Summary Organisation and Strategy Slides

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Samenvatting Organisation and Strategy: college(s), -Summary lecture slides

Erasmus Universiteit Rotterdam | International Bachelor Economics and BusinessEconomics (IBEB) | Organisation and Strategy

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ORGANISATION AND STRATEGY

LECTURE 1

Boundaries of the firm:

- Horizontal: what part of the market will the firm serve

- Vertical: given the market, which activities will the firm do itself and which part

will be outsourced to other firms.

- Geographical: on which geographical markets does the firm focus

Horizontal competition: substitutes/strategic comitments & entry

Vertical competition: buyer power & supplier power

Market of firm = degree of substitution between the products of different firms. Strategic

choices: performance characteristics, occasion for use, geographical area.

The environment:

Competitive advantage: when a firm is able to create more economic value relative to its

competitors � cost position or benefit position/differentiation.

LECTURE 2

Five forces model by Michael Porter:

• Internal rivalry

o Competition for market shares within industry

o Price competition vs. non price competition

• Entry

o New entrants steal market shares and increase internal rivalry

o Barriers to entry can be exogenous or endogenous

o Examples: High Minimum Efficient Scale, Brand loyal customers, Access to

key inputs/locations, experience curve and network externalities.

• Supplier power

o Indirect power if upstream market is competitive

o Direct power if upstream market is not competitive (ex: relationship

specific investment)

• Buyer power

o Same for buyers downstream



o Key factors supplier & buyer power: industry concentration, purchase

volumes, threat of forward integration

• Substitutes and complements

o Substitutes erode profits by stealing business + increasing internal rivalry

o Complements boost industry demand

o Key factors: Identification based on characteristics/performance, price-

value of substitutes and complements, price elasticity of industry demand

Five forces � fighting for a larger share of pie

Co-opetition and value net � cooperating to make the pie larger

Economies of scale: production process for a specific good or service exhibits economies

of scale over a range of output when average costs declines over that range (MC<AC).

Simply said: unit cost reduction by producing more at a particular point in time.

Economies of learning: unit cost reduction by accumulating experience over time.

Sources of economies of scale:

1. Spreading of fixed costs and indivisibilities

o Indivisibility: when an input cannot be scaled down below a certain

minimum size

o More likely when capital intensive

o Different technologies may offer the lowest AC at different levels op

output. Switch technology as they grow � LR economies of scale

2. Increased productivity of variable inputs

o Division of labor with specialization of workers in certain activities leads

to reduced average costs (specialization requires upfront investment)

o Adam Smiths theorem: division of labor is limited by the extent of the

market. Investment in specialization only if there is enough demand for it

3. Other sources: economies of density (within transportation network),

purchasing, advertising, R&D, physical properties of production (cube-sqaure

rule), inventories.

Economies of scope: firm achieves unit-cost savings as it increases the variety of

goods/services it produces � TC(q1+q2) < TC(q1) + TC(q2)

Diseconomies of scale/scope:

- High labor costs (more unionized)

- Spreading specialized resources too thin (Gordon Ramsey)

- Bureaucracy (slow information flow and coordination problems)

Unrelated diversification: carry activities with limited room for scope economies. Why?

- Efficiency based reasons: scope economies from spreading underutilized

organization resourced (dominant general management logic) and internal

capital markets (revenues from one business to fund other one)

- Problematic justifications: diversifying shareholders portfolios, identifying

undervalued firms, managerial reasons (looking for firm growth, even when not

profitable)


LECTURE 3

Vertical chain: process that begins with the acquisition of raw materials and ends with

the distribution and sale of finished goods and services.

Vertical boundaries: define activities that the firm performs itself as opposed to

purchases from independent firms = market firms.

Make-or-buy: activity internally of purchase from external supplier.

Reasons to buy:

- Exploiting scale and learning economies (specialized firms are more efficient

because proprietary information or patents and aggregating demand of many

buyers)

- Avoiding agency costs (agency costs are costs associated with shirking and the

administrative controls to deter it. Shirking: managers and workers knowingly

acting against the best interest of their firm. Agency costs very high in vertically

integrated firms, ex: monitoring overhead activities across divisions)

- Avoiding influence costs (direct costs of influence activities, ex lobbying, and

costs of bad decisions)

Reasons to make:

- Coordination advantages (especially for processes with design attributes)

o Timing fit (marketing campaign and increased production)

o Sequence fit (operations must be performed in certain order)

o Technical specification fit (pieces of car fitting together)

o Color fit

- Protection of private information (loss of competitive advantage)

- Transaction costs related to relationship-specific assets (all costs involved in

organizing transactions, ex: time and expense of negotiating, writing and

enforcing contracts, costs of opportunistic behavior) � relationship-specific

assets, quasi-rents, holdup problem.



