Class notes - Strategy & Org

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Samenvatting - Class notes - Strategy & Org

  • 1448406000 Week 1

  • Define Economies of Scale
    The production process for a specific good or service exhibits economies of scale over a range of output when average cost (cost per unit of output) declines over that range.

    If average cost declines as output increases, then the marginal cost of the last unit produced must be less than the average cost. 
  • Define Economies of Scope
    It exists if the firm achieves savings as it increases the variety of goods and services it produces. 
  • What are the sources of economies of scale?
    1. Economies of scale due to spreading of Product-Specific Fixed Costs

    Example: lower fixed costs per unit, as the factory functions at a full level




    2. Economies of scale due to Trade-Offs among Alternative Technologies


    Example: Larger sales-a certain type of factory, Low sales-a different type of factory
    Short-run economies of scale: reduction in average costs due to increases in capacity utilization
    Long-run economies of scale: reductions due to adoption of a technology that has fixed costs but lower variable costs
  • How can production be and give explanation?
    -Capital intensive: where the cost of productive capital such as factories and assembly lines represent a significant percentage of total costs.
    In this case, substantial product-specific economies of scale are more likely
     
    -Material or Labor intensive: where production expenses go to raw materials or labor.
    In this case, minimal product-specific economies of scale are likely, because materials and labor are divisible, they change in proportion to changes in output, with the result that average costs do not vary much with output. 
  • What are the special sources of Economies of Scale and Scope and give examples?
    1.Economies of density
    Refers to cost savings that arise due to increase in volume or density, so that the costs are spread among more units.
     
    2.Purchasing
     
    There are different advantages and disadvantages when buying individually or in bulk.
    3.Advertising
     
    Cost of sending message per Potential Consumer
     
    National has an advantage over local advertising companies
    Advertising Reach and Umbrella Branding
    Umbrella branding is effective when consumers use the information in an advertisement about one product to make inferences about other products with the same brand name, thereby reducing advertising costs per effective image.
     
    4.Research and Development
    5.Physical Properties of Production
     
    Economies of scale arising because of the physical properties of processing units.
     
    The cube-square rule: The volume of the pipe increases by a given proportion but the surface area increases by less than this proportion.
     
    Example: production CAPACITY is proportional to the volume of the production vessel, whereas the total cost of producing at capacity is proportional to the surface area of the vessel.
     
    6.Inventories  
  • What are the sources of diseconomies of scale?
    1.Labor costs and firm size
    Large firms have to pay a premium for their workers (for less interesting job, higher skilled worker)


    2.Spreading Specialized Resources Too Thin
    If a specialized input is a source of advantage for a firm, and that firm attempts to expand its operations without duplicating the input, the expansion may overburden the specialized input.


    3.Bureaucracy
    Information becomes slow. Incentives within large firms may be muted. 
  • What represents the learning curve?
    Refers to advantages that flow from accumulating experience and know-how. It refers to reductions in unit costs due to accumulating experience over time and can be independent of the current scale of activity. It involves cumulative output rather than marginal.
  • Describe neo-classical economics
    An approach to economics that relates supply and demand to an individual's rationality and his or her ability to maximize utility or profit.


    • Human beings are rational and self-interested (‘opportunism’)


    • Individuals maximize utility and firms maximize profits (‘constrained maximization’)


    • People act independently (‘methodological individualism’) on the basis of either full or imperfect and relevant information, i.e. prices (+ acting opportunistically)

    • Economic systems consist of atomistic (independent) decision units that choose among alternative uses depending on self-interest and price.


