STR203 Midterm Study Guide
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This 23 page Study Guide was uploaded by Danielle Katan on Sunday February 28, 2016. The Study Guide belongs to STR203 at a university taught by Gilbert in Spring 2016. Since its upload, it has received 112 views.
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Date Created: 02/28/16
Basic Definitions STR 203 – Using economic concepts to solve important organizational problems, which include understanding and development of corporate strategy, execution, performance evaluation and compensation systems Organization – group of individuals working toward common purpose to create and deliver benefits to its constituents • Set goals, allocate resources Business – a discrete collection of individuals working together to create and deliver customer benefits via products and services. Strategy – about crating greater value for a customer; iterative process Value – is a function of choices; how well customers needs are being met Core Competencies (set of activities) – something the company does especially well or can learn to especially well compared to rivals; something competitors don’t have/have difficulty matching Firm – a group of individuals who coordinate activities to complete a project or task Important People/Ideas Adam Smith (1700s) – Invisible hand (lack of market power) Ronald Coase (1930s) – Why do firms exist? Joseph Schumpeter (1940s) – Creative destruction Modern Industrial Study/Consulting Groups (1960s) -‐ GE/McKinsey • GE/McKinsey nine-‐block Williamson Meckling/Jensen Strategy – military origins Does a company have moat protecting from comp? “Secret sauce” • Ex. Intel, Qualcomm, Sony (had a moat but lost to LG/Samsung), Coca-‐Cola • Wal-‐Mart (other low cost competitors but no one has replicated their formula successfully) o Started in small (~5,000-‐25,000 person) towns, “state by state” –Sam Walton o Went to towns that didn’t have any competition, geographic segmentation, didn’t have any big stores, put small businesses out of business, distribute to other locations, connect o Capture economies of scale o Can lower prices and hold out longer than small stores o Fast production process-‐ helps them stay ahead o Learning curve – as production volume doubles, direct cost per unit decreases substantially (log scale) • Six Flags – amusement park o In competition? With theme parks? o Why moat? § Many locations (18 parks) § Population density § Cost $300+ million to start a new park Two sides to every market-‐ buyers and seller Meeting needs of a customer: • Functionality – uniqueness • Delivery • After market support • Price of the product or service • ^^ Package that makes value proposition Opportunities to create value: • Novelty of design or style, availability, ruggedness, after market care, ease of use, functionality, price (including quantity discounts) • These factors combine to crate value for a customer “Aim [is] to locate portions of the market [whose needs] are unserved or underserved.” -‐Spark innovation through empathic design 1997 HBR, Leonard + Jaworski • 86% of businesses deemed “incremental” or “me too” improvements, 75% of those fail • If a firm cannot find unserved/underserved area of market à use low prices to attract customers Creating Market Opportunity – finding a new company’s “space” in marketplace requires analysis • Current needs of customer, how needs are being met à whether the customer receives value • Understand cost structure • Understand costs of competitors o Visit location of rival (ex. count number of cars in parking lot) § Note start and end times, labor salary ranges based on position, salary ranges for managerial positions, local unemployment rates/salary adjustments in past year, inflation in the area § Cost of factory space sqf. – real estate taxes, utilities • “The essence of strategy is choosing to perform activities differently than rivals do” Charlie Guth – accidentally saved Pepsi • Changed bottle size, increased to 12 oz. from 6 oz., and increased price to 10 cents rather than 5 à failed • Chose to cut price of large bottle to 5 cents, same as 6 oz. Coke o Concluded would save money by purchasing less glass o Idea took off • Coca Cola had large market share, didn’t lower prices, sacrificing margins What causes D curve to shift? • International markets • Social trends • Emerging shifts (want to look ahead) Ex. Toyota hybrid cars – Prius, built cars around changing world Ex. BASF – plastic manufacturers, bought oil fields to reduce costs Elasticity of Demand – price sensitivity, increase in demand due to change in price (reduction) that causes revenues to increase • If total revenue doesn’t increase why lower your price? Inelasticity of Demand – price insensitivity Factors affecting elasticity: alternatives/substitutes, commodity like attributes Inelasticity – capture more consumer surplus