2. 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 V P1 P2 P A1 A2 A3
FIRM V2 V3
SEVERAL V P1 P P A1 A2 A3
SPECIALIZED V2
FIRMS V3
Common Issue--- What are TRANSACTION COSTS of markets compared with administrative costs of the firm? 35

3. Introduction (cont.) Types of Diversification Vertical integration
Strategy of acquiring control over additional links in value chain of producing and delivering products/services.
Backward integration
Moving closer to sources of raw materials by acquiring resource suppliers or manufacturing the components needed for production of final product.
Forward Integration
Just the opposite: moving closer to end-user (acquire retail outlets for distribution, etc.).

4. Exhibit: Vertical Integration
Backward Integration
Forward Integration

5. Determinants of Changes in Corporate Scope
: 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
: Contraction in size & scope of biggest industrial corporations. Increased market turbulence, more competition, accelerated technological change
Need for speed, flexibility, responsiveness
Large, complex corporations become relatively less efficient 38

6. The Costs and Benefits of Vertical Integration: BENEFITS
Technical economies from integrating processes e.g. iron and steel production
-- but doesn’t 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 39

7. Introduction (cont.) Advantages of vertical integration
Greater control over costs and supply of components.
Avoids the transaction costs associated with dealing with vendors or retailers.
Ability to protect proprietary technology.
Ability to maintain or cultivate a company’s reputation for outstanding quality or service.

8. The Costs and Benefits of Vertical 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 40

9. Introduction (cont.) Disadvantages of vertical integration
Higher fixed overhead costs.
Integrated firms must deal with transfer price dilemma which can create serious morale and other internal problems.
Demand uncertainty creates problems.
Low demand can lead to underutilization of plant capacity.
High demand can result in dependence on outside suppliers.
Technological change can leave these firms stuck with old technology.

10. 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.

11. 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? 41

12. Recent Trends in Vertical Relationships
From competitive contracting to supplier partnerships, e.g. in autos
From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services).
Diffusion of franchising
Technology partnerships (e.g. IBM- Apple; Canon- HP)
Inter-firm networks
General conclusion:- boundaries between firms and markets becoming increasingly blurred. 42

13. Different Types of Vertical Relationship
Low Degree of Commitment High
Low
Informal supplier/ customer relationships
Vertical integration
Supplier/ customer partnerships
Spot sales/ purchases
Formalization
Joint ventures
Agency agreements
Franchises
Long-term contracts
High 3

14. The Internationalization of Industries
The Process of Internationalization
HIGH
International Global
Industries Industries
--aerospace --automobiles
--military hardware --oil
--diamond mining --semiconductors
--agriculture --consumer electronics
Domestic Multinational/
Industries Multidomestic
--railroads Industries
--laundries/dry cleaning retail banking
--hairdressing hotels
--milk consulting
International Trade
LO W
LOW
HIGH
Foreign Direct Investment 1

15. Implications of Internationalization for Industry Analysis
INDUSTRY STRUCTURE
Lower entry barriers around national markets
Increased industry rivalry --- lower seller concentration
--- greater diversity of competitors
Increased buyer power: wider choice for dealers & consumers
COMPETITION
Increased intensity of competition
PROFITABILITY
Other things remaining equal, internationalization tends to reduce an industry’s margins & rate of return on capital 5

16. THE INDUSTRY ENVIRONMENT COMPETITIVE ADVANTAGE
Analyzing Competitive Advantage within an International Context: The Basic Framework
FIRM RESOURCES & CAPABILITIES
-- Financial resources
-- Physical resources
-- Technology
-- Reputation
-- Functional capabilities
-- General management capabilities
THE INDUSTRY ENVIRONMENT
Key Success Factors
COMPETITIVE ADVANTAGE
THE NATIONAL ENVIRONMENT
-- National resources and capabilities (raw materials;
national culture; human resources;
transportation, communication &
legal infrastructure
-- Domestic market conditions
-- Government policies
-- Exchange rates
-- Related and supporting industries 6