Relationship specific assets = investments made to support efficiently a specific

transaction Can not be redeployed to another transaction without some sacrifice in

productivity or adaption costs.

- Site specificity: production capacity side-by-side

- Physical asset specificity: machines with specific engineering properties

- Dedicated assets: new plant/equipment for particular buyer

- Human asset specificity: know-how and skills specific for certain firm

Contracts define the conditions for the exchange of goods/services. Effectiveness

depends on completeness (opportunistic behavior is eliminated) and available body of

contract law (set of standard provisions applicable to wide classes of transactions).

Reason for incomplete contracts: bounded rationality, difficult to specify and measure

performance, asymmetric information.

Quasi rent: difference between expected profit from the relationship for which you

decide to invest, and profit from the best alternative. A firm invests when there is an

expected rent (profit). If there is a lot to lose in the second best alternative � risk of

holdup.

A firms holds up its trading partney by attempting to renegotiate the terms of a deal in

order to capture part of the quasi-rent generated by the deal.

LECTURE 4

Technical efficiency = achieved when a certain activity is performed using the least-cost

production process.

Agency efficiency = achieved when organization of activity minimizes coordination,

agency and transaction costs (ex: holdup threats leads to reduced investment and higher

production costs).

Trade-off = make tends to improve agency efficiency and buy tends to improve technical

efficiency � economizing (minimize both inefficiencies).

Vertical integration is less likely to be optimal for ACTIVITIES involving high scale,

learning and scope economies � deltaT very large. More likely to be optimal for a FIRM

with high scale and high scope � deltaT small.


Double marginalization = when an upstream firm charges a price greater than marginal

cots, and the downstream firm does the same � two markups are applied � reduce

demand.

Organized in 3 ways:

- Non-integration (remain independent)

- Forward integration (firm 1 upstream owns assets of firm 2 downstream)

- Backward integration (firm 2 down owns assets of firm up)

Vertical integration is desirable when one firm’s investment in relationship-specific

assets has a significantly greater impact on the value created in the vertical chain than

the other’s investment does. When investments of both are of comparable importance,

non-integration is the best arrangement.

When firm a acquires firm b, decision making rights better stay with firm2: if success

depends on its key contacts an know how, firm 1: if success depends crucially on

centralized coordination.

Alternative to make/buy:

1. Tapered integration: mixture of vertical integration and market exchange

a. Advantages: protection against holdup risk, motivation tool for both

internal division and market firms, use of internal cost information to

negotiate contracts with market firms, expansion of input channels

without significant capital outlays.

b. Disadvantages: both internal and external production may stay below

minimum eff. Scale, coordination and monitoring problems, inefficient

internal divisions may be kept when not efficient.

2. Franchising: provide the capital to build and operate stores and pay a fee for

using the franchiser’s brand and business model.

a. Advantaged: franchisers focus on tasks involving high scale economies,

while franchisees follow closely the taste of the local market.

b. Disadvantaged: franchisees may ride free on the reputation of the

franchiser -> hampering the value of the brand

3. Strategic alliances and JV

− Horizontal: firms in same industry

− Vertical: firms doing different activities along vertical chain

− Across industries (MCD & Toys R Us)

a. JV: particular type of strategic alliance in which two or more firms create a

new independent organization.

b. Advantages: remain independent, but more cooperation, coordination and

info sharing -> like a marriage

c. Disadvantages: risk of losing control over proprietary information,

coordination difficulties, agency costs, influence costs (higher if no clear

hierarchical structure).

4. Close-knit semiformal relationships: based on LT contracts

− Implicit contracts

− Large business groups (Japan/Soutch Korea)

i. Keiretsy (Japan) – formalized institutional linkages

ii. Chaebol (SK) – family control



LECTURE 5

Agency problems van arise when 2 conditions are met:

1. Different objectives

2. The actions taken by the agent/or the information possessed by the agent is hard

to observe for the principal

Solutions:

− Bureaucracy: designing rigid rules limiting employees discretionary behavior.

