Chapter 6: Vertical Integration 1' CHAPTER 6: VERTICAL INTEGRATION TRUE/FALSE QUESTIONS 1.

Business strategy is a firm's theory of how to gain competitive advantage by operating in several businesses simultaneously. rue !alse Answer: !alse Page: 1"# Diffi !"#$: $asy C%a&#er O'(e #i)e: 1 %. &ecisions about whether or not to vertically integrate often determine whether or not a firm is operating in a single business or industry or multiple businesses or industries. rue !alse Answer: rue Page: 1"# Diffi !"#$: $asy C%a&#er O'(e #i)e: 1 '. ( firm's level of vertical integration is the number of steps in its value chain that the firm accomplishes within its boundaries. rue !alse Answer: rue Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 *. )ore vertically integrated firms accomplish fewer stages of the value chain within their boundaries than less vertically integrated firms. rue !alse Answer: !alse Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 +. ( firm engages in bac,ward vertical integration when it incorporates more stages of the value chain within its boundaries and those stages bring it closer to gaining access to raw materials. rue !alse Answer: rue Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 6. If -al.)art were to purchase a factory to ma,e soc,s and it planned to sell these soc,s in its stores/ this would be an e0ample of forward vertical integration. rue !alse Answer: !alse Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1

1* 3.

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-hen companies staffed and operated their own call centers in the 4nited 5tates/ they were engaging in bac,ward vertical integration/ but when they started using independent companies in India to staff and operate these centers/ they were more vertically integrated. rue !alse Answer: !alse Page: 1"1 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1 ". ( firm with a high ratio between value added and sales has brought many of the value.creating activities associated with its business inside its boundaries/ consistent with a high level of vertical integration. rue !alse Answer: rue Page: 1"% Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1 1. 7pportunism e0ists when a firm is unfairly e0ploited in an e0change. rue !alse Answer: rue Page: 1"' Diffi !"#$: $asy C%a&#er O'(e #i)e: % 1#. If Iron 6orse 6elmets 8I669 were to contract with a Chinese manufacturing firm to provide I66 with superior :uality helmets for sale in the 4nited 5tates/ but discovered that the shipments were actually of inferior :uality when they were received/ I66 would be said to be acting opportunistically. rue !alse Answer: !alse Page: 1"' Diffi !"#$: 6ard C%a&#er O'(e #i)e: % 11. If one of a firm's e0change partners behaves opportunistically/ this reduces the economic value of the firm. rue !alse Answer: rue Page: 1"' Diffi !"#$: )oderate C%a&#er O'(e #i)e: % 1%. !irms should only bring mar,et e0changes within their boundaries when the cost of vertical integration is more than the cost of opportunism. rue !alse Answer: !alse Page: 1"' Diffi !"#$: 6ard C%a&#er O'(e #i)e: % 1'. he threat of opportunism is the least when a party to an e0change has made transaction.specific investments. rue !alse Answer: !alse Page: 1"* Diffi !"#$: )oderate C%a&#er O'(e #i)e: %

Chapter 6: Vertical Integration 1+ 1*. ( transaction.specific investment is any investment in an e0change that has significantly more value in the current e0change than it does in alternative e0changes. rue !alse Answer: rue Page: 1"* Diffi !"#$: )oderate C%a&#er O'(e #i)e: % 1+. ransaction.specific investments ma,e parties to an e0change vulnerable to opportunism and vertical integration solves this vulnerability problem. rue !alse Answer: rue Page: 1"+ Diffi !"#$: )oderate C%a&#er O'(e #i)e: % 16. !irms should avoid vertically integrating in those businesses where they possess valuable/ rare/ and costly.to.imitate resources and capabilities. rue !alse Answer: !alse Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' 13. !irms should not vertically integrate into business activities where they do not possess the resources necessary to gain competitive advantages. rue !alse Answer: rue Page: 1"6 Diffi !"#$: $asy C%a&#er O'(e #i)e: ' 1". If a firm engages in vertical integration into a business activity where it does not possess any of the valuable/ rare/ or costly.to.imitate resources it needs to gain a competitive advantage/ it may find itself at a competitive disadvantage to the e0tent that some have firms already have competitive advantages in these business activities. rue !alse Answer: rue Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' 11. If a supplier is overly reliant on a single customer/ this supplier can be at ris, of opportunism on the part of the customer. rue !alse Answer: rue Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' %#. !le0ibility refers to how costly it is for a firm to alter its strategic and organi;ational decisions. rue !alse Answer: rue Page: 1"6 Diffi !"#$: $asy C%a&#er O'(e #i)e: *

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%1. !le0ibility is low when the cost of changing strategic choices is low. rue !alse Answer: !alse Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * %%. <esearch suggests that/ in general/ vertically integrating is more fle0ible than not vertically integrating. rue !alse Answer: !alse Page: 1"3 Diffi !"#$: 6ard C%a&#er O'(e #i)e: * %'. 7nce a firm has vertically integrated it has committed its organi;ational structure/ its management controls/ and its compensation policies to a particular vertically integrated way of doing business and it has enhanced its fle0ibility. rue !alse Answer: !alse Page: 1"3 Diffi !"#$: 6ard C%a&#er O'(e #i)e: * %*. !le0ibility is always valuable. rue !alse Answer: !alse Page: 1"3 Diffi !"#$: )oderate