17. National Influences on Competitiveness: The Theory of Comparative Advantage
A country is relatively efficient in the production of those products which make intensive use of resources which are relatively abundant within the country. E.g.
Philippines relatively more efficient in the production of footwear, apparel, and assembled electronic products than in the production of chemicals and automobiles.
U.S. is relatively more efficient in the production of semiconductors and pharmaceuticals than shoes or shirts.
When exchange rates are well-behaved, comparative advantage emerges as competitive advantage. 7

18. Porter’s Competitive Advantage of Nations
Extends and modifies traditional theory of comparative advantage to take account of the following factors:
Competitive advantage is about companies --- the importance of the national environment is providing a home base for the company.
Sustained competitive advantage depends upon dynamic factors-- innovation and the upgrading of firm’s resources and capabilities
The critical role of the national environment is its influence upon the dynamics of innovation and upgrading. 9

19. Porter’s National Diamond Framework
1. FACTOR CONDITIONS. “Home grown” resources and capabilities more important than natural endowments.
2. RELATED AND SUPPORTING INDUSTRIES. Competitive advantage occurs in “industry clusters” (e.g. semiconductors-computers-software in the U.S.).
3. DEMAND CONDITIONS. Discerning domestic customers drive quality and innovation (e.g. Japanese camera industry)
4. STRATEGY, STRUCTURE, RIVALRY. E.g. domestic rivalry drives innovation and upgrading.
FACTOR CONDITIONS
RELATING AND
SUPPORTING
INDUSTRIES
DEMAND
CONDITIONS
STRATEGY, STRUCTURE,
AND RIVALRY 10

20. Consistency Between Strategy and National Conditions
In globally-competitive industries, firm strategy needs to take account of national conditions:
U.S. textile manufacturers must compete on the basis of advanced process technologies and focus on high quality, less price-sensitive market segments
Malaysian semiconductor manufacturers can be competitive in high volume, less technologically advanced items (e.g. memory chips)
Dispersion of value chain to exploit different national environments (e.g. Nike: R&D in U.S., components in Korea and Taiwan, assembly in China, Thailand and India, marketing in Europe and North America) 11

21. International Location of Production
3 considerations:
National resource conditions: What are the major resources which the product requires? Where are these available at low cost?
Firm-specific advantages: to what extent is the company’s competitive advantage based upon firm-specific resources and capabilities, and are these transferable?
Tradability issues: Can the product be transported at economic cost? If not, or if trade restrictions exist, then production must be close to the market. 12

22. International Location of Industrial Activities within the Value Chain
Where is the optimal location
of X in terms of the cost and
availability of inputs?
The optimal location
of activity X considered
independently
What government incentives/ penalties
affect the location decision?
What internal
resources and capabilities does the firm
possess in particular locations?
WHERE TO LOCATE
ACTIVITY X?
What is the firm’s business strategy
(e.g. cost vs. differentiation advantage)?
The importance of links
between activity X and
other activities of the firm
How great are the benefits
of linkages through proximity? 15

23. Overseas Market Entry: Alternative Modes
TRANSACTIONS DIRECT INVESTMENT
Exporting: Exporting: Exporting: Licensing Franchising Joint Wholly owned
Spot Long-term with foreign technology venture subsidiary
trans contract distributor/ and Marketing & Fully Marketing Fully
actions agent trademarks distribution integral- & sales integral-
only ted only ted
Key issues:
Is the firm’s competitive advantages based upon firm-specific or country-specific resources and capabilities?
Is the product tradable and what are the barriers to/ costs of trade?
Does the firm possess the full range of resources and capabilities needed to serve the overseas market? 16

24. Introduction (cont.) Global diversification
Usually motivated by desire to grow (Boeing, Kellogg’s, Caterpillar).
Simplest route is exporting.
Others include licensing or franchising.
Most complex route is to establish wholly-owned subsidiaries.

25. Introduction (cont.) Challenges in global diversification:
Most difficult challenge is to appreciate the unique cultures and customs of foreign markets.
Need for products to be adapted to accommodate these markets.