− Monitoring: spending resources to check what agents do and gather their

privileged information (Limitations: never perfect, costly, and adds another

layer).

− Performance based incentives: align interests. Only slope matters (marginal

benefit, not the level of fixed payment). (Limitations: may imply risk for agents/

risk-averse, agents have to perform multiple tasks, they neglect tasks not inked to

pay).

ALL FORMULAS/RISK RELATED PROBLEMS/ PERFORMANCE BASED INCENTIVES.

LECTURE 6

Ways to organize tasks in small groups:

− Individually

− Self-managed teams

− Hierarchy of Authority

Large firms require complex hierarchies. Two key problems: departmentalization and

coordination/control.

Two approaches for coordination:

− Autonomy/self containment: single units work autonomously with own targets

and minimum information flows -> profit centers/responsibility centers

− Lateral relations: close coordination among work groups

Two approached for control:

− Centralization: more decision are made by senior managers

− Decentralization: more decisions are made at lower levels

Types of organizational structures:

1. Unitary functional structure = U form

a. Each unit/department is responsible for a basic business function

b. Centralized decision making, focus on operation efficiency

2. Multidivisional structure = M form

a. Multiple divisions by product line/geographical market

b. Divisions are organized in departments

c. Centralized supervision at top, but operation autonomy of divisions for

very different product lines focus on division profits

3. Matrix structure

a. Organization along multiple dimensions at once

b. Singly units report to two bosses

c. Rationale: economies of scope and scale


4. Network structure

a. Flexible organization where workers can contribute to multiple tasks and

be recombined as the tasks change.

b. Become more popular as organizational costs decline (ex, thanks to

internet)

c. Close alternative is Modular Organizations, with independent firms tied

together by a technology standard.

Two sets of environmental factors are particularly important with optimal structure:

− Technology and task interdependence

o Mature, slowly changing technology -> stable hierarchical structure

o 3 Types of task interdependence: reciprocal (software and hardware),

sequential (regulation department and sales of pharma company), and

pooled interdependence.

− Information processing

Alfred Chandler: Structure follows strategy

LECTURE 7

Competition: when one firm’s strategic choice affects the performance of another firm.

- Direct competition: directly affects performance of other firm

- Indirect competitors: affect performance of another, because of a strategic

reaction by a third firm.

Substitution: similar performance characteristics, similar occasion for use, sold in same

geographical area.

Cross price elasticity:

When n>0, implies if Px goes up, Qy goes up = substitution.

Market structure:

- Perfect competition: competitive equilibrium

- Imperfect competition: monopolistic/oligopoly/ monopoly

SCP = structure conduct performance: high concentration is bad for consumers and

paved the way for antitrust legislation.

Forward causation:

- market structure (concentrations) affect conduct (strategy), which in turn affects

performance (market power).

- Market structure is driven by basic supply and demand conditions.

- Performance is the measured outcome.

Hypothesis SCP:

1. Market power increases when market concentration increases

2. The larger the entry barriers, the higher the exercise of market power

How to measure structure � market concentration:



- N-firm conentrattion ratio = combined market share of the N largest firms

- Herfindahl index = sum of squared market shares

Entry barriers: Minimum efficient scale, sunk capital investments, advertising, R&D.

How to measure conduct: pricing of products, investment, mergers and acquisitions,

product choice, collusion.

How to measure performance:

- Price cost margin: Lerner index L = (P-c)/P with c=MC (measure of monopoly

power)

- Profitability: return on equity or return on assets

- Production efficiency

- Innovative performance

Market structure, firm strategy and performance are interrelated:

- SCP Harvard/Chicago

o Hypothesis SCP:

� Market power increases when market concentration increases

� The larger the entry barriers, the higher the exercise of market

power. High price-cost margin

o Chicago:

� Reverse causation: firms make choices which not only affect

performance, but also market structure

� Monopoly is often transitory: entry is important

o Collusion hypotheses: argues that a positive relation between

concentration and profitability is evidence of collusion designed to

enhance profit (ex, OPEC)

o Efficiency hypothesis: argues that a positive relationship between

concentration and profitability reflects a natural tendency for efficient

firms to be successful and to become dominant in their industries.

- High degree of concentration may be bad for consumers

- SCP showed a positive correlation between market concentration and market

power. Discontent with aggressive antitrust enforcements. Chicago school

emphasized the economic efficiency of various strategies that were considered

anticomp. by Harvard.