    • Uses deductive reasoning: reason from a priori beliefs or propositions (let us suppose that)
  • Describe institutional economics
    • Emphasizes importance of non-market factors (as social institutions) in influencing, or even conditioning, economic behavior and economic analysis, being subordinated to consideration of sociological factors, history, and institutional development


    • Institutions are systems of established and prevalent social rules that structure social interactions


    • Puts emphasis on habits, customs, path dependency, collective behaviour (‘rationality’)


    • Uses inductive reasoning: reason from observed facts, introspection needed (let’s collect some data)
  • What is functionalism?
    – Which addresses what functions various elements of the economic system perform, in order to create equilibrium for the entire system
    – Which sees society as made up of inter-dependent sections which work together to fulfil the functions deemed necessary for the survival of the economy as a system
    – Which sees people and firms as socialized into roles and behaviors which fulfil the needs of the economy
  • What is voluntarism?
    – Which emphasizes the primacy of the autonomous will
    – Which assumes that people (and firms) are free to do as they deem fit in order to maintain an institution (e.g. a firm), carry out a policy, or achieve an end (only restricted by the demands of functionalism)
     
  • What are the benefits of "Buying"?

    -Exploiting Economies of Scale and Learning Economies
     
    1.Market firms may possess proprietary information or patents that enables them to produce at lower costs
    2.Market firms are able to aggregate the needs of many customers, thereby enjoying economies of scale
    3.Market Firms may exploit their experience in producing for many customers to obtain learning economies.
     
    -Bureaucracy Effects: Avoiding Agency and Influence Costs
    Agency costs: costs associated with shirking and the administrative controls to deter it
    Influence costs: central office is unable to obtain objective information with which to compare competing projects. The result is an inefficient allocation of internal capital.
     
    -Organizational Design
    Assuring the independency of the outsourcing firm.

    -            Market firms are subject to the discipline of the market and MUST be efficient and innovative to survive. 
  • What are the costs of "Buying"?
    It is harder to coordinate the production flows


    Private information may be leaked when an activity is performed by an independent market firm.


    There are higher transaction costs 
  • What is Vertical Foreclosure?
    Use vertical integration in order to tie up channels
  • What are the reasons to make?
    - The influence of Contract Law

    - Coordination of Production Flows through the Vertical Chain
     
    - Leakage of Private Information


    - Transaction Costs


    - Relationship-Specific Assets
  • What are the reasons preventing complete contracting?
    1.Bounded Rationality
    2.Difficulties specifying or measuring performance
    3.Asymmetric information
  • What are the forms of asset specificity?
    1.Site specificity 
    2.Physical asset specificity
    3.Dedicated Assets
    4.Human asset specificity
  • What is a relationship specific investment?
    (RSI) the amount of your investment that you cannot recover if your company does not do business with that specific company. 
  • What is a rent?
    The profit that you expect to make when you build the plant, assuming all goes as planned
  • What is quasi-rent?
    The difference in profit that you expect to make from selling to the specific company and the profits that you make from your next-best option
  • What is the Hold-up problem?
    The trading partner can exploit the other partner’s quasi-rent by renegotiating the terms of the deal.



    It leads to:
    1.More difficult contract negotiations and more frequent renegotiations
    2.Investments to improve ex post bargaining position
    3.Distrust
  • What is the Property Rights Theory?
    Integration determines the ownership and control of assets, and it is through ownership and control that firms are able to exploit contractual incompleteness.
     

    In other words, integration matters because it determines who gets to control resources, make decisions, and allocate profits than when contracts are incomplete and trading partners disagree.
  • What are the alternative forms of organizing transactions?
    1.Nonintegration: The two firms are independent, each set of managers has control over its own assets
    2.Forward integration: The upstream company owns the assets of the downstream company
    3.Backward integration: The downstream company owns the assets of the upstream company
  • What is double marginalization?
    It results when an upstream supplier exploits its market power by marking up prices above marginal costs, and the downstream buyer exploits its own power by applying yet another mark-up to these already marked-up supply prices.  This “double mark-up can actually hurt profits. 
  • What are the alternatives to vertical integration?
    1.TAPERED INTEGRATION: MAKE and BUY
    Benefits:
    -expands the firm’s input or output channels without requiring substantial capital
    -the firm can use information about costs and profitability of its internal channel to negotiate contracts with independent channels
    -the firm can motivate its internal channels by threatening to expand outsourcing, and also the other way around
    -the firm can protect itself against hold-up
     
    Disadvantages:
    -may not achieve efficient scale of production
    -could lead to coordination problems
     
    2.FRANCHISING
     
    3.STRATEGIC ALLIANCES
    A joint venture is a particular type of strategic alliance in which two or more firms create, and jointly own a new independent organization.
    Risks:
    -Leakage of private information
    -It can compromise the coordination between the firms
    -Agency and influence costs
     
    4.IMPLICIT CONTRACTS AND LONG-TERM RELATIONSHIPS
     
    Implicit contract: an unstated understanding between independent parties in a business relationship. They can substitute for complete contracts. They are not enforceable in courts. There is also no central office that can resolve disputes.
     
