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1. Answer Key
Testname: PARTIAL 2 CVA
1) Product differentiation is a business strategy whereby firms attempt to gain a competitive advantage by increasing
the perceived value of their products or services relative to the perceived value of other firms' products or services.
These other firms can be either that firm's rivals or firms that provide substitute products or services. By increasing
the perceived value of a firm's products or services, a firm will be able to charge a higher price than it would
otherwise be able to do. This higher price can increase a firm's revenues and can generate competitive advantages.
While firms often alter the objective properties of their products or services in order to implement a product
differentiation strategy, the existence of product differentiation, in the end, is always a matter of customer
perception. If products or services are perceived as being different in a way that is valued by consumers, then
product differentiation exists. However, just as perceptions can create product differentiation between products that
are essentially identical, the lack of perceived differences between products with very different characteristics can
prevent product differentiation.
2) Product differentiation is ultimately an expression of the creativity of individuals and groups within firms and is
limited only by the opportunities that exist, or that can be created, in a particular industry and by the willingness
and ability of firms to creatively explore ways to take advantage of those opportunities. Thus, in general, the
potential bases of product differentiation are limited only by managerial creativity.
3) One of the best known explanations of when vertical integration can be valuable focuses on using vertical
integration to reduce the threat of opportunism. Opportunism exists when a firm is unfairly exploited in an
exchange. Obviously, when one of its exchange partners behaves opportunistically, this reduces the economic value
of a firm. The threat of opportunism is greatest when a party to an exchange has made what are called
transaction-specific investments. A transaction-specific investment is any investment in an exchange that has
significantly more value in the current exchange than it does in alternative exchanges.
One way to reduce the threat of opportunism is to bring an exchange within the boundary of a firm. That is, one
way to reduce the threat of opportunism is to vertically integrate into this exchange. This way, managers in a firm
can directly monitor and control this exchange instead of relying on the market to manage this exchange. If the
exchange that is brought within the boundary of a firm brings a firm closer to its ultimate suppliers, it is an example
of backward vertical integration. If the exchange that is brought within the boundary of a firm brings a firm closer
to its ultimate customer, it is an example of forward vertical integration.
Of course, firms should only bring market exchanges 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 exchange. This is the case for both backward and forward vertical
integration decisions.
4) A flexibility-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, should form a strategic
alliance to manage this exchange. A strategic alliance is more flexible than vertical integration but still gives a firm
enough information about an exchange to estimate its value over time.
An alliance has a second advantage in this setting. The downside risks associated with investing in a strategic
alliance are known and fixed. They equal the cost of creating and maintaining the alliance. If an uncertain
investment turns out to not be valuable, parties to this alliance know the maximum amount they can losean
amount equal to the cost of creating and maintaining the alliance. On the other hand, if this exchange turns out to
be very valuable, then maintaining an alliance can give a firm access to this huge upside potential.
5) A firm is implementing a corporate diversification strategy when it operates in multiple industries or markets
simultaneously. A firm is said to be implementing a product diversification strategy when it operates in multiple
industries simultaneously. A firm is said to be pursuing a geographic market diversification strategy when it
operates in multiple geographic markets simultaneously. When a firm implements both a product diversification
strategy and a geographic market diversification strategy simultaneously, it is said to be producing a
product-market diversification strategy.
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2. Answer Key
Testname: PARTIAL 2 CVA
6) Division general managers in an M-form organization have primary responsibility for managing the day-to-day
operations of a firm's businesses. Division general managers have full profit-and-loss responsibility and typically
have multiple functional managers reporting to them. As general managers, they have both strategy formulation
and strategy implementation responsibilities. On the strategy formulation side, division general managers choose
strategies for their divisions within the broader strategic context established by the senior executive of the firm.
Many of the analytical tools described in Parts I and II of this book can be used by division general managers to
make these strategy formulation decisions.
The strategy implementation responsibilities of division general managers in an M-form organization parallel the
strategy implementation responsibilities of senior executives in U-form organizations. In particular, division
general managers must be able to coordinate the activities of often conflicting functional managers in order to
implement a division's strategies.