C%a&#er O'(e #i)e: *

%+. !le0ibility is only valuable when the decision.ma,ing setting a firm is facing is uncertain. rue !alse Answer: rue Page: 1"3 Diffi !"#$: $asy C%a&#er O'(e #i)e: * %6. ( decision.ma,ing setting is uncertain when the future value of an e0change cannot be ,nown when investments in that e0change are being made. rue !alse Answer: rue Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * %3. he use of budgets in a vertically integrated 4.form organi;ation can lead functional managers to overemphasi;e short.term behavior that is easy to measure and underemphasi;e longer.term behavior that is more difficult to measure. rue !alse Answer: rue Page: 113 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6

Chapter 6: Vertical Integration 13 %". ( fle0ibility.based approach to vertical integration suggests that when the decision. ma,ing setting regarding a business activity is highly uncertain/ firms should form a strategic alliance to enter this activity instead of vertically integrating. rue !alse Answer: rue Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * %1. he downside ris,s associated of investing in a strategic alliance are un,nown but fi0ed. rue !alse Answer: !alse Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * '#. ( firm's vertical integration strategy is rare when few competing firms are able to create value by vertically integrating in the same way. rue !alse Answer: rue Page: 111 Diffi !"#$: )oderate C%a&#er O'(e #i)e: + '1. 7utsourcing can help firms reduce costs and focus their efforts on those business functions that are central to their competitive advantage. rue !alse Answer: rue Page: 111 Diffi !"#$: )oderate C%a&#er O'(e #i)e: + '%. ( firm's vertical integration strategy can only be rare when it is the only firm that is able to vertically integrate efficiently. rue !alse Answer: !alse Page: 111 Diffi !"#$: )oderate C%a&#er O'(e #i)e: + ''. If a firm has capabilities that are valuable and rare/ then vertically integrating into businesses that e0ploit these capabilities can enable the firm to gain at least a temporary competitive advantage. rue !alse Answer: rue Page: 11% Diffi !"#$: )oderate C%a&#er O'(e #i)e: + '*. ( firm may be able to gain an advantage from vertically integrating when it resolves some uncertainty it faces sooner than its competition. rue !alse Answer: rue Page: 11% Diffi !"#$: )oderate C%a&#er O'(e #i)e: +

1"

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'+. ( firm's ability to conceive of and implement vertical integration strategies tends to be highly susceptible to direct duplication. rue !alse Answer: !alse Page: 11* Diffi !"#$: 6ard C%a&#er O'(e #i)e: + '6. 5trategic alliances are the ma=or substitute for vertical integration. rue !alse Answer: rue Page: 11* Diffi !"#$: )oderate C%a&#er O'(e #i)e: + '3. -hile the functional or 4.form structure is used to implement a cost leadership or product differentiation strategy/ a matri0 structure is most often used to implement a vertical integration strategy. rue !alse Answer: !alse Page: 11+ Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 '". !rom a C$7's perspective/ coordinating functional specialists to implement a vertical integration strategy rarely involves conflict resolution. rue !alse Answer: !alse Page: 11+ Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 '1. !oreign direct investment is a fully vertically integrated international strategy. rue !alse Answer: rue Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 *#. Importing and e0porting are e0amples of a somewhat vertically integrated international strategy. rue !alse Answer: !alse Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 *ULTIPLE CHOICE QUESTIONS *1. Vertical integration is a type of (. business strategy. B. generic strategy. C. differentiation strategy. &. corporate strategy. Answer: & Page: 1"# Diffi !"#$: )oderate

C%a&#er O'(e #i)e: 1

Chapter 6: Vertical Integration 11 *%. he number of steps in a firm's value chain that it accomplishes within its boundaries describes the firm's level of (. product differentiation. B. diversification. C. vertical integration. &. competitive dynamics. Answer: C Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 *'. -hen >ateway computers opened retail stores to sell their computers and computer peripherals/ this was an e0ample of (. forward vertical integration. B. bac,ward vertical integration. C. forward hori;ontal integration. &. bac,ward hori;ontal integration. Answer: ( Page: 1"1 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1 **. If &ell computers were to open its own factory to manufacture the ?C& televisions it sells at its online store/ this would be an e0ample of (. forward vertical integration. B. product differentiation. C. forward hori;ontal integration. &. bac,ward vertical integration. Answer: & Page: 1"1 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1 *+. ( firm's @@@@@@@@@@@@@@@@ measures the percentage of a firm's sales that is generated by activities done within the boundaries of a firm. (. value added as a percentage of sales B. simple product diversification C. competitive advantage &. competitive dynamic Answer: ( Page: 1"% Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 *6. -hich of the following is not used to determine a firm's level of vertical integration using the value added as a percentage of sales approachA (. Value added B. Bet income C. 5ales &. >ross margin Answer: & Page: 1"% Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1

