3rdchap13ppt4924.Ppt the Scope of a Firm

8/9/2019 3rdchap13ppt4924.Ppt the Scope of a Firm

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Vertical Integration and

The Scope of the Firm

Vertical Integration and

The Scope of the Firm

Transactions Costs and the Scope of the Firm

--Why does the firm exist?

--The trend over time The Costs and Benefits of Vertical Integration

Designing Vertical Relationships: Long-term

Contracts and Quasi-Vertical Integration

Recent Trends

OUTLINE


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From Business Strategy to Corporate

Strategy: The Scope of the Firm

From Business Strategy to Corporate

Strategy: The Scope of the Firm

Business Strategyis concerned with howa firm

computes within a particular market Corporate Strategyis concerned with where a

firm competes the scope of its activities

The dimensions of scope are

geographical scope

vertical scope

product scope


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Transactions Costs and the

Scope of the Firm

Transactions Costs and the

Scope of the Firm

Which is more efficient : several specialist firms linked by markets, or

the combination of these specialist firms under common

ownership.

VERTICAL PRODUCT GEOGRAPHICAL

AREAS

SINGLE V1 P1 P2 P3 A1 A2 A3

FIRM V2

V3

SEVERAL V1 P1 P2 P3 A1 A2 A3SPECIALIZED V2

FIRMS V3

Common Issue--- What are TRANSACTION COSTS of markets

compared with administrative costs of the firm?


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Transactions Costs and The Existence

of the Firm

Transactions Costs and The Existence

of the Firm

Transaction cost theory explains not just the boundaries of

firms, also the existence of firms.

In 18th century English woolen industry, no firms --

independent spinners, weavers, and merchants. Residential remodeling industry -- mainly independent self-

employed builders, plumbers, electricians, painters.

Key issue -- transaction costs of the market vs.

administrative costs of firms.

Note: transaction costs = cost of locating, negotiating, and

enforcing a contract.


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Changes in Aggregate

Concentration Over Time

Changes in Aggregate

Concentration Over Time

Since early 19th century, firms have grown in size

Alfred Chandler points to growing vertical, geographical and product

scope of industrial companies

What factors explain this trend?

Why has the trend reversed since the late 1970s?

1930 1940 1950 1960 1970 1980 1990

50%

20%

35%

Salesof10 0

biggestcos.as%

ofUSin

dus

trialoutput


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Determinants of Changes

in Corporate Scope

Determinants of Changes

in Corporate Scope

1800 - 1975: Expansion in size & scope of biggest industrial corporations.Administrative costs of firms fell due to Advances in transportation, information and communication

technologies Advances in management - accounting systems, decision sciences,

financial techniques, organizational innovations, scientific management

1975 - 1995: Contraction in size & scope of biggest industrialcorporations. Increased market turbulence, more competition,

accelerated technological change

Need for speed, flexibility, responsiveness

Large, complex corporations become relatively less efficient


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The Costs and Benefits of Vertical

Integration: BENEFITS


Integration: BENEFITS

Technical economies from integrating processes e.g. iron

and steel production

-- but doesnt necessarily require common ownership Superior coordination

Avoids transactions costs of market contracts from:

-- small numbers of firms

-- transaction-specific investments

-- opportunism and strategic misrepresentation

-- taxes and regulations on market transactions


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Integration: COSTS


Integration: COSTS

Differences in optimal scale of operation between different

stages prevents balanced VI

Strategic differences between different vertical stages creates

management difficulties Inhibits development of and exploitation of core

competencies

Limits flexibility -- in responding to demand cycles

-- in responding to changes in technology,

customer preferences, etc.(But VI may be conducive to system-wide flexibility)

Compounding of risk


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When is Vertical Integration More Attractive

than Outsourcing?

How many firms are available The fewer the companies

to undertake the activities? the more attractive is VI

Is transaction-specific investment If yes, VI more attractive needed?

Does limited information permit VI can limit opportunism cheating?

Are taxes or regulation imposed VI can avoid them on

transactions?

Do the two stages have similar Greater the similarity, the optimal

scale of operation? more attractive is VI

Are the two stages strategically Greater the strategic

similar? similarity ---the more attractive is VI

How uncertain is market demand? Greater the unpredictability ----the more

costly is VI

Does VI increase risk? If heavy investment required and risks

between stages are inter- related----VI increases risk.


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Designing Vertical Relationships: Long-

Term Contracts and Quasi-Vertical

Integration

Designing Vertical Relationships: Long-

Term Contracts and Quasi-Vertical

Integration

Intermediate between spot transactions and vertical

integration are several types of vertical relationships---such relationships may combine benefits of both market

transactions and internalization

Key issues in designing vertical relationships

-- How is risk allocated between the parties?

-- Are the incentives appropriate?


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Recent Trends in Vertical RelationshipsRecent Trends in Vertical Relationships

From competitive contractingto supplier partnerships, e.g.

in autos

From vertical integration to outsourcing (not just

components, also IT, distribution, and administrativeservices).

Diffusion of franchising

Technology partnerships (e.g. IBM- Apple; Canon- HP)

Inter-firm networks

General conclusion:- boundaries between firms and

markets becoming increasingly blurred.


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Different Types of Vertical

Relationship

Different Types of Vertical

Relationship

Spot sales/

purchases

Long-term

contracts

Agencyagreements

Franchises

Vertical

integration

Joint

ventures

Informal

supplier/

customer

relationships Supplier/

customer

partnerships

Low Degree of Commitment High

Low

High

Forma

liza

tion

3rdchap13ppt4924.Ppt the Scope of a Firm

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