Topic 2: Business Strategy and Competitive Advantage

Companies:
- Walmart
- Aldi
- eBay
- Amazon
- LAN Airlines
- Southwest Airlines

Business Strategy and Competitive advantage focuses on the intra-industry differences or within-industry
effects on business profitability and strategy. Within-industry effects accounts for a larger proportion of
determining company profitability and return on equity than industry-level effects.

Value creation, value captured and Willingness to buy and sell

- Willingness-to-pay (WTP) is the most that buyers will pay for a firm’s product.
- Actual price of good should be less than or (≤) WTP or the firm will not sell.
- Willingness-to-sell (WTS) is the least price for which suppliers will provide inputs for a firm’s
product, including raw materials, capital, and labour.

You have a competitive advantage over a competitor when your difference between your buyers’ WTP
and your suppliers’ WTS sell is greater than your competitor’s difference between their buyers’ WTP and
their suppliers ’WTS.

Your WTP-WTS > Competitors WTP-WTS

Porters (1980) Types of Competitive Advantage (and how to increase competitive advantage):
1. Cost Leadership – Similar product, lower cost
2. Product Differentiation – Price premium from unique product, benefit advantage
3. Dual Advantage – cost leadership and product differentiation, suppler and buyer power dependent

Porters strategies are focused on increasing the wedge between supplier’s opportunity cost and
customers willingness to pay price. The greater the difference between these 2 the greater the added
value and competitive advantage a firm has, relative to competitors and industry offerings.

All of these strategies are included within HAX’s delta triangle which suggests how firms can achieve the
best product.

Cost Leadership

Create more value than competitors:

- Same benefits as competitors do at lower cost – benefit parity, volume focused
- Slightly lower benefit – benefit proximity,
- Qualitatively different product
- Same price but benefit from greater margins due to lower Supplier opportunity costs

Suppliers opportunity cost must decrease greater than the decrease in willingness to pay by consumers
in order to increase the wedge between the two.
Differentiation

Focused on increasing WTP instead of reducing SOC. Differentiation tactics:

- Tangible differentiation
- Intangible differentiation
- Cost Parity
- Cost proximity
- Substantially higher benefit and cost

Walmart v Aldi – 2 Cost Leadership Examples

Walmart
- Strategy: EDLP
- Branded and Private Label products – Different priced products
- Geographical lock in – regional economies of scale achieved v individual store economies
- Logistics, software and operations are highly efficient
- Grocery only offered for general merchandise to be purchase by same customers
- Offers vast range of products and services, groceries are almost a loss leader for the firm to get
customers to enter the store to get then to purchase more profitable areas including general
merchandise

How Walmart reduces SOC:

- Has complete bargaining power over suppliers – sales volumes are so huge Walmart can drive
down prices lower than rivals
- Walmart collaborate and invest in suppliers to drive down their suppliers costs through efficient
inventory management, industry leading information and research and future opportunities for
both themselves and suppliers
- Opportunity cost of working with other retailers for Walmart’s suppliers is higher than working
with Walmart and the other complementary benefits

Aldi

Comparative Company Analysis with Walmart:

- Suggests operating incomes are marginally similar and neither seems to have a competitive
advantage between over the other
- When accounting for capital costs, Aldi has an advantage over Walmart
- Aldi currently offers a lower price and greater net customer benefits than Walmart – Customers
are leaving Walmart for Aldi

How Aldi Achieves a cost leadership, i.e. lowering its costs in relation to willingness to pay by the buyers
in a non-commensurate way:
- Private label
- Basic groceries
- Special buys
- Small bare bones stores, with low set up and fixed costs
- Long-term supplier contracts and relationships
- High quality for the cost point
- Simplicity
- No advertising on private label
- Offers limited SKU’s compared to Walmart – this is an advantage
Should Walmart Compete with Aldi, NO:
- Walmart is significantly larger than Aldi in terms of revenues, although Aldi is undercutting on
price, the difference in number of sales and customers would result in a greater loss for Walmart
if they matched prices just to compete with Aldi than it would be if they left Aldi to remain
focused on undercutting them on price to a niche area of the market. On a long term basis this is
detrimental for Walmart
- Slowly over time Aldi will compete with Walmart and take market share from Walmart but the
significance is currently not large enough to impact Walmart, especially as only 50% of sales are
dependent on grocery for Walmart vs Aldi’s 95+% on groceries for revenue