1## 2art III *3. ( firm with a @@@@@@@@@ ratio between value added and sales has brought @@@@@@@ of the value.creating activities associated with its business inside its boundaries/ consistent with a high level of vertical integration. (. lowC many B. highC many C. mediumC many &. mediumC few Answer: B Page: 1"% Diffi !"#$: 6ard C%a&#er O'(e #i)e: 1 *". In 11'3/ which Bobel 2ri;e.winning economist first articulated the :uestion of vertical integration/ which stages of the value chain should be included within a firm's boundaries and whyA (. <onal Coase B. (dam 5mith C. &avid <icardo &. )ilton !reidman Answer: ( Page: 1"' Diffi !"#$: )oderate C%a&#er O'(e #i)e: % *1. @@@@@@@@@ e0ists when a firm is unfairly e0ploited in an e0change. (. Competitive advantage B. Business level strategy C. 7pportunism &. Corporate level strategy Answer: C Page: 1"' Diffi !"#$: )oderate C%a&#er O'(e #i)e: % +#. (8n9 @@@@@@@@@@@@@@@ is any investment in an e0change that has significantly more value in the current e0change than it does in alternative e0changes. (. opportunity.specific investment B. transaction.specific investment C. competition.specific investment &. opportunistic investment Answer: B Page: 1"* Diffi !"#$: $asy C%a&#er O'(e #i)e: % +1. (ccording to @@@@@@@@@@@@@ of when vertical integration creates value/ vertical integration is valuable when it reduces threats from a firm's suppliers or buyer due to any transaction.specific investments a firm has made. (. firm capability e0planations B. opportunity.based e0planations C. fle0ibility.based e0planations &. opportunism.based e0planations Answer: & Page: 1"+ Diffi !"#$: )oderate C%a&#er O'(e #i)e: %

Chapter 6: Vertical Integration1#1 +%. he essence of the @@@@@@@@@@@@@@@@ to vertical integration is that if a firm possesses valuable/ rare/ and costly.to.imitate resources in a business activity/ it should vertically integrate into that activity otherwise it should not vertically integrate into that activity. (. fle0ibility.based e0planation B. opportunism.based e0planation C. firm capability e0planation &. opportunity.based e0planation Answer: C Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' +'. o the e0tent that other firms may have competitive advantages in business activities that a firm is considering to enter through vertical integration/ vertically integrating into these activities could put the firm at a (. competitive advantage. B. temporary dynamic disadvantage. C. sustainable competitive advantage. &. competitive disadvantage. Answer: & Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' +*. @@@@@@@@@ refers to how costly it is for a firm to alter its strategic and organi;ational decisions. (. !le0ibility B. &ynamic capability C. 7pportunism &. 4ncertainty Answer: ( Page: 1"6 Diffi !"#$: $asy C%a&#er O'(e #i)e: * ++. <esearch suggests that/ in general/ vertically integrating is @@@@@@@@@@ than not vertically integrating. (. significantly more fle0ible B. somewhat more fle0ible C. comparatively fle0ible &. less fle0ible Answer: & Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * +6. ( decision.ma,ing setting is @@@@@@@@@ when the future of an e0change cannot be ,nown when investments in that e0change are being made. (. uncertain B. opportunistic C. fle0ible &. dynamic Answer: ( Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: *

1#% 2art III +3. (8n9 @@@@@@@@@@@@@ approach to vertical integration suggests that/ rather than vertically integrating into a business activity whose value is highly uncertain/ firms should not vertically integrate/ and/ instead should form a strategic alliance to manage this e0change. (. alliance.based B. fle0ibility.based C. firm capabilities.based &. opportunism.based Answer: B Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * +". -hich of the e0planations of vertical integration is the oldest and has received the greatest empirical supportA (. 7pportunism.based B. !le0ibility.based C. !irm capabilities.based &. (lliance.based Answer: ( Page: 1"" Diffi !"#$: 6ard C%a&#er O'(e #i)e: + +1. If a firm decided to maintain relationships with several different call center management companies/ each of whom have adopted different technological solutions to the problem of how to use call center employees to assist customers who are using very comple0 products to reduce the uncertainty of whether the people staffing the phone can help the firm's customers/ this would be consistent with which e0planation of vertical integrationA (. 7pportunism.based B. !le0ibility.based C. !irm capabilities.based &. (lliance.based Answer: B Page: 11# Diffi !"#$: 6ard C%a&#er O'(e #i)e: + 6#. Between 1113 and %###/ the si;e of the outsourced services mar,et (. decreased by +#D. B. remained roughly the same. C. increased slightly. &. doubled. Answer: & Page: 111 Diffi !"#$: )oderate C%a&#er O'(e #i)e: +