Factors affecting elasticity – few substitutes, high switching costs Willing to accept some of customer cost – make supplier more attractive Ex. Wegmans/Tops merchandiser from suppliers, don’t need employee stocking – trade off Eyeware delivery – care about delivery; price, quantity Understand customers real cost – make it part of yours then work it out of the system Customers will pay a premium for what they’re looking for; lower total cost Understand customer profile • Budget limitations/extra income Why did McDonalds start serving breakfast? Economies of scale Costs • Fixed inputs o Big capitol expenditures, ex. equipment o Building operating costs (insurance, within a range heat, light) o Costs that doesn’t depend on quantity • Variable inputs o Labor, materials (to make the product), supplies (consumables) o Costs directly related to quantity produced • All costs are variable in the long run (not short run) Porter – What is Strategy? • 3 primary strategies: o Perform different activities o Perform the same activities in different ways o Identify undeserved groups • Perform activities differently than rivals do; maintaining differences • Difference between operational efficiency and strategy; operational efficiency is a type of strategy • Do enough people respect your business that you’ll make a market? o Ex. Distinguishing factors that make a customer chose one product over another: § Samsung – writing notes on phone § Blackberry – security o Deliver greater value or comparable value at a lower cost o Similar but different Why not every customer? Why just some customers? Functionality, uniqueness, quality, delivery, support, price > value proposition Value is a function of choices • Somewhat individualized, do better job meeting needs Look for opportunity, ex. novelty of design, ruggedness, many factors Locate underserved/un-‐served markets Reduce price à reduce revenue further rather than increase – Priceline Price is not strategic Customer profile à most important; underserved market segments Create more value during periods of low demand Ex. Happy hour, kids eat free Capture more consumer surplus Accept some of customer costs added to own Understanding business landscape – world around us Competition à encourage companies to perform at higher level Porter – How Competitive Forces Shape Strategy • Understand business landscape and competitive advantage • What’s around us • Do we enter the market or not o Some industries more competitive • Competition encourages a company to perform at a higher level • More choices for consumers à better value • Competition reduces margins for suppliers • Competitive landscape and its boundaries o Geography, customers and their end markets, type of distribution, functionality • 5 constituents in any market: New entrant, customer, substitute, suppliers, firm & rival o Only so much profit can be created, limited • 5 constituents – all profit split among them Porters 5 forces: Mapping market attractiveness • Gathering information o Important to best understand segment being considered o Decide whether should enter market Industry definition • How interesting is the industry? o Is it growing? At what rate? o Who are current direct/indirect competitors § Ex. Indirect Competition -‐ Wegmans, sells some pet food but isn’t a direct competitor with pet stores o Substitutes – similar and identical o Strong buyers o Strong suppliers • Horizontal analysis: o Does the industry intersect other segments? o Does geography, proximity, to possible customers matter? • Vertical analysis: o Interlocking supply o Distribution channels Are the customers the right one? • Customer profile? • Customer value most? • Customers buying pattern/habits? • Is the firms message clear? • Have to make some selections, can’t be everything for everyone • Understand if you make a profile with certain customers and not others Factors that determine correct customers: • Speed of delivery • Seamless quality • Breadth of choices • Geographic footprint • Amount of inventory carried • Prices • Material management • Test systems • Process technology Groups with unusual power: • Suppliers that have a large portion of cost structure, usually materials • Supplier capturing majority of industry value: o Intel chips (semiconductors) o Microsoft (operating system) o Boeing (aircraft) o A lot of buying power o Walmart-‐ large buying capabilities o Sam’s club – owned by same people, coordination o Costco o General Electric o Disney • Buyers who have larger market share (firms as buyers) • Ex. GE both supplier and buyer, 90% of freight train market share • Market share à buying power; figure out how to close gap with competition Gap analysis à closing the gap • Dissection of competitor o Focus on: operating efficiency, profit margins, cash flow • Developing financial models to estimate rivals production and overhead costs o Location/plant