Summary

Aldi’s strategic positioning is cost focused narrow segment whilst Walmart currently is focused on both
benefit and cost through its broad range of offerings and different types of merchandise within the store,
not just groceries. Customer segments and product groups overlap but are differentiated through their
private label v branded product categories, not including Walmart’s other offers of non grocery products
and some services also.
Topic 3: Business Models

Business model is a series of choices and consequences:

- Choices
o Policies – decisions about the course of action
o Assets – tangible assets decisions
o Governance – contractual agreements about the decision rights over policies and assets
- Consequences
o Rigid – do not change quickly with the decisions made that precede the consequence
o Flexible – high sensitive and react quickly to the preceding choice made regarding that
consequence

A virtuous cycle is a value loop whereby a continuous positive feedback loop is evident from the specific
choices and consequences involved which are not only self-sustaining but also generate value at every
stage through acting a complementary set of choices and consequences in a positive feedback value
loop.

Complementarity is the mutually reinforcing effects on performance of the choices and consequences in
the positive feedback value loop which when one variable changes then the rest of the loop is often
positively impacted also.

Products, Platforms and Networks

Network effects:
- Cross-side or indirect network effect: Values to customers on side of the platform typically
increases with the number of participating customers on another side of the platform
o Cross sided indirect network effects can create barrier to entry but required the users or
customers to accepts any high switching costs they may have whilst also the multi sided
platform also creating high switching costs of its own once users have joined to prevent
competitors entering the market as customers become entrenchment with existing
platforms
o Indirect network effects are essentially focused on complementary products and services
- Direct network effects are known as one sided network effects where by the value of a platform
or network is derived from one side of the network, e.g. mobile phones network value is in other
customers also having phones to be able to communicate with each other at any time and place
o Network size is the basis of value for direct network effects

Facebook is an example of both indirect and direct network effects.

Walmart v Amazon

Preface: The last mile of delivery or collection is the key battleground between Walmart and amazon
which the 2 have different approaches towards, physical stores v online order and delivery, this impacts
both WTP and costs. Physical stores operated by Walmart is the externalisation of costs on to the
customer.

Static Arguments

Costs argument of the WTP-C:

 WM Costs < Amazon Costs
o Procurement – economies of scale purchasing
o Logistics and fulfilment advantage – receives bulk delivery to stores rather than amazons
delivery of one or 2 items to the home. This advantage is greatest in rural areas as the
delivery or transportation costs of the physical goods to the home is externalised by
Walmart on to the customer, where delivery costs for amazon are highest and to its ability
to keep costs low in the final mile in rural areas is greatest for Walmart compared to
amazon who has high delivery costs
o Amazon delivery is in single items and so many deliveries required – compounds the
above problem
o Labour costs – amazon required packaging v just scanning by walmart

 Amazon Costs < WM Costs:

o Physical asset costs - Retail and real estate costs are lower significant for urban areas
o Has advantage over long tail or low demand items – stores have a limited number of items
on offer to be sold as any one time, low demand items are often unique and differentiated
items and so have longer and slow inventory turnover which produces lower sales due to
lower volumes and also increase working capital cycle of those inventories also, amazon is
able to use third party sales on its website to offer no core or high sales volume products
and effectively externalises its less popular products and goods and thus does not need to
stock these in its website wasting space or reducing inventory turnover and sales

Higher WTP:
 Walmart
o Types of goods – immediate needs, perishable or short tail good
o Rural areas
o Price-sensitive customers – low opportunity cost of time

 Amazon
o Urban and suburban areas
o Affluent customers with high opportunity cost of time – not in a rush for products or
goods and can wait and order over periods of time for changing quantities of goods
o Products – long tails and not required immediately, single items, higher known quality
products through reviews (certain quality and recommendations),

Competitive Advantages always covers the full scope, consisting of:

 Geography
 Customers
 Products
 (Vertical Integration)
Dynamic Arguments

How is current static situation changing:

 Amazon lowering relative costs

o Increasing volume – economies of scales, bargaining power increases, spreading of fixed
costs of logistics and infrastructure, drives number of reviews which increases the
willingness to pay
o Last mile issue – Amazon lockers, drones, prime, drop points including whole food stores,
reduces cost of delivery and increase willingness to pay
o Training customer behaviour to plan ahead and reduce behaviour of focused on Walmart
and physical and to order ahead of time instead
o Amazon data advantage – tailoring products, recommended products, smarter pricing
strategies of products

What should Walmart do:

- Storefront retailing – improve the experience to defend against amazon
- Web-to-Home – same as amazon
- Web-to-Store