    5.BUSINESS GROUPS 
  • What are the key concepts in performance assessment?
    1.Allocative efficiency
    -The effects on market prices in the industry
    -(competitive prices lead to optimal allocation of resources)
    2.Productive efficiency
    -The effects on internal efficiency of the firm
    -(‘least cost production for given quality’)
    3.Dynamic efficiency
    -The effects on innovative output of the firm
    -(demand-pull or technology push)
  • What is an European relationship based approach?
    -broader representation of interests on the board of directors
    -long-term shareholders
    -banks play an active role
    -companies have close ties to political elites
  • How do you increase control in a company?
    -arranging pyramid corporate structures
    -shareholders agreements
    -discriminatory voting rights
    -procedures intended to reduce the participation or influence of other minority investors
     
  • What is a pyramidal ownership structure?
    An entity whose ownership structure displays a top-down chain of control. In such a structure, the ultimate owners are located at the apex and what follows bellow are successive layers of firms. A direct result of the pyramidal structure is a loss of transparency. 
  • When are two products substitutes?
    Two products are substitute if, when the price of X increases and the price of Y stays the same, purchases of X go down and purchases of Y go up.


    Products tend to be substitutes when three conditions are met:
    1.They have the same or similar product performance characteristics
    2.They have the same or similar occasions for use

    3.They are sold in the same geographic market
  • What are the measures used in market structure?
    -The N-firm concentration ratio: it gives the combined market share of the N largest firms in the market

    -The Herfindahl index (the number equivalent of firms): the sum of the squared market shares of all the firms in the market
  • What is the Structure, Conduct, Performance paradigm?
    Is a concept in which the structure of the market can profoundly affect the conduct and financial performance of its firms.
  • Describe a market in which there is a perfect competition
    The opposite of monopoly. The firm maximizes profit by producing a volume of output at which marginal revenue equals marginal cost.
    -Firms are price takers
    -All firms sell homogenous products
    -All firms have a relatively small market share
    Market conditions will tend to drive down prices towards marginal costs when at least of the following conditions are met:
    1.There are many sellers
    Prices tend to fall as the number of sellers increases.
    2.Consumers perceive the product to be homogenous
    3.There is excess capacity
  • Describe a Monopoly market
    Monopoly power: the ability to act in an unconstrained way, such as increasing price or reducing quality. 
  • What is a strategic commitment and how does it have to be?
    A decision involving the strategic approach of the company which alters the strategic decision of rivals. 

    A strategic commitment to be effective has to be:
    -visible
    -understandable
    -credible
  • What is strategic substitutes?
    When one firm chooses more of some action, such as an output decision, and its rival firm cuts back on the same action. (cournot model)
  • What is strategic complement?
    When one firm chooses more of some action and its rival chooses more as well. 
  • What are the effects of commitments?
    -Direct effect: when the commitment has an impact on the present value of the firm’s profits if the competitor’s behavior does not change
     
    -Strategic effect: when the commitment alters the tactical decisions of rivals, and, ultimately the market equilibrium
  • What are the impediments to price coordination?
    1. Misread problem
    2.Sales transactions
    3.Asymmetries among firms and the sustainability of cooperative prices
  • How can you facilitate cooperative pricing?
    1.Price leadership
    A way to overcome the problem of coordinating on a focal equilibrium. In price leadership, each firm gives up its pricing autonomy and cedes control over industry pricing to a single firm.