cost o Hourly wages o Exempt wages/position • Analytical tools, compare firm and rivals in the industry: o ROA, Asset turnover, Days of Inventory, not inventory turn, ROE, DSO, DPO, Profit Margin % Rivals Most observable: • Historical references and implications • Quickest way for value dissipation to take place • Some employee swap Many rivals: • More competitive and commoditized • Refrain from aggressive behavior to manage everyone else’s behavior, similar to an oligopoly • Any price changes will be felt throughout, cause everyone to change their prices; notice and react Small number of rivals: • Behavioral changes will go unnoticed by rivals o Failed assumption for any period o Unnoticed changes o Equilibrium and balance Dominant rival – big player in market, controls price, “enforcer” • Ex. Saudi nation controls gas prices -‐ gas prices are low as a result of lowering prices to hurt smaller rivals trying to play around/work with competitors Two categories of rivals: • Similar but not equal (capability, size, customer focus, geographic breadth) • Similar (lumber, paint, nails, bolts) o Truer rivals, fewer Understanding rivals • Position costly to exit/change, they view portion of business to be key importance, less likely to change or exit o Likely to be more aggressive o Entrenched behavior à opportunity Southwest Airlines • How does the airline industry compete? (points of competition) o Price o Meals o Seating [class and choices] o Entry and exit process o Lounges o Hub connectivity o Friendly service o Speed [time to destination] • Point to point vs. spoke and hub o Had some spoke and hub because of acquisition • Points of competition – price, meals, seating, etc.; end up being investment areas • Decided on one class of service, eliminate extras o Improve operating margins • They value – friendly service, convenience (storage), more departures, increase experience, simple and cool • Presented attributes differently but same business, convenience • Picked point to point, fewer locations • Secondary airports – lower cost, less traffic/ hassle, concentration of spare parts (only use one kind of plane) o Walmart also uses secondary locations – money in the methodology • Accountability – employees on flight to assure service/audit • Strategy à what’s important to customer is also important to staff • Driven by speed, arriving at destination on time Messaging has to match delivery, execution tied to performances Margins – study and understand other competitors Analytics are very important for decision-‐making Supplier power – protected, advantage • Legal – copyright/patent position o Patents are publically available while under review, companies are getting smarter about releasing method patents, keeping more things internally • Physical – location, etc. • Knowhow o Ex. Southwest airlines method – did actions that all airlines do differently • Contracts Security – intranet within companies, difficulties for cloud computing Buyers – care about whether product meets requirements/distribution capabilities, different than a consumer who may care about brands Threat of new entrant – barriers restricting entry, ex. Legal, physical, knowhow, capital intensity Threat of a New Entrant • Industry profitability is not stable o Can be influenced by new/existing rivals o Whenever profits adjusted for WACC (weighted average cost of capital) are > 0 new entrants are possible • Barriers to entry – factors that prevent/delay new companies from entering the market o Legal o Physical o Knowhow o Capital intensity o Brand identity o Economies of scale o Distribution presence o Product/service offering o Limited number of key customers Schumpeter and creative destruction – The Theory of Economic Development (1912) • Focused on growth of the economy o Economic recessions/depressions as cleansing – remove inefficient firms o Prepare economy for growth with only sustainable firms o Most growth from new firms • Entrepreneurial innovation = growth engine • Importance of new entrants • Schumpeter – entrepreneurs create value; new capability, delivery system or ease of use o Thought recessions were good, force certain underperforming firms out of system o Reshaping attributes delivered to a customer o Inventions – high risk factor vs. innovation – new feature o Different configuration creates opportunity o Didn’t use the word “entrepreneur,” rather individual risk takers o Encourage competition à drives innovation Schumpeter x Porter • (S) New capability, new delivery system or ease of use • (P) Reshaping attributes delivered to a customer. The attributes are the same as rivals – configuration creates opportunity Clayton Christensen – Disruptive technology Used to take 108 men 5 days to fill a ship with timber, now it takes 8 men 1 day (introduction of machinery and containers) – creative destruction Kodak – new market (slightly digitized products) wasn’t