Strategic Management - Exam Three Study Guide

Corporate Level Strategy

Part I. Chapters 13 & 15 (pages 392-404, 450-459, 461-464)

1. Benefits and Costs of Concentration

A. Benefits (Advantages):

1) Firms can master one industry environment (top managers acquire an in-depth
knowledge of the industry)
2) All resources are put back into the business (creates sustainable competitive
advantage)
3) There are typically lower overhead costs and fewer “layers” in the
organization which leads to reduced “bureaucratic costs”

B. Costs (Disadvantages):

1) There is a total dependency on the industry (the firm has all its eggs in one
basket)
2) Firms tend to develop a “myopic” view and management doesn’t see change
coming and therefore is unable to change when times get tough
3) Top managers are not challenged and may become bored and stagnant
4) The firm misses opportunities to leverage resources and capabilities in an area
outside of the industry that may be more profitable

2. Vertical Integration

A. What is vertical integration?

Vertical integration is the degree to which a firm owns its upstream suppliers and
its downstream buyers. Typically a firm does not vertically integrate unless by
doing so it can either cut costs or create a differentiation advantage.

B. What are the pros (benefits) and cons (drawbacks) of vertical integration?

Benefits of Vertical Integration:

1) Reduce transportation costs if common ownership results in closer geographic

proximity.
2) Improve supply chain coordination.
3) Provide more opportunities to differentiate by means of increased control over
inputs.
4) Capture upstream or downstream profit margins.
5) Increase entry barriers to potential competitors, for example, if the firm can
gain sole access to a scarce resource.
 6) Gain access to downstream distribution channels that otherwise would be
inaccessible.
7) Facilitate investment in highly specialized assets in which upstream or
downstream players may be reluctant to invest.
8) Lead to expansion of core competencies.

Drawbacks of Vertical Integration:

1) Capacity balancing issues. (For example, the firm may need to build excess
upstream capacity to ensure that its downstream operations have sufficient
supply under all demand conditions.)
2) Potentially higher costs due to low efficiencies resulting from lack of supplier
competition.
3) Decreased flexibility due to previous upstream or downstream investments.
4) Decreased ability to increase product variety if significant in-house
development is required.
5) Developing new core competencies may compromise existing competencies.
6) Increased bureaucratic costs.

C. What are the reasons to pursue forward vertical integration?

A firm should vertically integrate only if it can cut costs by doing so or create a
differentiation advantage by doing so. The best potential to cut costs by forward
integration exists when a firm can lower costs by facilitating capacity (riding the
experience curve).

D. What are the reasons to pursue backward vertical integration?

The best potential to cut costs by backward vertical integration exists when a firm
can replace a supplier and make a part that:
1) is a major cost component or has a high profit margin, and
2) the technology needed to manufacture the part is easily mastered, and
3) in making the part the company can achieve the same economies of scale.

3. Diversification

A. What is “diversification?”

“Diversification” is when a firm goes outside of the industry it is currently in and

introduces a new product to a new market. There are three basic tests for
evaluating a potential diversification move: attractiveness, cost of entry, and
“better off test.
 B. What is “related diversification?”

“Related diversification” is diversification into a value chain with a valuable

strategic fit into the current value chain.

C. What is “unrelated diversification?”

“Unrelated diversification” is diversification into any industry with good profit

potential regardless of whether it “fits” or benefits the current value chain.

D. How can diversification create value? (Describe sources of value creation)

Any diversification (both related and unrelated) adds value through a successful
transfer of superior governance management capabilities (place different
business with their own, hold division manager accountable, decentralized
management, rewards based on performance).

In addition to this, related diversification creates value in three additional ways:

1) It creates value through the transfer of distinctive competencies,
2) It realizes economies of scope (which is a cost savings that results from sharing
resources) which can also lead to economies of scale, and
3) It helps to manage rivalries by keeping a potential competitor out of your
market through the threat of entering his in retaliation.

E. How can diversification dissipate value?

F. Describe the bureaucratic costs of related and unrelated diversification.

Related diversification has the bureaucratic cost of coordinating actual business

activities. Sometimes it is more of an obstacle than a benefit to share resources.
This coordination has both direct bureaucratic costs (structuring decisions) and
indirect bureaucratic costs (costs associated with accountability and control).

Unrelated diversification sometimes has the bureaucratic costs that come with
having too many businesses in the corporate portfolio. It can be very difficult to
keep up with all of them except for on a superficial level and bad decisions can be
made that harm one business far more than it helps another.

4. Alternatives to Vertical Integration and Diversification

A. Alternatives to Vertical Integration include contracting and partnering. There

are both short-term and long-term solutions. The benefit of short-term is that it
can keep costs down; the drawback is the lack of long-term commitment. The
benefit of long-term is the commitment, but the drawback is that you are stuck
with (and somewhat at the mercy of) your partner.
 B. Alternatives to Diversification involve creating agreements to share the
benefits and the costs and the risks through some type of joint venture. There are
two ways to achieve this:

1) Two (or more) firms can agree to undertake a joint activity without creating a
new business entity, or

2) Two or more firms can form a new business entity with shared interests in the
new entity.