Walmart’s internal barriers to incumbent response:

- Perception – did not see amazon as an initial threat and operated as both a niche and in a
different space initially until amazons size a volume and offering increased which eventually
overlapped with walmarts grocery and general merchandise offering
- Motivation – Cannibalization of its own business would be a consequence of making the decision
to pursue and compete with amazon on amazons terms rather than focusing on its compewtitive
advantage and where walmart can drive the greatest wedge between costs and wtp
- Inspiration – No alternatives than doubling down on walmarts current assets, usps and wtp and
costs focuses
- Coordination – large organization and size has significant governance costs internally, cooperation
and coordination costs when any major strategic decision is made or implemented, including time
which also lends to amazons growing competition as months can pass before walmart is in a place
to compete with amazon

Incumbents such as Walmart, really struggle to respond to new business models such as amazon. To
compete against amazon it is very difficult as most options would sacrifice Walmart giving up some of
their current competitive advantage to compete on amazons terms which it would not win anyway so
Walmart has very limited choices and available decisions to compete with amazon. Walmart is currently
only able to compete using its storefront retailing and producing an offering which has an improve
experience in its physical stores is essential to compete. Walmart can not compete in the web to home
space and is behind and is struggling to compete with amazon on the web to store front also. Other
retailers now amazon and walmart are the biggest losers.
Amazon and eBay

eBay – Platform for connecting buyers and sellers

- Choices: Auction style connection of buyers and sellers, and no warehousing, both reduced or
removed friction preventing the connection of buyers and sellers on eBays platform
- Consequences – Used/ rare products from auction style format and low cost due to no inventory
or warehousing
- Strong network effects from virtuous cycle - Virtuous cycle: more sellers, more selection, more
buyers and higher volume

Key choices and consequences:

- No inventory or warehousing needed – platform merely acts to connect buyers and sellers and
facilitate the transactions
- Highly attractive margins as a result of very little costs of good sold

- Multiple services and software introduced including feedback and fraud prevention
- Strengthens the integrity of the system and platform as trust is built and prevents any misuse or
mismanagement of the platform by all 3 parties involved

- Fixed price and auction formats

- Covered both low price categories and tails and unique and sued products also

Amazon – MSP
- Aimed as buyers, sellers and producers or developers
- Virtuous cycle: volume led to economies of scale, reducing units costs enabling low prices and
created more traffic and volume

Key choices and consequences:

- Investment in inventory, warehousing and logistics/ distribution
- Economies of scale, buying power over suppliers and optimization of inventory management and
distribution

- Total customer solution focus – reviews, numerous services, free shipping and recommendations
and prime
- Increases sales, customers and volume

Amazon v eBay

Amazons aggressive investment early on in infrastructure enabled fulfilment, inventory management,

management of third party sellers, and other merchants to sell with ease and convenience with amazon
managing all the problems including payments.
- This was added the virtuous cycle as the third party increase the number of sellers which
increased the offering and thus more buyers and more volume on to the site and the business

Both companies in their infancy and growth periods had their own value propositions and choices and
consequences did not overlap too much in their business models despite having a similar virtuous and
overlapping cycle or value loop. Both companies had strong network effects at the time with barriers to
entry for both firms in comparison t the other. Moreso, amazon at the time was winning the trust and
convenience competition whilst ebay won the price and selection side.
Amazon enabled a foreclosure strategy on ebay through a form of platform envelopment. Amazon was
able to combine the third party sellers typical of ebays platform on to its own platform through its single
product detail pages which integrating thr third party sellers, ebay primary sellers on to amazons page
with such ease that ebay lost its competitive advantage, network and platform effects through amazons
bunlding of both retail and marketplace on to one single page. This enabled to over take or match ebays
price and selection advantages and better offferings that it once had, thus competing on all 4 fronts of
online sales. Later, amazon compounded this by enabling third party sellers to use amazons vast
distribution and fulfilment centres and thus increasing its third party offering.

Corporate advantage at the corporate level for amazon stems from the complementarity of both
combining online retail and marketplace together as they both positively impact the returns of each
business. The interdependency between each business model and the design and organization of each
model enables synergies, and reduces governances costs whilst also enabling a virtuous cycle that is
sustaining and accelerating.