growing as quickly as the older film market had • Saw digital camera being a future force, invested in R&D, developed first million pixel sensor o Were trapped, didn’t see how quickly the market would grow o Had the technology but didn’t move fast enough, didn’t view the market to grow as rapidly • Took huge revenue cuts, needed cash, took blows to cash flow o Decrease dividends, corporate spending • “When you come to a fork in the road, take it!” –Yogi Berra • Should have promoted digitized products as a separate brand, or license out technology to other photo giants Organizations don’t have smooth paths, “lurching forward” Not everything that changes is creative destruction – first isn’t necessarily best Many early tech developments not successful Ex. Apple early table, the “Newton” or video chat phones Important how you shape product in marketplace, ex. Corporate vs. personal intended use/price range Gerber-‐ population births going down, developed new product “Gerber Singles” Everything developed is not necessarily an advance Economic perspective: • Buyer power – buyer size vs. industry as a whole, and buyer’s margins • Seller – similar substitutes, cost of switching • Rivals – growth rate of industry, intensity o High fixed costs? Struggle if revenue decreases • New entrants – unrecoverable capital from startup, prices lowered? How similar are alternatives? • Value/price – trying to capture consumer surplus Who gets the surplus? • Buyers and sellers – haggling determines who gets surplus o If buyer understands sellers cost structure or company, can put up a better argument • More buyers (2 buyers 1 seller) – seller is the monopolist and likely to retain much of the value *correction* o 2 buyers compete for price o Buyer power – depends on market share; strength if large part of market or they have info that can capture greater reward § Buyers have greater strength if they are large part of the market or if they have info/knowledge that can capture greater reward • More sellers (1 buyer 2 sellers) – buyer gets surplus, sellers compete and drive prices down Shumpeter – concept of innovation • New delivery system or ease of use • Reshape rivals, “reconfiguration creates opportunity” Seller is a monopolist à captures most of the value Chapter 3 – economic profits for Airline and Pharmaceutical • Airline – big guy losers, little guys relative winners o Highly elastic, consumers won’t buy tickets if the price goes up slightly; not a necessity • Pharmaceutical – big guy winners, little guy relative losers o Inelastic, actual need for products, few/bad substitutes o High R&D costs, patents (not key point but additional factor) • Second important consideration: contract/fixed determined relationship with pharmaceuticals • Airlines have a different contract relationship Must understand firms/rivals’ competitive advantage as they see them • Create competitive advantage à start with economic profit of the industry o Industry EP may be more or less than average across all industries § Each industry has own characteristics • Firm can perform relatively higher than average of other industries o Company’s comparative advantage influences outcome within the industry o Ex. Southwest Airlines vs. the valance of the U.S. industry, didn’t play by others rules Competitive Position Assessing competitive position: • Cost analysis • Differentiation appreciation • Added value • Cost benefit trade-‐offs, experience Economic profit might be out of phase with other industries • Ex. Oil & Gas industries being crushed, used to be hugely lucrative, within any industry there are times that are more/less attractive or earn higher or lower profits; firms act in their own best interest • Ex. Southwest didn’t play by certain rules; other airlines would reschedule their passengers on other airlines’ flights if they had delays, Southwest didn’t abide; operated differently; invested in different activities Little Debbie – effort to automate, understood competitive position • Defined self for price à value; stole large amount of market share • Understood attributes that customers need/want through multi-‐step analytical process o Step 1: Find variables o Step 2: Rate yourself and competition against variables • Have to lower costs to offer lower prices Look at a company and costs (centers per unit) Try to minimize costs, ex. transportation & preservation to increase shelf life McKinsey consulting – helped struggling large companies, focus on costs • Focused on cost drivers (what incurred additional costs) o Disaggregated a businesses cost structure across business units or product lines o Assessed how costs were developed (drivers) § Costs divided into raw materials cost and ‘cost added’ • Costs added = ‘activiites’ § Looked for opportunities to capture ‘scale’ effect and simplification § Allocation methods – especially services used by more than one