Chapter 6: Vertical Integration1#' 61. If a computer company decided to open its own call centers to provide technical support to its corporate customers because the employees in these call centers need a significant level of in.depth training that was highly speciali;ed to the computer company's products/ this would be consistent with which e0planation of vertical integrationA (. 7pportunism.based B. !le0ibility.based C. !irm capabilities.based &. (lliance.based Answer: ( Page: 11% Diffi !"#$: 6ard C%a&#er O'(e #i)e: + 6%. ( firm is li,ely to be among the first in its industry to vertically dis.integrate an e0change when (. the firm concludes that the level of specific investment re:uired to manage an economic e0change is high. B. the firm believes that the e0change is costly to imitate. C. the level of uncertainty about the value of an e0change has increased. &. the firm believes that the e0change is rare. Answer: C Page: 11* Diffi !"#$: 6ard C%a&#er O'(e #i)e: + 6'. -hich of the following statements regarding direct duplication and substitutes for vertical integration is accurateA (. ( firm's valuable and rare vertical integration choices may be sub=ect to direct duplication and substitutes. B. ( firm's valuable and rare vertical integration choices are sub=ect to neither direct duplication nor substitutes. C. ( firm's valuable and rare vertical integration choices may be sub=ect to direct duplication but not to substitutes. &. ( firm's valuable and rare vertical integration choices may be sub=ect to substitutes but not to direct duplication. Answer: ( Page: 11* Diffi !"#$: )oderate C%a&#er O'(e #i)e: + 6*. he ma=or substitute for vertical integration is (. vertical dis.integration. B. strategic alliances. C. a product differentiation strategy. &. a low cost strategy. Answer: B Page: 11* Diffi !"#$: $asy

C%a&#er O'(e #i)e: +

6+. -hich organi;ational structure is used to implement a vertical integration strategyA (. )atri0 B. !unctional C. )ulti.&ivisional &. 2roduct.&ivisional Answer: B Page: 11+ Diffi !"#$: $asy C%a&#er O'(e #i)e: 6

1#* 2art III

66. !rom a C$7's perspective/ coordinating functional specialists to implement a vertical integration strategy almost always involves (. conflict resolution. B. competitive positioning. C. product differentiation. &. corporate e0pansion. Answer: ( Page: 11+ Diffi !"#$: $asy C%a&#er O'(e #i)e: 6 63. If Brenda hompson/ om )i0Es supervisor/ wanted to use a budgeting process to help evaluate omEs performance but wanted to ensure that using a budget did not encourage om to focus on short.term behaviors at the e0pense of long.term results she should (. develop the budget herself using realistic goals based on the economic reality facing omEs function and use both :uantitative and :ualitative evaluations of the performance of omEs function and then give the budget to om to follow. B. wor, with om in an open and participative process to develop the budget based on the most optimistic scenario possible and use both :uantitative and :ualitative evaluations of the performance of omEs function. C. develop the budget herself based on the most pessimistic scenario possible and use both :uantitative and :ualitative evaluations of the performance of omEs function and then give the budget to om to follow. &. wor, with om in an open and participative process to develop the budget based on the economic reality facing omEs function and use both :uantitative and :ualitative evaluations of the performance of omEs function. Answer: & Page: 113 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 6". $valuating a functional managerEs performance relative to budgets can be an effective control when (. the process used in developing budgets is open and participative. B. the process reflects the economic best.case scenario developed by the functional manager. C. the process reflects the economic worst.case scenario developed by the functional manager. &. the process relies solely on :uantitative criteria to evaluate the functional managerEs performance. Answer: ( Page: 113 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 61. -hich committee in a 4.form organi;ation meets monthly and usually consists of the C$7 and each of the heads of the functional areas included in a firmA (. $0ecutive committee B. !unctional committee C. 7perations committee &. )anagerial committee Answer: C Page: 11" Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6

Chapter 6: Vertical Integration1#+ 3#. -hich committee in a 4.form organi;ation meets wee,ly and reviews the performance of the firm on a wee,ly basis and typically consists of a C$7 and two or three functional senior managersA (. op management team B. $0ecutive committee C. 7perations committee &. !unctional committee Answer: B Page: 113 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 31. Investments made by employees that have more value in a particular company than in alternative companies are ,nown as (. firm.specific investments. B. individual.specific investments. C. group.specific investments. &. corporate.specific investments. Answer: ( Page: 11" Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 3%. (ccording to the opportunism.based e0planations of vertical integration/ which of the following would be the most appropriate type of compensation to support strategy implementationA (. Cash bonuses for corporate performance B. Cash bonuses for group performance C. 5toc, options for individual performance &. 5toc, grants for individual performance Answer: & Page: %## Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 3'. (ccording to the capabilities.based e0planations of vertical integration which of the following would be the most appropriate type of compensation to support strategy implementationA (. 5alary B. Cash bonuses for corporate performance C. Cash bonuses for individual performance &. 5toc, grants for individual performance Answer: B Page: %## Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 3*. (ccording to the fle0ibility.based e0planations of vertical integration/ which of the following would be the most appropriate type of compensation to support strategy implementationA (. 5toc, options for individual performance B. 5toc, grants for individual performance C. 5toc, grants for corporate performance &. Cash bonuses for individual performance Answer: ( Page: %## Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6

1#6 2art III 3+. Currently/ the trend in vertical integration decisions in an international conte0t seems to be for (. firms to reduce their level of vertical integration by outsourcing functions that used to be within their boundaries to independent foreign operations. B. firms to increase their level of vertical integration by outsourcing functions that used to be within their boundaries to independent foreign operations. C. firms to reduce their level of vertical integration by bringing functions that used to be outside of their boundaries within their foreign operations. &. firms to increase their level of vertical integration by bringing functions that used to be outside of their boundaries within their foreign operations. Answer: ( Page: %## Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 36. -hich of the following international strategy options would be considered to be the least vertically integratedA (. ?icensing B. !oreign direct investment C. ImportingFe0porting &. Goint ventures Answer: C Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 33. -hich of the following international strategy options would be considered the most vertically integratedA (. $0porting B. 5trategic alliances C. Goint ventures &. !oreign direct investment Answer: & Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 3". If a domestic firm grants a firm in a nondomestic mar,et the right to use its products and brand names to sell products in that nondomestic mar,et/ this is best described as an e0ample of a8n9 (. e0porting agreement. B. licensing arrangement. C. foreign direct investment. &. =oint venture. Answer: B Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3