- Therefore, antitrust legislation

Cartel= group of firms that attempt to reduce the degree of competition among each

other. Incentive to defect (nash equilibrium) � unstable.


CHAPTER 8

Entry: the beginning of production and sales by a new firm in a market. How� brand

new firm, or diversifying into new market. Effects � market shares of incumbent firm

reduces + competition intensifies.

Exit: when a firm ceases to produce and sell in a market. How � fold up, discontinue a

particular product or product group, or a firm may leave a particular geographic market

segment. Effects � market share of incumbent increases and competition decreases.

Enter when the sunk cost of entry are lower than the net present value of the post-entry

profit stream.

Barriers to entry: anything that allows incumbent firms to earn above normal profits

without the threat of entry. Entry barriers reduce the likelihood of entry and affect the

returns of both the incumbent and the entrant.

1. Structural barriers (natural advantages of incumbent firms)

a. Control of essential resources (protection by government policy and

regulations, special know-how, natural resources controlled by incum.).

b. Cost advantages: economies of scale and scope.

c. Marketing advantages (brand umbrella and easier to negotiate the vertical

chain as easier to get shelf space with established brand).

2. Strategic barriers

a. Limit pricing: price sufficiently low to discourage entrants

b. Predatory pricing: setting price below SR MC, expecting to recoup the

losses via monopoly profits once the rival exists

c. Expanding capacity: by holding excess capacity the incumbent can

credibly threaten to lower the price if entry occurs. Only works when

incumbent has cost advantage, market demand growth is slow and when

entrant is not trying to establish reputation for toughness.

d. Strategic bundling: combination of goods are sold cheaper than separately

Entry conditions of a market are:

− Blockaded entry: existing structural barriers are effective, no action by

incumbents

− Accommodated entry: structural barriers are low and strategic barriers may be

ineffective or not cost effective, incumbents should not bother to deter entry

− Deterred entry: strategy to deter is cost-effective

Differences predominantly in terms of entry costs: sunk costs for incumbents are

already made, established relationship with customers and suppliers are not easy to

replicate, learning curve effects, switching costs for customer from incumbent to entrant

are often high.

Different barriers to exit possible: sunk

costs (make the marginal cost of staying

low + obligations and commitments to

suppliers and employees), relationship

specific assets, government regulations.



CHAPTER 9

Tactics: short term effects, easy to reverse.

Strategy: long term effects, difficult to reverse/irreversible.

Strategic commitment: decisions or strategies of a firm that have LT impact and are

difficult/impossible to reverse. They involve risk and uncertainty. Commitments can

have a profound effect on the decisions of competition.

- Inflexibility can be beneficial to a firm

- Limits the options of the firm, but affects the expectations of competitors:

simultaneous game � sequential game.

Commitment is only valuable whenever it is visible, understandable and credible.

Principles of credibility:

- Change the payoffs of the game. Make it in your own interest to follow through on

your commitment (turn a threat into a warning, or promise into an assurance).

- Limit your ability to back out (ex: relationship specific investments)

- Use others to help maintain commitment (team instead of individual)

Strategic complements: when a firms action induces a rival to take the same action.

Strategic substitutes: when a firm’s action induces a rival to take the opposite action.

Tough commitment: has adverse effect on competitors of the firm (traditional view of

competition).

Soft commitment: had beneficial effect on competitors of the firm.

Real option: choice to adjust an investment decision based on future information �

potential actions in the future can be assigned financial value � value of flexibility.

Option to delay decision, to expand, to abandon.


Two effects of commitments � direct (in own net value) and strategic (other firms

reaction).

Value of real option = 12.2-10.7 = 1.5

Analysis on other ways than game theory. Framework for analysis:

- Positioning analysis

- Sustainability analysis

- Flexibility analysis

- Judgement analysis

LECTURE 10

Strategic positioning: a firm has to try to position itself in such a way that it is able to

produce more value relative to its competitors � competitive advantage (so it

outperforms competitors in the same market).

Created value: difference between the value that resides in the finished good and the

value that is sacrificed to convert inputs into the finished product � offer as much

consumer surplus as possible (increasing the perceived benefit/quality or lowering the

price). Created value is also consumer surplus + producer surplus.



Value chain: representation of the firm as a set of value creating activities.

Primary activities: inbound logistics, operation, outbound logistics, marketing and sales,

and service. Support activities: firm infrastructure, human resource management,

technology development, and procurement.