product line • Separate raw materials from everything else – is there a way to buy cheaper or outsource? • Capture “scale” effect and simplification • Allocation methods (accounting) • Benefit -‐ more information for managerial decisions, more accountability and more coordination from various parts of the organization • Risks – long process; delays; customer decision made by numbers, not relationship There is give and take with customers & company/buyers & suppliers Bain – economies of scope • Thought about problem of assessing competitive position and advantage from a market perspective • Emphasis of economies of scope vs. scale • Recognized it costs more to attract a new customer than to retain an existing one • Economies of scope – value in representing multiple products to a single customer; one person to many items o Costs more to attract new customers • (Versus) Economies of scale – cost advantages due to size of the operation; one item to many people • Bottom line – get some of consumer surplus Differentiation – analyze competitive position by looking at customer • Segment of the served market vs. the defined customer profile, who should be the customer • Product differentiation – what products were attractive in the market and did the firm’s products have any of the attributes o Pricing tactic, design, functionality Porter – competitive advantage à value chain, system to break it down • Distinction between cost and benefits o Regrouped cost by categories within a value chain by activity o Value chain = systematic way to deconstruct activities and related firm costs and customer benefits § Producing, marketing, delivery, after market support • Cannot look at firm as a whole – understand linkage between activities • Divided activities into primary and secondary o Primary activities = actual making of product/service o Secondary activities = support activities • Perform similar activities in a different way Primary activities à actual making of product “hands in a box” Secondary activities à support making of product Companies will go to lengths to satisfy an unhappy customer Return à can’t sell as new, “refurbished” Pick up and return at store system – reduce transaction costs for business and wait time for customer • Incentive to keep shopping, customer might see something else they like • Bonuses for customer that come out of cost saved Create competitive advantage Only motivated to change if sales decrease/profits drop Added value – spread between willing to pay and opportunity cost • Understand the spread between the customer’s willingness to pay and supplier’s opportunity cost • At best, estimates of opportunity cost • Estimate spread and close gap on who has the power Low cost strategy can be more materially rigorous • Organization structure • Remuneration and reward system • Corporate culture, decision making, latitude of responsibility, accountability • Leadership style • Capabilities When analyzing competitive advantage • Identify discrete activities or processes believed to be advantageous, why they create value – for the firm and its rivals o Relative cost position o Comparative willingness to pay • Linking competitive positioning concepts to strategic planning and action o Ex. Dell computers – saw emerging shift in computer literacy market • Performed the same activity differently than rivals o Analysis and observation shapes insight Using activities to analyze relative willingness to pay • Differences in activities account for differences in customer value • Any activity in value chain can affect customers’ willingness to pay Value à customer loyalty Within organizational structures – reward system Identify advantageous discrete activities, why they add value Ex. Dell à saw shift in market: increased computer literacy • Changed distribution to direct mail/catalog/phone Ex. Liz Claiborne – made work close for women, which previously didn’t exist Little Debbies – model defined by price, not freshness • Use more additive à longer shelf life, fewer returns/transportation, reduction of costs Everything that money is spent on not necessarily adding value for customers Have to break up: producing, marketing, delivery, after market support • Strategic deconstruction • Varying levels of value added Understand value of cost: inspection vs. late delivery • Inspection – value added • Late delivery – cost incurred • Can redirect value o Ex. put in an extra $10 to make sure it gets there on time Points of competition become areas to invest in Ex. Southwest identified items not valued by flyers: meals, lounges, classes of service, hub connectivity • Cut costs to improve operating efficiency Add building blocks – understanding of competitive position Internal analysis: organization structure, remuneration & reward system, corporate culture, leadership style, decision-‐making, accountability, capabilities Customers don’t