Chapter 6: Vertical Integration1#3 31. -hich one of the following is not one of the advantages of vertical integration in international operationsA (. Integration enables a firm to reali;e any sources of value that might e0ist in an internal opportunity. B. Integration enables managers to use a wider range of organi;ational controls to limit the threats from any transaction.specific investments that have been made. C. Integration enables a firm to capture all of the economic profits from their international operations. &. Integration tends to be less costly and ris,y than other international strategies such as e0porting/ licensing or =oint ventures. Answer: & Page: %#% Diffi !"#$: 6ard C%a&#er O'(e #i)e: 3 "#. -hich of the following would be considered a somewhat vertically integrated international strategyA (. $0porting B. !oreign direct investment C. 5trategic alliances &. Importing Answer: C Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 &igipic is an assembler of digital cameras. (s an assembler/ &igipic's operations are limited to purchasing all of the components necessary to assemble the cameras and then selling these cameras to wholesalers who/ in turn/ sell them through online stores and in retail electronics stores. "1. If &igipics were to begin manufacturing lenses for the cameras they assembled/ this would be an e0ample of (. bac,ward vertical integration. B. a strategic alliance. C. forward vertical integration. &. opportunism. Answer: ( Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 "%. If &igipics were to begin selling the cameras they assembled directly to customers through a website operated by the company/ this would be an e0ample of (. bac,ward vertical integration. B. a strategic alliance. C. forward vertical integration. &. opportunism. Answer: C Page: 1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1

"'. If one of the suppliers that &igipics purchases its components from purposefully

1#" 2art III delivered a batch of their product that was substandard but did not inform &igipics of this/ this would be an e0ample of (. fle0ibility. B. opportunism. C. uncertainty. &. vertical integration. Answer: B Page: 1"' Diffi !"#$: )oderate C%a&#er O'(e #i)e: % "*. If &igipics were to agree to spend a significant amount of money to establish a new assembly line for a large client/ 2ic2ro/ that has uni:ue needs that would ma,e this assembly line largely useless for any other customer/ the funds &igipics spent in establishing this line would be an e0ample of (. forward vertical integration B. bac,ward vertical integration. C. a transaction.specific investment. &. opportunism. Answer: C Page: 1"* Diffi !"#$: 6ard C%a&#er O'(e #i)e: % "+. he fact that it would be very costly for &igipics to alter its operations if the large customer referred to in the previous :uestion decided to stop doing business with &igipics suggests that &igipics has @@@@@@@@@@@ in this situation. (. low fle0ibility B. low opportunism C. high fle0ibility &. high opportunism Answer: ( Page: 1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * erra?oc competes in the mar,et for global positioning devices and services. he company manufacturers its own >25 units that are smaller than those of any other competitor and include a proprietary battery that lasts %##D longer than any other competitor's battery and that erra?oc manufacturers on.site. erra?oc also has developed proprietary software that is much faster and more precise than any competitor. -hen developing the proprietary battery/ erra?oc decided to manufacturer the battery in.house to reduce the possibility that the company they outsourced the battery manufacturing to might reverse engineer the battery and sell a similar product to competitors. his possibility was especially troubling given that the company e0pected a significant increase in demand due to the improved battery life. (dditionally/ erra?oc sells its products and services through its own direct sales force to ensure that its representatives highlight the longer battery life of erraloc's units.

"6.

erra?oc's decision to manufacture the battery in.house is most consistent with

Chapter 6: Vertical Integration1#1 which e0planation of vertical integrationA (. !le0ibility.based e0planations B. !irm capability.based e0planations C. (lliance.based e0planations &. 7pportunism.based e0planations Answer: & Page: 1"' Diffi !"#$: 6ard

C%a&#er O'(e #i)e: %

"3. erra?oc's development of the new battery technology is li,ely to (. reduce the rarity of erra?oc's vertical integration strategy since competitors can purchase batteries from other sources. B. increase the rarity of erra?oc's vertical integration strategy since erra?oc has reduced uncertainties related to increased battery.life in its products. C. increase the imitability of erra?oc's vertical integration strategy since competitors can purchase traditional batteries from other sources. &. decrease the imitability of erra?oc's vertical integration strategy since it increases competitor's fle0ibility. Answer: B Page: 11% Diffi !"#$: 6ard C%a&#er O'(e #i)e: + "". erra?oc is most li,ely to use the @@@@@@@@@@@@@ organi;ational structure. (. matri0 B. product.based multidivisional C. functional &. geography.based multi.divisional Answer: C Page: 11+ Diffi !"#$: )oderate C%a&#er O'(e #i)e: 6 "1. If erra?oc were to use a 4.form organi;ational structure and the C$7 decided to use budgets as a management control but wanted to ma,e sure that the managers did not become too focused on the short.term/ the C$7 should do all of the following e0cept (. use an open process in developing budgets. B. determine budgets for her managers and allow them to focus only on meeting the budgets. C. use both :uantitative and :ualitative evaluations of managers' performance. &. ma,e sure that the process used in developing budgets reflects the economic reality facing the firm's managers. Answer: B Page: 113 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 1#. If erra?oc wanted to e0pand internationally and wanted to do so through a highly vertically integrated strategy/ erra?oc should consider e0panding through (. foreign direct investment. B. e0porting. C. licensing. &. a =oint venture. Answer: ( Page: %#1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 3 ESSA+ QUESTIONS