Part II. Chapter 14 (pages 412-420, 424-439)

5. Reasons (motivations) for International Expansion

Firms are motivated to engage in international expansion in order to gain

competitive advantage through:

A. The transfer of distinctive competencies into areas where indigenous

companies lack those competencies.
B. The realization of location economies by producing the product where it is
best produced in order to gain cost or differentiation advantage.
C. To move quickly down the experience curve by serving the world instead of
just one country and therefore increasing plant volume.

6. International Expansion and Porter’s Five Forces

Internationalization affects competition in three ways:

1) Reducing barriers to entry

2) Increasing the buyer power of domestic buyers
3) Increasing rivalry
Four ways rivalry is increased:
a) lowering seller concentration
b) increasing diversity of competitors
c) increasing excess capacity
d) increasing the bargaining power of industrial buyers
7. Porter’s National Comparative Advantage Model

Porter enumerates four factors that contribute to a nation-state advantage:

1) Factor Conditions (also called factor endowments),
2) Local Demand Conditions,
3) Competitiveness of Suppliers & related industries, and
4) Firm Strategy, Structure, Rivalry

A. Factor Conditions - a given nation’s position in factors of production.

Factor conditions include the cost and quality of factors of production. Basic
factors include labor, raw materials, capital, and land. Advanced factors include
“know how,” managerial sophistication, and advanced physical infrastructure.
 B. Local Demand Conditions – nature of the “home demand.”
Companies are usually most sensitive to the needs of the customers who are
located where they are located.

C. Competitiveness of Suppliers & Related Industries – presence or absence in a

nation of related/supplier industries that are internationally competitive.
Successful companies in an industry are usually clustered geographically together
with successful companies in related industries.

D. Firm Strategy, Structure, and Rivalry – conditions in the country that govern
how companies are created, organized, and managed plus the nature of domestic
rivalry (“catch-all” category).

1) Managerial ideologies may differ. For example, top management teams in one
country may be mostly finance majors, while top managers in another country
may be mostly engineers.

2) The nature of the rivalry may force efficiency or responsiveness. Usually, the
more vigorous the domestic rivalry, the more competitive a company is globally.

8. Pressures for cost reduction and local responsiveness

A. Pressures for cost reduction are intense when:

1) the industry [produces commodity-like products

2) the industry has excess capacity
3) in industries where the major competitors are low cost locations
4) in industries where there are powerful buyers

B. Pressures for local responsiveness exist as a result of:

1) differences in customers tastes and preferences

2) differences in infrastructure or traditional practices that would make you want
to customize
3) differences in distribution methods and techniques
4) the demands of the host government

The degree to which these pressures are felt vary depending on the type of
strategy selected by the firm.
9. Multinational Strategies: International Strategy, Multi-Domestic Strategy,
Global Strategy, and Transnational Strategy

A. International Strategy - characteristics

1) transfer distinctive competencies (that result in a unique product) to other

countries where the indigenous firms lack the capacity
2) product was developed at home and home country retains centralized control
3) centralize R&D at home and establish manufacturing and marketing function
in each country you do business

B. Transnational Strategy - characteristics

1) enable “global learning” by creating means of communication throughout the

network
2) experience competing pressures because they have high pressures in both
directions (see diagram below)… win it all or lose it all

C. Multi-Domestic Strategy - characteristics

1) orient themselves to maximum local responsiveness

2) requires a complete set of value creation activities which drastically increases
cost structure

D. Global Strategy - characteristics

1) focus on riding experience curve and reaping benefit from it

2) focus on location economies
10. Modes of Entry into a Foreign Market

Entry into a foreign market can take place through various strategies ranging from
exporting to specific spots for specific transactions (spot transactions) on one end of the
spectrum to establishing a fully-owned subsidiary on the other end of the spectrum. A
firm can

There are five factors to consider when deciding how to enter into a foreign market:

1) Is the firm’s competitive advantage based on firm-specific or country-specific

resources?

If it is based on firm-specific resources, then the competitive advantage should be capable

of being transferred. If the competitive advantage is based on country-specific resources,
the firm must exploit the overseas market by exporting to that market and keep the
resources in the country where it creates the advantage.

2) Is the product tradable and what are the barriers to trade?

If a product cannot be brought into a country, a firm may have no choice but to create the
product in the foreign country if it wants to exploit that country’s market.
3) Does the firm possess the full range of resources and capabilities for establishing a
competitive advantage in the foreign market?

If the firm doesn’t have the full range of resources and supplier relationships it needs, it
may be limited in the manner in which it can enter a foreign market. If it does not have
the manufacturing or marketing resources, it may need to license its product or
technology or even its trademark to a company within the country which has the
resources. It may even have to form a partnership or joint venture with a host nation
corporation if it wants to enter the market.

4) Can the firm directly appropriate the returns to its resources?

Whether a firm licenses it proprietary resources or exploits them directly in the foreign
market depends in part on considerations concerning the appropriability of the resource.
A chemical company would be less hesitant to license its product because of the strong
patent laws that would protect their product from being unlawfully copied. A software
company would be more hesitant to license a program because the patent laws protecting
software are not strong and they may therefore choose to export their product directly to
the foreign market instead of licensing a foreign company to make and sell the product.