In addition to their responsibilities as a U-form senior executive, division general managers in an M-form
organization have two additional responsibilities: to compete for corporate capital and to cooperate with other
divisions to exploit corporate economies of scope. Division general managers compete for corporate capital by
obtaining high rates of return on capital invested in previous periods by the corporations in their business. In most
firms, divisions that have demonstrated the ability to generate high rates of return on earlier capital investments
gain access to more capital, or to lower-cost capital, compared to divisions that have not demonstrated a history of
such performance. Division general managers cooperate to exploit economies of scope by working with shared
activity managers, corporate staff managers, and the senior executive in the firm to isolate, understand, and use the
economies of scope around which the diversified firm was originally organized. Division general managers can
even become involved in discovering new economies of scope that were not anticipated when the firm's
diversification strategy was originally implemented but nevertheless may be both valuable and costly for outside
investors to create on their own.
7) Both cost-leadership and product-differentiation strategies are implemented through the use of a functional, or
U-form, organizational structure. However, where the U-form structure used to implement a cost-leadership
strategy has few layers, simple reporting relationships, a small corporate staff, and focuses on only a few business
functions, the U-form structure for a firm implementing a product-differentiation strategy can be somewhat more
complex. For example, firms pursuing a product-differentiation strategy often use a matrix structure that includes
temporary cross-divisional and cross-functional teams to manage the development and implementation of new,
innovative, and highly differentiated products. These teams bring individuals together from different businesses
and different functional areas to cooperate on a particular new product or service.
One of the key management controls in a product-differentiation strategy is broad decision-making guidelines.
These broad decision-making guidelines help bring order to what otherwise might be a chaotic decision-making
process. When managers have no constraints in their decision-making, they can make decisions that are
disconnected from each other and inconsistent with a firm's overall mission and objectives. This results in decisions
that are either not implemented or not implemented well.
However, if decision-making guidelines become too narrow, they can stifle creativity within a firm, and a firm's
ability to differentiate its products is only limited by its creativity. Thus, decision guidelines must be narrow
enough to ensure that decisions that are made are consistent with a firm's mission and objectives.
8) The flexibility-based explanation of vertical integration focuses on the impact of vertical integration on a firm's
flexibility. Flexibility refers to how costly it is for a firm to alter its strategic and organizational decisions. Flexibility
is high when the cost of changing strategic choices is low; flexibility is low when the cost of changing strategic
choices is high. In general, vertical integration reduces flexibility since it has committed its organizational structure,
its management controls, and its compensation policies to a particular vertically integrated way of doing business.
When a decision-making environment is uncertain, that is when the future value of an exchange cannot be known;
when investments in that exchange are being made, the value of vertical integration is decreased and should be
avoided.
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3. Answer Key
Testname: PARTIAL 2 CVA
9) When the companies in a diversified firm share a variety of activities throughout their value chains, these activities
can serve as the basis for operational economies of scope. Potential shared activities can be found throughout a
firm's value chain from input activities through dealer support and service. Activity sharing can have the effect of
reducing a diversified firm's costs, and failure to exploit share activities across business can lead to out-of-control
costs. Shared activities can also increase a diversified firm's businesses through shared product development and
sales activities as well as by enhancing business revenues by exploiting strong, positive reputations of some of a
firm's businesses in other of its businesses. There are three important limits to activity sharing. First, substantial
organizational issues can be associated with a diversified firm's learning how to manage cross-business
relationships. Second, sharing activities may limit the ability of a particular business to meet its specific customer's
needs. Finally, if one business in a diversified firm has a poor reputation, sharing activities with that business can
reduce the quality of the reputation of other businesses in the firm.
10) An agency relationship exists whenever one party to an exchange delegates decision-making authority to a second
party. In the agency relationship, the party delegating the decision-making authority is called the agent and the
party to whom the authority is delegated is called the agent. In the context of corporate diversification, an agency
relationship exists between a firm's outside equity holders (as principals) and its managers (as agents) to the extent
that equity holders delegate the day-to-day management of their investment to those managers.
The agency relationship between equity holders and managers can be very effective as long as managers make
investment decisions in ways that are consistent with equity holders' interests. Thus, if equity holders are interested
in maximizing the rate of return on their investment in a firm and if managers make their investment decisions
with this objective in mind, then equity holders will have few concerns about delegating the day-to-day
management of their investments to managers. Unfortunately, in numerous situations the interests of a firm's
outside equity holders and its managers do not coincide. When parties in an agency relationship differ in their
decision-making objectives, agency problems arise. Two common agency problems have been identified:
1. Managers can decide to take some of a firm's capital and invest it in managerial perquisites that do not add
economic value to the firm but do directly benefit those managers.
2. To the extent that very risky investments may jeopardize a firm's survival and thus management's compensation
and positions, managers may be more risk averse in their decision making than equity holders would prefer them
to be.
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