Topic 4: Corporate Advantage, Synergies and Benefits to Collaboration and Governance Costs:
Impediments to Collaboration

Corporate Advantage: Owning a multi-business company is of more value than the value of owning the
individual businesses in isolation or separately.
- The goal of maximizing the corporate advantage may or may not be aligned with maximising the
value of each individual business within the multi-business firm
- Some firms can give up some of their competitive advantage in order to enhance the competitive
advantage of other business or businesses in a non-commensurate way – there can be optimal
winners and losers in order to maximise the firm’s corporate advantage over each business’
competitive advantage
- Corporate advantage is joint ownership focused, synergies concern joint operation, decision
rights and necessary ownership for governance costs

Competition for corporate strategists determines the corporate strategy, strategists competes on both
fronts:
1. Portfolio assembly – investor orientated
2. Business Modification – other corporate strategists

Synergies

Operational synergy – 2 businesses are more valuable than the two businesses operated independently.
This is done through coordination and collaboration.
- Decisions across the value chain – primary and supporting activities – is the basis of operational
synergies
- Does not concern common ownership but often the case and aids coordination
- Unlike an investor, firms can benefit from join operation and decision-making rights and thus
more value is created than just through risk diversification and cash flow rights

Value Chain is the source of a firms operational synergies and represents the firms activities:
- Primary activities – scale of activity dependent on production scale
- Supporting activities – not production scale dependent
- Synergies are valuable ways to coordinate decision making across the value chain activities of the
two businesses involved
Types of Synergies:
1. Consolidation – Similar resources and high resource modification required
- Creates value through rationalization across similar resources and eliminates costs or invest
capital required. E.g. merging firms and overlapping activities in departments reduce costs or
removing low utilised factories to increase utilisation in remaining factories
2. Combination – Similar resources and low resource modification required
- Pooling similar resources from similar value chain activities, e.g. combing purchasing volume for
discounts or acquiring firms to raise prices
3. Customization – Dissimilar resources and high level modification
- Co-specialization of dissimilar resource to produce customised products or services which rely on
each others specialities, essentially customisation through coordination and collaboration to
produce either a new product or service with a low cost of differentiated style of strategy which
add value and widens the WTP-SOC wedge
4. Connection – Dissimilar resources and low modification
- Pooling or bundling of resources from dissimilar resources from value chain activities

Governance Costs: Impediments to Collaboration

Governance costs are the frictions which prevent two businesses operating smoothly together to realize
synergies.
- The costs of achieving effective collaboration over and above the direct cost of the exchange
- Ownership costs: Governance costs arising under common ownership
- Transaction costs: governance costs raising from interaction between independent firms
- Cooperation: the alignment of incentives to ensure people work across businesses effectively and
productively
- Coordination: alignment of actions so people know how to work with each other across the
businesses.

Governance costs are higher between independent businesses when synergies either need to be
modified or are one-sided.

LAN Airlines – Corporate strategy and advantage, synergies and governance costs: How LAN Airlines is
better off jointly owning and operating its cargo and passenger’s business than they would be
operated independently

LAN Competitive Advantage Strategy – Low-cost

Business Model – Key Choice: Investment in both cargo and passenger:

- No frills, lost-cost business model for domestic passengers

LAN’s corporate strategy adds value which investor diversification and separate ownership can’t offer.
Cargo, full-service international passenger and low-cost domestic enables LAN to fully maximise its
utilisation of its most important physical assets, its extensive fleet of airplanes.
- Maximises revenue – cargo and passengers are optimized for each plane, reducing costs and
increasing utilisation and efficiency
- Spreads risk – no reliance on sole revenue streams of cargos or passengers
- Expands the network domestically and internationally as it lowers the load factor and minimum
threshold for either cargo or plane to ensure more routes can be offered for both
- Increases barriers to entry for competitors – airlines are winner takes all services
- Stimulates demand through greater network of flights
- Greater willingness to pay due to more routes
- Economies of scale and scope
The choices and consequences are:
- Aligning with the goal
- Reinforcement – complement each other
- Robustness and Virtuous cycles – positive feedback loops help sustaining competitive advantage
and model strength over time

Through optimization and flexibility of operations LAN can benefit from adapting and rolling with
uncertainty which is operated separately or ownership together but run independent then returns for
the investor would be lower due to corporate advantage does not occur. The synergies and low
governance costs run joint ownership and operation enable LAN to maximise revenues in the face of
uncertainty which separate businesses could not.
- Essentially, LAN maximises strategic advantages comes from their ability to exploit the synergies
at the production and consumption level between its cargo and passenger businesses, which
could not be obtained from separate operation or ownership, both are required for LAN,
especially as the governance costs are directly reduced due to joint operation and ownership
LAN’s WTP-Cost Differential