5) What transaction costs are involved?

Issues of transaction costs are fundamental to any decision regarding mode of entry into a
foreign market. Import tariffs, exchange rates, information costs are examples of the
transaction costs that must be considered when choosing a mode of entry.

A Note about Joint Ventures

Joint ventures and other forms of strategic alliances across national borders have
dramatically increased in the last few years. Although these joint ventures can be an
effective way to partner to exploit a market, joint ventures have their own special
problems. For joint ventures to work, both firms must profit from the venture and share
in the benefits. The successful sharing of benefit depends on three key factors:

1) The strategic intent of the partner firms (What do they want to accomplish?)
2) Appropriability of contribution (Can skills and resources be shared?)
3) Receptivity of the company (Do they really want to be in a joint venture?)
Part III. Chapter 6 (pages 191-195, 204-207)

11. What is Organizational Structure?

Organization structure involves arranging organizational activities in such a way that it

creates maximum value. The structure of the organization can be defined simply as the
ways in which labor is divided into distinct tasks (which is a specialization decision) and
the method through which coordination is achieved among these tasks. A good structure
is one that increases the value created (consistent with a differentiation advantage) which
decreases bureaucratic costs, which should provide a cost advantage.

12. Understand the basic building blocks (vertical differentiation, horizontal

differentiation, integration)

There are three basic choices a firm has to make regarding the structure of the
organization. These choices are called structure decisions.

Vertical Differentiation Decisions (specialization)

The vertical differentiation decision determines the number of levels a firm has
(how tall is the organization?) and determines how centralized or decentralized
authority will be (how is the organization distributed?)

Horizontal Differentiation Decision (specialization)

The horizontal differentiation decision determines how wide the organization will
be.

Integration Decision (coordination)

The integration decision determines how each of the organizational activity units is
coordinated.
13. Problem of tall structures with principle of minimum chain of command

This is a vertical differentiation issue. There are four main issues that challenge “tall”
organizations.

1) Tall organizations tend to have communication and coordination problems

because of the time required to for information to go from the top to the bottom of
the structure and vice versa. This leads to inflexibility.

2) Tall organizations suffer more from information distortion (the more

information is repeated, the more it gets distorted).

3) Tall organizations suffer more motivational problems (people in chain feel

less responsible for the outcome).

4) Tall organizations often have too many middle managers.

14. Pros and Cons of “Functional Structure”

This is a horizontal differentiation issue. There are four types of horizontal

differentiation structures: simple, functional, multidivisional, and hybrid.

In the functional structure, people who are performing similar tasks using similar
equipment are grouped together in functional units.
 A. Advantages of a Functional Structure

1) employees can learn from each other and get a better at the job
2) communication within the function is enhanced
3) employees can monitor each other (especially true in R&D)
4) units are fairly easy to control (little hierarchies emerge)
5) there are enhanced economies of scale

B. Disadvantages of a Functional Structure (severe when a company expands)

1) communication outside the function is impaired due to function “orientation”

2) there are measurements problems (what is the contribution of X to the firm?)
3) there are location/autonomy problems that come with geographic expansion
4) 1 – 3 above result in strategic problems because the managers are taking care
of these operational issues instead of focusing on strategic decisions.

The disadvantages of a firm with a functional structure may lead the firm to reorganize as
a multidivisional structure.

15. Pros and Cons of “Multidivisional Structure”

This is also a horizontal differentiation issue. In the multidivisional structure, you have
every function (R&D, marketing, accounting, etc) within every division. Going from a
functional structure to a multidivisional structure usually means adding at least one level
vertically and drastic expansion horizontally.
 A. Advantages of a Multidivisional Structure

1) better focus due to divisions based on product or geography

2) enhanced corporate financial control (easy to account for division profits)
3) enhanced strategic control (managers relieved from operational concerns)
4) supports growth
5) allows for vigorous internal efficiency (clear how well each division is doing)

B. Disadvantages of a Multidivisional Structure

1) problems with setting corporate divisional authority structure

2) information may be distorted (to get a larger share of corporate funds)
3) interdivisional competition over resources can destroy synergy
4) divisional short-term focus to look better for rewards (i.e. cut R&D $$$)
5) increased bureaucratic costs

16. Integration mechanisms (arranged IAW their cost, effectiveness, and

complexity)

This is an integration decision which is an issue of coordination. Basically, the question

deals with different methods or “mechanisms” of coordinating between units.

Mechanisms of Integration (in order of complicatedness)

1) Direct Contact (fact-to-face) Least Complicated

2) Interdepartmental Liaison
3) Temporary Task Force
4) Permanent Teams (standing committees)
5) Integrating Role
6) Integrating Department
7) Matrix Structure Most Complicated

Possible areas for test questions that are not on the study sheet provided:

1. “Strategic Outsourcing” and “The Virtual Organization” (4 April class)

2. Two reasons why international companies are sometimes clustered (11 April class)
3. Advantages of centralization/decentralization in vertical integration (18 April class)