Each activity in the value chain can potentially add to the perceived benefits (and costs).

So by configuring the value chain differently or performing the activities more efficiently

-> add more value.

Two competitive strategies:

- Cost leadership: offers lower quality and has much lower costs

o When: nature of products does not allow differentiation, consumers are

relatively price sensitive, concerns a search good (quality is known before

purchase).

- Benefit leadership/differentiation: offers higher benefit at slightly higher costs

o When: consumers are willing to pay premium, economies of scale and

learning are significant, concerns an experience good

- + Focus strategy: customer specialization, product specialization, geographic

specialization.

CHAPTER 11

Rivals can erode the competitive advantage of industry leaders by imitation or

innovation.

Sustainable competitive advantage: LT competitive advantage that is not easily

duplicable or surpassable by competitors. This is because of superior resources and

capabilities (scarce, imperfectly mobile and unavailable in the open market) or isolating

mechanism to protect competitive advantage.

Resources: a firm’s assets, including people and the value of its brand name. Represents

inputs into a firm’s production process.

- Tangible: financial resources, organizational, physical, and technological.

- Intangible: human resources, innovation resources, reputational resources

Capabilities: firms capacity to deploy resources that have been purposely integrated to

achieve a desired end-state. Emerge over time through complex interactions among

tangible and intangible resources. Are often based on developing an exchanging

information and knowledge through human capital.

Examples: distribution, human resources, marketing, management, manufacturing, R&D.

Two different groups isolating mechanism:

- Impediments to imitation: impede potential entrants from duplicating the

resourced and capabilities

o Legal restrictions (patents, trademarks, copyrights)

o Superior access to inputs/customers (through vertical integration or LT

contracts)

o Market size and economies of scale

o Intangible barriers (network is difficult to understand � advantage lies in

distinctive organizational capabilities)


� Causal ambiguity (superior ability to create value may be obscured

and imperfectly understood)

� Historical circumstances (capabilities may be bound up with

history of the firm)

� Social complexity (maybe the advantage is rooted in socially

complex processes)

- Early mover advantages (economies power increased over time)

o Learning curve

o Reputation and buyer uncertainty

o Switching costs

o Network effects: valuation depends on how many others are using the

product

� Actual networks

� Virtual networks (arise from the use of complementary goods)

Standards are difficult to replace, but you can offer superior quality and new options and

attract early adaptors.

LECTURE 12

Product innovation: new product or a product of improved quality.

Process innovation: the introduction of a new production method.

Incremental innovation (discontinuities): build upon existing knowledge and resourced,

competence enhancing, relatively small changes in performance or utility, very common.

Radical innovation (shocks): requires new knowledge and resources, existing

competence is likely to lose value, potential for large changes in performance, relatively

rare.

Arise of innovation: information � knowledge (absorptive capacity) � innovation

(capacity to turn knowledge into new product or process).

Stage-Gate process model: idea screen, second screen, go to development, go to testing,

go to launch.

Disruptive technologies: market is cleared and less efficient product/processes and

organizational forms are displaced � higher B-C primarily through lower B and much

lower C. Isolating mechanism are not permanent.

Effect of innovation on the economy (Schumpter):

- Technological improvement and LT growth is more importsnt that optimal

allocation of resources at a given point in time � dynamic versus static

efficiency.

- Society benefits more from competition between new product, new technologies

and new forms of organization than from price competition.

- � Arguments to defend monopoly.



Innovators dilemma: Innovative investments by incumbents cannibalize their successful

business model, while failure to innovate may invite entry. Incentives to refrain from

innovation: sunk cost effect (stick with current technology) +replacement effect

(monopolist can only replace itself). Incentive to innovate: efficiency effect (more to lose

from another firms entry than that firm can gain, thus larger incentive to innovate than

entrant).

Innovator has bargaining power and can realize the full value of the innovation when

the technology is protected by patents + the necessary knowledge to market the product

is not scarce. Otherwise -> established firm gets power.

Often different methodologies available for innovation that effect the probability of

success. Correlation between methodologies or research approaches can be a severe

problem for a large firm.

Innovation leads to competitive advantage � patents or early mover advantages.

Sustainable innovation capacity depends on: dynamic capabilities: ability of a firm to

maintain and adapt the capabilities that are the basis of its competitive advantage �

exploitation and exploration.


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Summary Organisation and Strategy Slides