11# 2art III

,-. Define )er#i a" in#egra#i/n an0 0ifferen#ia#e 'e#ween f/rwar0 )er#i a" in#egra#i/n an0 'a 1war0 )er#i a" in#egra#i/n. Vertical integration is a corporate strategy. ( firmEs level of )er#i a" in#egra#i/n is simply the number of steps in this value chain that a firm accomplishes within its boundaries. )ore vertically integrated firms accomplish more stages of the value chain within their boundaries than less vertically integrated firms. ?ess vertically integrated firms accomplish fewer stages of the value chain within their boundaries than more vertically integrated firms. ( firm engages in 'a 1war0 )er#i a" in#egra#i/n when it incorporates more stages of the value chain within its boundaries and those stages bring a firm closer to the beginning of the value chain/ i.e./ closer to gaining access to raw materials. ( firm engages in f/rwar0 )er#i a" in#egra#i/n when it incorporates more stages of the value chain within its boundaries and those stages bring a firm closer to the end of the value chain/ i.e./ closer to interacting directly with final customers. Page: 1"#.1"1 Diffi !"#$: )oderate C%a&#er O'(e #i)e: 1 ,2. I0en#if$ #%e #%ree f!n0a3en#a" e4&"ana#i/ns /f %/w )er#i a" in#egra#i/n an rea#e )a"!e an0 0is !ss %/w )a"!e is rea#e0 !n0er ea %. here are three e0planations of how firms can create value through vertical integration including: a. O&&/r#!nis356ase0 E4&"ana#i/n: <educing opportunistic threats from a firm's buyers and suppliers due to any transaction specific investments it may have made. b. Ca&a'i"i#ies56ase0 E4&"ana#i/n: By enabling a firm to e0ploit its valuable/ rare/ and costly to imitate resources and capabilities. c. F"e4i'i"i#$56ase0 E4&"ana#i/n: -hen the decision.ma,ing environment is uncertain/ firms create value by engaging in vertical integration. 4nder high uncertainty vertical integration can commit a firm to a costly.to.reverse course of action and the fle0ibility of a non.vertically integrated may be preferred. Pages: 1"'.1"" Diffi !"#$: $asy C%a&#er O'(e #i)e: % ,7. Dis !ss #%e /&&/r#!nis35'ase0 e4&"ana#i/n /f )er#i a" in#egra#i/n )a"!e rea#i/n an0 i0en#if$ w%en8 !n0er #%is e4&"ana#i/n fir3s s%/!"0 )er#i a""$ in#egra#e. In $/!r answer 'e s!re #/ "ear"$ 0efine /&&/r#!nis38 an0 #%e r/"e #%a# #ransa #i/n5s&e ifi in)es#3en#s &"a$ in #%e /&&/r#!nis35'ase0 e4&"ana#i/n. 7ne of the best ,nown e0planations of when vertical integration can be valuable focuses on using vertical integration to reduce the threat of opportunism. O&&/r#!nis3 e0ists when a firm is unfairly e0ploited in an e0change. 7bviously/ when one of its e0change partners behaves opportunistically/ this reduces the economic value of a firm. he threat of opportunism is greatest when a party to an e0change has made what are called transaction specific investments. ( #ransa #i/n s&e ifi in)es#3en# is any investment in an e0change that has significantly more value in the current e0change than it does in alternative e0changes. 7ne way to reduce the threat of opportunism is to bring an e0change within the boundary of a firm. hat is/ one way to reduce the threat of opportunism is to vertically integrate into this e0change. his way/ managers in a firm can directly monitor and control this e0change instead