High WTP:
- Quality service
- Extensive route network - Wider variety of destinations: cost effective to fly to many different
destinations due to mix of cargo and passengers subsidising each other’s transportation to those
locations
- Total customer solutions strategic positioning
- High utilisation through combination of cargo and passengers enables costs to be reduced whilst
offering extensive route network, high quality services, high frequency of routes

Cost:
- Passenger and cargo combination enables high resource utilisation and benefits with great
efficiency to reduce costs
- Drives down costs through 3.5 cheaper employee salaries due to geographical location and
economic nature of countries the firm operates in
- LAN does not offer incentives

Margins for LAN’s cargo and passengers are roughly similar – evident LAN well optimizes its net revenues
through the appropriate passenger and cargo balance.

Has different kinds of planes and others different to southwest which increase costs compared to SW,
reduce economies of scale, buying power, infrastructure for cargo goods and products are needed in key
areas, sophisticated and expensive IT system,

Southwest Airline Business Model

Cost leadership approach and business model:

Due to its domestic flight target market, southwest is not only competing with cost from other rivals but
also that of other modes of transport, such as surface transport. Southwest’s cost leadership strategy has
made many choices to produce the lowest cost per mile flown in order to increase the WTP-WTS
difference and drive down costs as much as possible:
- Point to point structure
- Secondary airport focus
- Homogenous fleet
- Productive staff
 - Online sales only

Southwest WTP, lower than LAN’s:

- Fails to provide full service or international routes
- Secondary or lower traffic airports
- Homogenous plane types prevent longer haul flights and has less demand

Costs:
- Very low costs - regards surface transportation as its competitors and not other airlines due to
o High demand areas
o High frequency flights
o Both enable high utilisation
o Low quality service – not bothered by the target market due to nature and demand of
service demanded by short haul flights
o Homogenous fleet
o Fuel hedging
Summary

There are 2 ways to achieve success within the industry, LAN’s pursuit of economies of scope through
multi-business models focused on both cargo and passengers and Southwest’s pursuit of economies of
scale focused on asset utilisation and passenger flights.
- Both cases have very few similar features

Lan operates a differentiated on the frontier of its production possibilities, maximising its production
synergies for its 3 different business models it operates with: low cost domestic, full service international
and global cargo. The production synergies are maximised for its quality of service, extension of networks
and vast routes. The cargo business enables a higher asset utilisation of its airplane fleets, of all different
sizes due to optimization of passengers and cargo on their planes. Low demand and lower frequency of
pure passengers flights ensures that cargo is essentially to maximise the production and customer
synergies whilst reducing tis governance costs greatly, especially its coordination and cooperation costs.

Southwest is a pure low cost single business model focused on the US domestic passenger market.
Economies scale is SW’s aim with high utilisation and volume of flights to drive revenues and profits. The
firm operates in areas of high demand, high demand for high frequency flights with short routes to
secondary airports and a homogenous plane type to ensure flight costs are best utilised and minimised.

Virtuous circle for LAN; more routes and frequencies caused by cargo and passenger multi-business
model firm enables added value to customers which results in higher willingness to pay and premium
prices for its higher end target market which creates more revenues and profits to support and invest in
both more routes and one time investments in locations to ensure cargo and passenger distribution and
routes expand continuously which supporting a sustainable competitive advantage and reducing threat
of new entrants which compound as more routes are added.
Topic 5: Diversification

Diversification concerns a firm entering a new market or business. Entering a new business can be done
through either internal or external sources, or known as inorganic and organic growth.
- Internal:
o R&D investments
o New Product developments
- External
o Acquisition
o Non equity alliance
o Equity Alliance

Empirical evidence on performance post diversification shows firms at the individual level often perform
worse than before diversification but the new multi business firm performs greater at the corporate level
post diversification, not only offsetting the decline in individual firm performance but increasing it
greater than the decrease across the individual businesses.

In order for a firm to realise any potential synergies when diversifying, the interdependencies must be
actively managed between the firms which creates coordination governance costs. Costs for managing
the interdependencies and coordinating them may rise

Disney

Multi-business model including media networks, parks and resorts, studio entertainment and consumer
products and interactive media.
- Media networks Is the firms most profitable company which includes ABC, ESPN and Disney as
well as radio stations and equity interests in various online media platforms and streaming
services
- Although the current largest segment for Disney, analysts have concerns over this divisions future
given technology impact on cable television and the current but changing state of how viewers
are watching media content

Sustainable advantage:
- Intangibles – happy memories and inexperience’s with family is a continuous cycle as people grow
up become parents takes their kids who grow up and so on

Original corporate advantage:

- Typical cartoons and animations improved the competitive advantage of other businesses such as
hotels and theme parks also

Pixar Acquisition – Vertical Integration back down the value chain, Disney distributes a lot of the films
produced by Pixar and it has been a very profitable relationship and venture for both involved.