get care internal factors when trying to get a product (coat example) Ex. Wegmans – good at conducting focus groups Ex. Dollar store – focus on households < $30,000/yr, small towns, most things for $1, nothing more than $5 • Intense focus on core customer base • Small town, low-‐income urban areas • Performance based culture • Deliver promise by supplying off brands that are high quality • Cut overhead • “Cut” trick – if sales increase and costs are flat, cost will comparatively decrease as a percentage of sales • Cut 200 SKUs every year (out of 3500+/-‐), get rid of slow movers and have new merchandise in store • Manage scarce resource à cash • Purchasing people, “customer representatives” o Have to negotiate/cut costs • Invest in community development, help employees get GEDs à business is better with more educated employees o Incentive system, make sure employees stay; offer managers stock options and other perks Ex. K-‐Mart and Sears failing? • Appeal to lower/middle and upper/middle classes – some disconnect, wouldn’t want to shop in same places • Value proposition: low price on housewares, pull in shoppers then offer higher priced apparel • Tried to offer blue light specials to go after bargain hunting moms, new moms didn’t identify with older program • Walmart beat their advertised low prices • Would be out of stock of advertised item • Invested in companies that were outside of their core business à failing • End result: lack performance, bad culture, failing/downsize of additional businesses Ex. Target – smaller selection but more upscale than Walmart • 40% name brand, 60% private label • Not competing with Walmart’s buying power • Focused on middle income households and middle upper incomes, that want a bargain; offer lower but not low prices o Merchandising directed at market segments o Shopping ease, style, bright stores Successful companies focus on creating value for customers by performing similar activities differently Fast foods – different specialty items, change with time – force by customer (healthier market); fast food market well saturated Ex. In-‐n-‐Out • Simple menu, don’t look for more; fewer buyers, less labor, less waste • SoCal geographic cluster Is the distribution of customers large enough to create a business? • A good idea with worthless without buyers Look at market and realize its saturated, doesn’t make sense to compete in same way, use it to establish differences Game Theory Game theory – economic perspective of competitive behavior • Understand incentives under conditions of competitions • Think through competitor’s routines à behavior may not represent true goals and beliefs • Profiling to identify competitor’s predispositions • Rivals incentive – what they really want and payoffs under certain conditions • Advantages and disadvantages of Game theory • Choices o Empty threats (credibility of rival), bargaining, entry deterrence, advantage of moving first, asset allocation (Walmart 153 stores à 1009 in 1986), auction (English, Dutch, sealed bids) Life is more complicated with many competitors Companies react to behavior of other companies à unexpected events We expect uniformity, doesn’t normally accompany strategy Markets are decentralized • Price = primary unifying mechanism • Price for demand and supply of goods Trying to reach an entire market can be costly; you can’t supply everything to everyone Ex. buying meals for the next 3 months – wouldn’t be practical, difficult to store, cost of storing, food expiring Asymmetric warfare – have to think in counterintuitive way Ex. take away key customers to eventually take over the business Understand other companies’ routines/actions à understand decision-‐making Pros/cons (+/-‐) to game theory – wrong assumptions à wrong results Look at behavior, can result in a range of outcomes, interacting economic events Threats can be empty – consider credibility Strategic plans – waste of time or planning process is invaluable Asset allocation – Wal-‐Mart did in a way that others couldn’t copy • Did whatever was necessary for growth • Only so much money to be spent • Borrow limit • Growth (huge) • Assets are necessary to expand, consider tradeoffs Dutch auction – start high, come down; good way to see what people are willing to pay Charlie Brown – kick or don’t kick; from past experience pulled away, understand rival’s experience Guessing game – thinking systematically/symmetrically Companies react to other companies We expect uniformity Firms vs. rivals – study of econ • Doesn’t consider emotion/rationality Price is unifying mechanism in the marketplace – provides information • Price is a sponge o Gives/takes info • Info about marginal value of a product and opportunity costs for the use of funds • Price is impacted by information – react to news or other price changes Purely competitive markets efficient when: • Information freely exchanged and buyers