    2.Advance announcements of Price Changes
    It reduces the uncertainty that firms will try to undercut them. This announcement can benefit or hurt customers. The DOJ argued that preannouncements actually facilitate price increases.


    3.Most favored customer class

    A provision in a sales contract that promises a buyer that it will pay the lowest price the seller charges.
    There are two types of most favored customer clauses:
    A)Contemporaneous
    The seller agrees that while the contract is in effect, if it sells the chemical to any other buyer at a lower price, it will sell it at the same price to this particular customer as well.
    B)Retroactive
    The seller agrees to pay a rebate in case, under this contract, it sells at a lower price to any other buyer.
     
    4.Uniform Delivered Prices
  • What is a SPV and what are the requirements?
    Definition: A firm in which off-balance activities can be hived off.


    There should be ‘adequate distance’ between the sponsor and the new entity. The external investor must have
    – Substantive equity stakes ‘at risk’ in the SPV (> 3 % of total equity + debt)
    – A controlling financial interest in the SPV (> 50 %)
    In case of absence of “adequate distance”, the firm will not be an SPV but only a subsidiary company. 
  • What are the exemplary goals of SPV?
    Exemplary goals of SPV
    -Gain competitive advantage: preserve intellectual property
    -Asset transfer: sell as packages
    -Property transfer: pay different tax rates
  • What are the real/basic goals of SPV?
    -Financial engineering: tax avoidance and manipulations of financial services
    -Securitization: securitize loans
    -Risk sharing: isolate high risk projects from the company
  • What is a LBO and what are the advantages of LBOs?
    Def: The take-over of a firm, or part of it, with the help of relatively much credit (approx. 80%)


    LBOs are attractive because of interest payments which are tax deductible, profits turn directly into returns on equity (the leverage effect)
  • Describe the Cournot Model
    A model in which competing firms that make the same homogeneous and undifferentiated product choose a quantity to produce independently and simultaneously. They seek to maximize profit based on their competitors’ decisions of Quantity. 


    Q and P are interdependently related:
    -A and B charge the same price P (identical goods). Firm A estimates correctly Firm B’s quantity. Firm B does the same for A.  A and B maximize individual profits
    -Then A chooses how much to produce (B does the same) based on its reaction function to B.
    -Equilibrium is established, price clears the market.
  • Describe the Bertrand Model
    A model in which each firms select a price and stand ready to meet all the demand for its product at that price. Each firm selects a price to maximize its own profits, given the price that it believes the other firm will select.  Each firm views its rival’s price as fixed. 

    Q and P are interdependently related
    -Firm A estimates Firm B’s Price (firm B does the same for A). A and B maximize profits.
    -Then A chooses its price as a function of each other’s conjectures and their respective marginal costs, (B does the same) leading to a particular Q
    -Equilibrium is established       
  • What are the assumptions made for the Cournot and Bertrand model?
    1.Firms have market power
    2.No collusion
    3.Produce homogenous product (no product differentiation)
    4.No entry, no exit, no investment, no R&D, no advertising, no history
    5.Firms compete in quantities(prices) and choose quantities(prices) simultaneously
    6.Firms are economically rational, seeking to maximize profit given their competitor’s decisions.
  • Describe a real oligopoly
    1.Firms have market power
    2.There is tacit collusion, or understanding
    3.Heterogeneous products
    4.Entry, exit, investment, R&D, advertising
    5.Firms compete in qualitatively different products, and choose quantity(prices) sequentially
    6.The firms are economically non-rational or pseudo-rational, seeking to keep up with peers or perform better after competitors’ performance becomes evident. 
  • Under what conditions do business changes occur?
    -Technological change, thus innovation
    -Coincidental developments
    -Policy actions
    -Competitive actions
  • Reasons to diversify/economies of scope
    1. Increases efficiency through:
    -scope economies
    -use of internal market  
    2. Acquisitions benefits managers
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Voorbeelden van vragen in deze samenvatting

Define Economies of Scale
1
Define Economies of Scope
1
What are the sources of economies of scale?
1
How can production be and give explanation?
1
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