- Pixar has proprietary technology and excellent creatives in producing blockbuster movies whilst
Disney has great distribution capabilities and vast resources in marketing and branding – a highly
interdependent relationship with unique complementarity
- Negotiation of contracts was increasingly difficult but both companies’ unique complementarity
meant each other was high in the value loop for each other suggesting vertical integration
- Benefits of acquiring pixar:
o Change the culture of Disneys belief that animation is just hype a trend or a fad that will pass
and is not a sustainable form of media entertainment
 o Pixar has software and technology capabilities of animation that Disney does not have
o Sequels and spin offs provide huge sustainable revenue streams for Disney
o No debt
o Block competitors
o Known the well – long term relationship within them
o Disney is best for distribution and merchandising
o Alternatives to acquisition was problematic – re contract
- Problems of acquisition:
o Destroy creativity
o May ruin pixar creativity and culture
o Pixar already have power

- Consolidation and customization operational synergies could be achieved by Disney acquiring

Pixar
- Pixar passed both synergy and ownership tests
- Pixar is highly creative but Disney’s revenues and profits really come from sequels and spin offs
which the creatives at Pixar have no interest in working on, so the acquisition enabled the control
of Pixar which now has to do sequels and spin offs as brand credit in order to be able to do its
own creative projects such as Up, this balance could not be negotiated in contracts or through
joint ventures or strategic alliances so acquisition test is passed

Topic 6: Outsourcing

Outsourcing is moving one section of activities in the value chain outside of the business to another firm.
Divestiture is the complete removal of a business from a multi business firm by selling or removing its
value chain and withdrawing from the products it offers to the relevant customers.
- Offshoring is moving sections of the activities in a value chain to a different geography – this can
be as outsourcing or internal

Key question for outsourcing is whether a firm needs all sections of the value chains activities inside the
corporate portfolio to maximise the corporate advantages stemming from owning all activities inside that
value chain.
- The value of outsourcing certain specifics of the value chain is of greater value than the sum of
keeping in house all value chain activities.

Outsource if:
1. Synergy test failed
- If joint ownership and operation does not create synergies across the different value chain
business units then outsourcing the ownership may provide greater value to the business as the
synergy test has been failed, so these units provide no synergistic value to the business
2. Vendor can do better an inhouse activity units
- With synergy tests still able to be passed, then outsourcing value is optimised when a different
firm outside of the multi business firm the value chain activity or business unit currently sit has
superior capabilities whereby they utilised their own business and overall corporate advantages
and synergies across their value chain to add greater value to the outsourcing activity than if it
was still apart of the existing current multi business firm
- Essentially, if a firm is able to outsource its value chain activity to other firms that have a
comparative advantage and can operate more efficiently or effectively then the firm should
outsource and focus its time on its own comparative and competitive advantage to double down
- Comparative advantage or international theory suggests only focusing on your relative
advantages and really doubling down on them as opposed to focusing on absolute advantages
 - Often done with greater efficiency, effectiveness and flexibility by the specialist outsourcer
- Efficiency is costs, effectiveness is WTP and flexibility is moving assets off the balance sheet or
meeting the changing needs of customer demands

Transaction costs occur as a result of outsourcing due to the inefficiencies and ineffectiveness of
contracts and other unforeseen possibilities.

Always outsource unless the synergy test is passed, and the vendor is unable to better manage the
specific value chain activities involved. Outsourcing may still occur if it enables the outsourcer of the
specific activity to focus on the activities where the firm is able to add the greatest about of value
through focus and specialization on those specific activities.