and sellers have same data • No buyer or seller can influence the market by actions of one buyer or seller • The products are essentially the same • Resources are free to move in and out of the market Knowhow – knowing how to do something well/efficiently is an invaluable asset • If you don’t know how to assemble something it doesn’t matter whether you have the necessary parts • Getting information is a cost o Uncertainty, negotiation, recourse • Contracts have to include what they’re not supposed to do also – not costless • Search costs – capturing info Contracting – important to maintain relationships à better prices Game Theory – economic perspective to behavior • Best you get is a range, right within a certain tolerance • Profiling à identify rivals behavior • Assumes rationality, however people don’t think systematically • Creates a payoff matrix under various conditions • Cons: o If assumptions are incorrect, results will be incorrect o Assumes rationality • Pros: o Forces a discipline of looking at all aspects of behavior related to a transaction o Range of outcomes given different circumstances and interacting economic events • Games: o Rival past behavior o Asymmetric thinking o Analytics Price is revealing, it provides/absorbs information like a sponge • Info about product and opportunity cost • Price doesn’t reflect all costs • Determined by marginal value • Doesn’t reflect all costs o Ex. having to do an extra step Transaction costs associated with capturing information • Search costs • Cost of asymmetry – if one person knows what another doesn’t it’s a cost to them Contracting costs, reaching an agreement • Bargain, enforcement, write/document, policing each other/ enforcement Firms contracting costs aren’t equal to individuals, advantages: • Frequency, repetitive • Bulk material & return customers, relationships vs. one time purchases • Ask the right questions • Employees – paid less but have less risk; ex. Average employees don’t have agreements Coase – the nature of a firm – use a firm when it costs less than going into the market to complete a project • There are transaction costs – costs associated with capturing information • Contracting costs, reaching an agreement • Firms do not have the same contracting costs • Individuals work for someone else than work for themselves à paid less but less risk • Transactions come with costs beyond price • Help is a firm • Firm utilized when project cost < what an individual can complete the project for in the marketplace • Costs beyond price mechanism in market Decision-‐making – has various levels of complexity • If not made in timely manner, organization is paralyzed, can’t go forward Volume of decision-‐making increases à complexity & time increase • Can’t run a business as efficiently if the pace is slow Firms stop growing when: • Too large/diversified to manage business o Too many internal costs, ex. Management o Could no longer coordinate/organize actions o Can’t focus on necessary activities o Need additional management, sometimes in pieces • Transaction costs = marketplace costs • Entrepreneur can’t efficiently coordinate all activities Ex. Few firms that have divided into smaller businesses: Xerox, Conoco Phillips, Apple/Alphabet Firms – central planning systems, no free trade within • Managers control asset allocation – don’t always direct to the most efficient uses • Employees have no real incentive to participate in better solution – no direct gain • Firms succeed through knowhow, knowledge and market economics Firms has benefits – ease Knowledge is property à has rights à value à income Purchase of land based on buyers’ specific knowledge à better use of the property = more value Specific knowledge creates economic consequences • Creates property rights • Difficult to transfer to someone else Oliver Williamson – there are costs to our relationships • Putting value on it, give and take • Relationships develop between entities and groups • Asset specificity – assets have a use but not many alternative uses o Ex. putting a factory in a region for a special customer o Ex. modifications to packaging – equipment just for triangle milk cartons • Investments can be difficult to maximize o Geographic, unique equipment, technology, human skills o Ex. Manufacturer of chem equipment that was difficult to use; dedicate a business day to explaining equipment to university students • Conflicts can develop o Party feels taken advantage of • Relationship difficult to monetize and/or have complete information • “Information impactedness” – difficult to ascertain costs of information pertaining to a relationship o May pay higher price due to uncertainty and opportunism o Can’t access all of the information, don’t know what they don’t have access to Boundaries • Resolving conflict encourages continued investment, renews
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