26. Alliances and Joint Ventures: Management Issues
Benefits: ability to combine different resources and capabilities of separate partners, ability to learn from one another.
Problems: management differences between the two partners. Conflict potential greatest where the partners are also competitors.
Collaborating with competitors: benefits seldom shared equally. Determinants of distribution of benefits:
Strategic intent of the partners- which partner has the clearer vision of the purpose of the alliance?
Appropriability of the contribution-- which partner’s resources and capabilities can more easily be captured by the other?
Absorptive capacity of the company-- which partner is the more receptive learner? 17

27. Multinational Strategies: Globalization versus National differentiation
The case for a global strategy:
National preferences in decline-- possible to view the
world becoming a single, if segmented, market.
Access to global scale economies--cost savings in purchasing, manufacturing, product development and marketing.
Strategic strength from global positioning-- but
locating in multiple national markets, by locating in multiple national markets, the global competitor can cross-subsidize to attack nationally focused rivals.
Need to access market trends and technological
developments in each of the world’s major economic
centers- N. America, Europe, EastAsia. }
Ted
Levitt
“Global-
-ization
Thesis”
Hamel &
Prahalad
Thesis
Kenichi Ohmae’s
“Triad Power”
Thesis 20

28. Strategy and Organization of the MNC: The Evolution of Multinational Strategies and Structures : (1) Pre 2nd WW: Era of the Europeans
The European MNC as Decentralized Federation :
National subsidiaries self-sufficient and autonomous
Parent control through appointment of subsidiaries senior management
Organization and management systems reflect conditions of transport and communications at the time e.g. Unilever, Phillips, Courtaulds, Royal Dutch/Shell. 21

29. Strategy and Organization of the MNC: The Evolution of Multinational Strategies and Structures: (2) Post 2nd WW: U.S. Dominance
American MNC’s as Coordinated Federations :
National subsidiaries fairly autonomous
Dominant role as U.S. parent-- especially in developing new technology and products
Parent-subsidiary relations involved flows of technology and finance, and appointment of top management.e.g. Ford, GM, Coca Cola, IBM 22

30. Strategy and Organization of the MNC: The Evolution of Multinational Strategies and Structures: (3) 1970’s and 1980’s: The Japanese Challenge
The Japanese MNC as Centralized Hub
Pursuit of global strategy from home base
Strategy, technology development, and manufacture concentrated at home
National subsidiaries primarily sales and distribution companies with limited autonomy. e.g. Toyota, NEC, Matsushita 23

31. Matching Global Strategies and Structures to Industry Conditions
Degree of globalization depends upon the benefits of global
integration versus the benefits of national differentiation.
Key issue: --How important are global scale economies?
--How different are customer requirements between countries?
Jet engines
Benefits of
global
integration
Consumer
electronics
Telecommunications
equipment
Packaged
grocery products
Cement
Benefits of national differentiation 24

32. Marketing Global Strategies and Situations to Industry Conditions: Firm Success in Different Industries
Consumer Electronics Branded, Packaged Telecommunications
Consumer Goods Equipment
- Global industry Substantial national - Requires both global
- Matsushita the most differentiation, few global integration and national
successful scale economies differentiation.
- Philips the survivor Kao has limited success - NEC only partially
- GE sold out outside Japan successful Unilever and P&G most - ITT sold out successful - Ericsson most successful
Matsushita
NEC
Kao
Erickson
global integration
Philips
global integration
P&G
global integration
Unilever
General Electric
ITT
local responsiveness local responsiveness local responsiveness 25

33. Reconciling Global Integration with National Differentiation: The Transnational Corporation
Tight complex controls and coordination and a shared strategic decision process.
Heavy flows of technology, finances, people, and materials between interdependent units.
The Transnational: an integrated network of distributed interdependent resources and capabilities.
Each national unit and source of ideas, skills and capabilities that can be harnessed to benefit whole corporation.
National units become world sources for particular products, components, and activities.
Corporate center involved in orchestrating collaboration through creating the right organizational context. 26