Types of outsourcing costs:

- Contracting costs: cost of initiating the relationship through to agreeing contracts between the 2
parties involved
- Transition costs – Cost of knowledge transfer and capture from one personnel to another.
- Interaction costs – Costs of manging the interaction between the activity remaining inside the
business and the activities being outsourced

Outsourcing motives:
- Efficiency – Lower costs
- Effectiveness – Increases willingness to pay
- Flexibility – Move assets and costs off balance sheet and meet changing market demands

Learning by supplying:
- Because out have outsourced certain value chain activities, then your suppliers can easily and
quickly learn have to move down the value chain to the ultimate end of consumer facing activities
- Be very conscious of who your suppliers are in these markets, as they may be your competitor in
the end
- However, very difficult for suppliers who try to move into the other value chain activities, as
multiple other different value chain activities are required to be successful and competitor with
the firm’s they originally supplied
- Comparative advantage suggests firms focus and specialising on what they are very good at
- Who a firm supplies as customers is very important, as they differ in the extent to which they are
able to and willing to share technological and marketing knowledge with their suppliers
- Leading branded producers use more restrictive outsourcing agreements, probably increases the
contract costs for outsourcing, while encouraging technology sharing, distance suppliers from
customers facing activities
- Suppliers working with such sizeable firms tend to develop strong technological capabilities, but
find themselves effectively locked into a subordinate role, thwarting ambitions to move up the
value curve to develop as viable independent participants in the industry
Bharti Airtel Limited – Outsourcing (Disney’s acquisition of Pixar also related to outsourcing as Disney
was outsourcing to Pixar before acquiring them)

Topic 9: Designing the Multi-Business Corporation

- Focus on the organizational macro design of multi business corporations – the stable pattern of
interactions between groups of individuals specified at high levels of aggregation

The multi-business corporation as a collection of value chain bundles along three dimensions:
- Activities
- Output
- User

Design:
- Grouping through boxes – activities within this group or box shared common characteristics,
including goals, performance targets, procedures etc
- Linking through lines – relationship between the different groups or boxes and how they interact
with each other and how their activities are interacting too

Basic principles of designing organizational structure:

1. Nesting – Organizations beyond some size are bound to run into limits of organizing within a single
box, which necessitates boxes within boxes.
- Activities are linked to each other are certain levels which at the next layer are all within a box
- Large divisions are linked to each other and at the next layer the departments are linked to each
other and so on

2. Silos – Boxes enhance the integration of activities within them, but also impede integration across
activities in different boxes.
- Benefits are observed within units or within boxes but silo syndrome occurs between other boxes
or units creates difficulties
- Geographic boundaries added or compound this problem
- Linking mechanisms are therefore used to combat these integration problems, grouping is more
powerful integration mechanism as grouping enables common characteristics which promote
interaction and integration with much greater effectiveness

3. Residual integration – The linking elements provide the residual integration that cannot be provided by
grouping structures, but is still desirable, even if not fully achieved.
Organizational structures:

1. Pure Forms
- Grouping activities by one of the three dimensions – activities, output or user
- Function form – emphasises integration across all similar value chain activities
- Product or multi divisional form – integration across all activities that are necessary to generate
an outcome
- Customer centric form – integration across all value chain activities mean to cater to the needs of
specific users

Function or f form is focused on similar activities whereas the other two, m and c forms, combine
different activities. The essential idea is that grouping similar activities together, i.e. f form, emphasizes
economies of scale at the expense of economies of scope: whereas grouping different activities
together, i.e. m and c forms, do the exact opposite.

Different strategic imperatives are evident from the different m and c forms, as m focuses on cross
division collaboration to improve time to market of products through high levels of integration, the c
form, focuses on users’ needs and enhancing its responsiveness to them. This is inter-functional
integration as grouping is across different value chain activities. Intra-functional is due to similar value
chain activities, i.e. f form.

Matrix form – The same activity could belong to multiple groupings or boxes at the same time. One
dimension may be more dominant than others.

Hybrid form – Direction of grouping can be different for different parts of the value chain.

When to change structure:

- External factors – Change in competitive environment or a shift in technology.
- Internal factors – Opportunity costs and informal organization

External Factors
 Changes in the competitive environment
When the technology in an industry is mature and there is a well-defined efficiency frontier, the curve
A may be applicable: there are gains from focus
 Shift in Technology
Could create periods in which it is better to pursue both differentiation and cost advantage
simultaneously as the efficiency frontier moves
Internal Factors
 Inefficiencies within one activity - Opportunities cost of de-emphasised to be past a tolerance level
and initiates re-organisation
 Informal Organisation Effects
The off – the – chart pattern of linkage; Connection between individuals; Culture of Organisation
A shift towards one particular form directly realigns the formal structure, whereas the informal
organisation, the channels of communication and cooperation in the organisation, will only adapt with
a time lag
Common Mistakes to avoid
 Do not forget to combine activities
Managers usually put more focus on thinking about the partitioning up of the activities within the
organisation than on how to integrate them
 Do not avoid re-organising just because they are painful
 Do not blindly follow competitors
While share external factors, a structure should also take into account the factors internal and
possibly unique to the organisation
 Do not focus exclusively or primarily on the informal structure
 Do not ignore location
Take into account how the geographical location will reinforce and undermine the new structure