Chapter 6: Vertical Integration111 of relying on the mar,et to manage this e0change. If the e0change that is brought within the boundary of a firm brings a firm closer to its ultimate suppliers/ it is an e0ample of bac,ward vertical integration. If the e0change that is brought within the boundary of a firm brings a firm closer to its ultimate customer/ it is an e0ample of forward vertical integration. 7f course/ firms should only bring mar,et e0changes within their boundaries when the cost of vertical integration is less than the cost of opportunism. If the cost of vertical integration is greater than the cost of opportunism/ then firms should not vertically integrate into an e0change. his is the case for both bac,ward and forward vertical integration decisions. Page: 1"'.1"+ Diffi !"#$: )oderate C%a&#er O'(e #i)e: % ,9. Dis !ss #%e fir3 a&a'i"i#ies 'ase0 e4&"ana#i/n /f %/w )er#i a" in#egra#i/n an rea#e )a"!e. In $/!r 0is !ssi/n i0en#if$ #%e #w/ 'r/a0 i3&"i a#i/ns /f #%is a&&r/a % an0 w%en8 !n0er #%is a&&r/a %8 fir3s s%/!"0 engage in )er#i a" in#egra#i/n. he capabilities based e0planation of how vertical integration can create value focuses on firm capabilities and their ability to generate sustained competitive advantages. his approach has two broad implications. !irst/ it suggests that firms should vertically integrate into those business activities where they possess valuable/ rare/ and costly to imitate resources and capabilities. his way/ firms can appropriate at least some of the profits that using these capabilities to e0ploit environmental opportunities will create. 5econd/ this approach also suggests that firms should not vertically integrate into business activities where they do not possess the resources necessary to gain competitive advantages. 5uch vertical integration decisions would not be a source of profits to a firm/ since they do not possess any of the valuable/ rare/ or costly to imitate resources needed to gain competitive advantages in these business activities. Indeed/ to the e0tent that some other firms have competitive advantages in these business activities/ vertically integrating into them could put a firm at a competitive disadvantage. 4nder this approach/ a firm should pursue vertical integration into an activity when it has valuable/ rare/ and costly to imitate resources in a business activity/ vertically integrate into that activity. If a firm does not have valuable/ rare/ and costly to imitate resources in a business activity/ and other firms already engaging in this activity do/ the firm will find itself at a competitive disadvantage. Pages: 1"+.1"6 Diffi !"#$: )oderate C%a&#er O'(e #i)e: ' ,:. Dis !ss #%e f"e4i'i"i#$ 'ase0 e4&"ana#i/n /f )er#i a" in#egra#i/n. In 0is !ssing #%is e4&"ana#i/n 'e s!re #/ 0efine f"e4i'i"i#$8 #%e r/"e /f !n er#ain#$ in #%is e4&"ana#i/n8 an0 i0en#if$ w%en8 !n0er #%is e4&"ana#i/n8 fir3s s%/!"0 engage in )er#i a" in#egra#i/n. he fle0ibility based e0planation of vertical integration focuses on the impact of vertical integration on a firm's fle0ibility. F"e4i'i"i#$ refers to how costly it is for a firm to alter its strategic and organi;ational decisions. !le0ibility is high when the cost of changing strategic choices is lowC fle0ibility is low when the cost of changing strategic choices is high. In general vertical integration reduces fle0ibility since it has committed its organi;ational structure/ its management controls/ and its compensation policies to a particular vertically integrated way of doing business. -hen a decision.ma,ing environment is uncertain/ that is when the future value of an e0change cannot be ,nown when investments in that e0change are being made the value of vertical integration is decreased and should be avoided. Page: 1"6.1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: *

11% 2art III

,6. ;i#%in #%e f"e4i'i"i#$5'ase0 a&&r/a % #/ )er#i a" in#egra#i/n w%en s%/!"0 fir3s engage in s#ra#egi a""ian es8 ins#ea0 /f )er#i a" in#egra#i/n8 an0 w%a# are #%e a0)an#ages /f a""ian es !n0er #%ese /n0i#i/ns< ( fle0ibility.based approach to vertical integration suggests that/ rather than vertically integrating into a business activity whose value is highly uncertain/ firms should not vertically integrate and/ instead/ form a strategic alliance to manage this e0change. ( strategic alliance is more fle0ible than vertical integration/ but still gives a firm enough information about an e0change to estimate its value over time. (n alliance has a second advantage in this setting. he downside ris,s associated with investing in a strategic alliance are ,nown and fi0ed. hey e:ual the cost of creating and maintaining the alliance. If an uncertain investment turns out to not be valuable/ parties to this alliance ,now the ma0imum amount they can loseHan amount e:ual to the cost of creating and maintaining the alliance. 7n the other hand/ if this e0change turns out to be very valuable/ then maintaining an alliance can give a firm access to this huge upside potential. Page: 1"3 Diffi !"#$: )oderate C%a&#er O'(e #i)e: * ,=. I0en#if$ #%ree reas/ns w%$ a fir3 3a$ 'e a'"e #/ rea#e )a"!e #%r/!g% )er#i a" in#egra#i/n w%en 3/s# /f i#s /3&e#i#/rs are n/# a'"e #/ rea#e )a"!e #%r/!g% )er#i a" in#egra#i/n. here are at least three reasons for why vertical integration can be rare. !irst/ a firm may have developed a new technology/ or a new approach to doing business/ that re:uires its business partners to ma,e substantial transaction specific investments. !irms that engage in these activities will find it in their self.interest to vertically integrate/ while firms that have not engaged in these activities will not find it in their self.interest to vertically integrate. If these activities are rare and costly to imitate/ they can be a source of competitive advantage for a vertically integrating firm. 5econd/ a firm may have unusual s,ills or capabilities/ if these s,ills or capabilities are valuable and rare/ then vertically integrating into businesses that e0ploit these capabilities can enable a firm to gain at least a temporary competitive advantage. !inally/ a firm may be able to gain an advantage from vertically integrating when it resolves some uncertainty it faces sooner than its competition. In this situation/ the firm no longer needs to retain the fle0ibility and can gain some of the advantages of vertical integration sooner than its competitors and can gain at least a temporary competitive advantage. Page: 11%.11* Diffi !"#$: )oderate C%a&#er O'(e #i)e: +

