production

l

Distribution

l

Sales/Marketing

l

Customer Service

Human resources, R&D and corporate infrastructure all support these activities

Consumer Value

Cost/Efficiency

Ability of firm to extract some of the difference between the two

Upstream = early steps in production (ex. inputs)

Downstream = finished goods (ex. sales)

Establishes the vertical boundaries of the firm

Make = perform activity yourself

Buy = purchase from independent firm; arms length transactions (only choose between 1 company or another)

Exploiting Scale and Learning Economies

Agency & Influence Effects 

Market specialist can sell to many buyers and take advantage of economies of scale and scope

Think of linamar production of car parts for ford. Can produce more units at lower cost

Market firms enjoy benefits related to incentives over their integrated rivals

Independent firms must survive discipline of market competition; this encourages efficiency & innovation

Corporate success can hide inefficiencies and lack of innovatieness 

Independent firms may have more incentive to innovate within a division within a firm because departments can never be sure if they are making/losing money

Define the following:

Agency Costs

Transfer Price

Influence Costs

Agency Costs

- Costs associated with slack effort and administrative costs to deter slack effort

- EX. Employees searching web during work

Transfer Price

- Internal price between divisions of company

- EX. IT support in large firm 

- Difficult to determine this

Influence Costs

- Costs associated with lobbying for resources which may lead to biased information and destructive competition within a firm 

- EX. John Deere sprayers - engineers want high tech sprayers, where marketing wants cheap sprayer

Co-ordination of Production Flows

Leakage of Private Information

Transaction Costs

Production flow in the vertical chain can be compromised when purchasing from independent market

Fit can be in terms of time, size, colour, sequence or R&D fit

fit can be attained through either doing tasks in house or through contract with independent firm

Firms don't want to risk losing private information (dealing with independent market may require divulging info.)

Private information gives firms advantage in market

Firm can constrain use of certain information through contracting with non-compete clause or patents 

Costs of transacting with other firms can be avoided by performing activity yourself 

Transaction costs = cost of organizing and transacting exchanges between arms-length partners in market

Monetary price -> administrative costs -> information search -> quotes for business -> enforce contract

Define the following:

Arms-length transactions

Contract

Arms-length Transactions

- Autonomous or independent parties acting in their own self-interest exchange goods and services with another

Contract

- An agreement that defines the conditions of exchange

- If this agreement is broken, there are formal (ex. court) or informal (ex. reputation in town) institutions that will settle the problem 

Prevent trading partners from taking advantage of one another

Without them, exchange activities would be biased towards those in which performance occurs simultaneously with payment (pay cash immediately)

Cost of transacting business would increase significantly

Complete Contract

- Stipulates each party's responsbilities and rights for every contingency that could possibly occur

- Must be enforcable

- Must stipulate what acceptable performance is and measure it

Incomplete Contract

- Most contracts are incomplete

- Have amiguity or open-endedness about what each party involved is required to do

What factors prevent complete contracting?

"BAD"

1. Bounded rationality

- We cannot come up with all the potential "what ifs"

2. Difficulty in Specifying & Measuring Performance

- Hard to quantify different things (ex. wear and tear on rental vehicle - what constitutes this?)

3. Asymmetric Information

- Occurs when one party knows more tan the other about the conditions of exchance and takes advantage of them 

- See agriculture industry moving towards more reliance on contracts and product vs. process standards 

An investment made to support a specific transaction

Cannot be redeployed to another transaction without some loss of productivity or by incurring an additional cost

Can take the form of site specific, physical asset specificity, dedicated assets or human asset specificity