,>. I0en#if$ #%e /rgani?a#i/na" s#r! #!re #%a# is !se0 #/ i3&"e3en# a )er#i a" in#egra#i/n s#ra#eg$ an0 w%$ fr/3 a CEO@s &ers&e #i)e8 //r0ina#ing f!n #i/na" s&e ia"is#s #/ i3&"e3en# a )er#i a" in#egra#i/n s#ra#eg$ a"3/s# a"wa$s in)/")es /nf"i # res/"!#i/n an0 %/w #%is /nf"i # an 'e res/")e0. he organi;ational structure that is used to implement a cost leadership and product differentiation strategyHthe functional or 4.form structureHis also used to implement a

Chapter 6: Vertical Integration11' vertical integration strategy. Indeed/ each of the e0changes included within the boundaries of a firm as a result of vertical integration decisions are incorporated into one of the functions in a functional organi;ational structure. !rom a C$7Es perspective/ coordinating functional specialists to implement a vertical integration strategy almost always involves conflict resolution. Conflicts among functional managers in a 4.form organi;ation are both e0pected and normal. Indeed/ if there is no conflict among certain functional managers in a 4.form organi;ation/ then some of these managers probably are not doing their =obs. he tas, facing the C$7 is not to pretend this conflict does not e0ist/ or to ignore it/ but to manage it in a way that facilitates strategy implementation. he C$7Es =ob is to help resolve conflicts in ways that facilitate the implementation of the firmEs strategy. !unctional managers do not have to Ili,eJ each other. 6owever/ if a firmEs vertical integration strategy is correct/ the reason that a function has been included within the boundaries of a firm is that this decision creates value for the firm. (llowing functional conflicts to get in the way of ta,ing advantage of each of the functions within a firmEs boundaries can destroy this potential value. Pages: 11+.116 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 ,,. Dis !ss #%e r/"e /f #%e '!0ge#ing &r/ ess as a /n#r/" 3e %anis3 in )er#i a""$ in#egra#e0 U5F/r3 /rgani?a#i/ns8 #%e &/#en#ia" !nin#en0e0 nega#i)e /nseA!en e '!0ge#s an %a)e8 an0 #%ree #%ings CEOs an 0/ #/ /!n#er #%is &/#en#ia" /nseA!en e. Budgeting is one of the most important control mechanisms available to C$7s in vertically integrated 4.form organi;ations. Indeed/ in most 4.form companies/ enormous management effort goes into the creation of budgets and the evaluation of performance relative to budgets. Budgets are developed for costs/ revenues/ and a variety of other activities performed by a firmEs functional managers. 7ften/ managerial compensation and promotion opportunities depend on the ability of a manager to meet budget e0pectations. (lthough budgets are an important control tool/ they can also have unintended negative conse:uences. !or e0ample/ the use of budgets can lead functional managers to overemphasi;e short.term behavior that is easy to measure and underemphasi;e longer.term behavior that is more difficult to measure. C$7s can do a variety of things to counter the Ishort.termismJ effects of the budgeting process. hree things a C$7 can do to counter Kshort.termismK are to 1. $nsure that the process used in developing budgets is open and participative %. )a,e the budgeting process reflects the economic reality facing functional managers and the firm/ and '. (ugment :uantitative evaluations of a functional managerEs performance with :ualitative evaluations of that performance. Page: 113 Diffi !"#$: 6ard C%a&#er O'(e #i)e: 6 -BB. I0en#if$ #%e )er#i a" in#egra#i/n /&#i/ns a)ai"a'"e #/ a fir3 &!rsing in#erna#i/na" 3ar1e# /&&/r#!ni#ies8 i0en#if$ w%i % e4%i'i# #%e "/wes# 0egree /f )er#i a" in#egra#i/n8 w%i % are s/3ew%a# )er#i a""$ in#egra#e0 an0 w%i % are #%e 3/s# )er#i a""$ in#egra#e0 an0 0is !ss #%e &ri3ar$ 'enefi#s /f n/n5)er#i a""$ in#egra#e0 )ers!s )er#i a""$ in#egra#e0 s#ra#egies.

11* 2art III hese options available to a firm pursing international mar,et opportunities range from vertically non.integrated 8e0portingFimporting9/ to somewhat vertically integrated 8licensing/ strategic alliances/ =oint ventures9/ to fully vertically integrated 8foreign direct investment9. he advantages of adopting a non.vertically integrated approach is engaging in an international strategy includes its relatively low cost and the limited ris, e0posure since the firm's limited its foreign direct investment/ it does not ris, losing this investment if it ceases international operations. (lthough vertical integration in international operations can be e0pensive and ris,y/ it can have some important advantages for internationali;ing firms. !irst/ this approach to internationali;ation can enable a firm to reali;e any sources of value that might e0ist in an international opportunity. )oreover/ integration enables managers to use a wider range of organi;ational controls to limit the threats from any transaction specific investments that have been made. !inally/ unli,e strategic alliances/ where any profits from international operations must be shared with international partners/ integrating into international operations enables firms to capture all the economic profits from their international operations. Page: %#1.%#% Diffi !"#$: $asy C%a&#er O'(e #i)e: 3