MCNs and structure

Key premise in the design of multi-national organisation
 The closer we get to customer in the front-end facing activities in each geography, the smaller the
opportunities for achieving synergies with other parts of the company
 The further upstream we travel in a value chain, the greater the possibility of potential synergies
across geographies
 Within a value chain the synergies are always potentially high across succeeding stages, as each is
a necessary input to the next

4 Types of Structure
International Sales Division
Grouping all international activities together
Foreign operations of the firm get their requisite focus
With Sub-units dedicated to individual countries, often only the front end (Customer facing) parts of the
value chain are located in the different geographies the MNCs operates in
(e.g. Sharp R&D, Manufacturing in Japan, only sales unit abroad)

Common frictions:
Between the front & back ends of the value chain
Between the HQ in the home country & international country units

Transnational Structure
Particular geographies specialise in particular parts of the value chain or product lines
(e.g. Manufacturing in Asia, R&D in the US) (e.g. CT scanner in Japan, X-ray in Europe)
Integration arises mostly through global mandate in each geography that specialise in a particular part of
value chain

Frictions
Both within & across more upstream parts of value chains

Centralized back end

Does not privilege the country of origin in terms of the front of the value chain, though all back-end
operations are grouped in the home country
Frictions
Between the front end and back ends of the value chain

Distributed functions
Individual functions may be grouped organisationally but distributed geographically
Create a need for horizontal integration across geographies
Coordination may often be required within the project
Frictions
Within value chain vertical integration challenges across geographies
Case Study – P&G

Initial:
1. P&G started with a geographic focused organizational design – This enabled them to build their
share in every market and gain a competitive advantage by tailoring the product to each market.
2. As competition became as differentiated as P&G, they had to look to areas for other sources of
competitive advantage – this was impetus for them to change to achieve more advantage in the
face of tough competition. P&G has potential for economies of scope to be exploited however
their current structure did not permit these economies to be taken advantage of and so had to be
reorganised to take advantage – the company changed to a matrix focus in order to be able to
continue their geographic dimensional advantage as well as take advantage of the economies of
scope
3. This reduced P&G’s costs, the competition quickly caught up. The next advantage for the firm was
through economies of scale in their R&D and new product innovation, due to the size of the firm,
these were realistic advantages due to significant FCF’s able to be invested in the firm. However,
another reorganization was needed to produce a global product organization, but needed tom
maintain its focus on geographical customization and functional cost minimization.
4. P&G is now trying to excel across all 3 ways or organizing a firm – through product, geography
and function.
a. Design always leads to one dominating over the other and they have focused on
geography
b. However, they have introduced dotted lines to keep costs in check and maximise product
rollouts outs quickly
5. Now P&G has a focus on of all 3 areas and are equal in their dominance and priority

Recent changes:
- P&G scrapped the traditional idea of organizing by one dimension, then underneath organizing by
a different dimension, and so on
o Historically, geography was the top dimension in the global organization, then the product
dimension below geography, and finally were functions
o In the new design, “nothing sits on top of each other, but the three different ways of
organizing all sit next to each other”
o So all product-based activities are located in GBUs, all local, geography-based, product
customization activities are in MDOs, and all globally shared functions are in GBS
o P&G is now not one organization, but an amalgam of three heavily interdependent
organizations – this again is guaranteed to create upheaval
- There are no more dotted lines • Not necessarily a good idea given the need for an interdependent
organization – some dotted lines between the different parts of the organization needed to ensure
the organization can function

Trian believes P&G can regain lost market share through the following strategic initiatives:
- Organize P&G in a way that promotes accountability
- Ensure P&G’s cost cutting plan actually delivers results
- Fix the “Innovation Machine”
- Develop small, mid-size and local brands
- Make M&A a growth strategy and core competency
- Win in Digital
- Address P&G’s insular culture
- Improve corporate governance
Conclusion:
- Organizational designs need to follow strategy
o No perfect design, so fit to strategy is important
- Simple designs are easier to manage
o But maybe insufficient to achieve the strategic goal
o Dotted lines often used to make up for shortcomings of one design
- Social networks can substitute for formal architecture
- Requires very careful design to encourage appropriate social relationships
- Requires cultural changes and symbolic changes in the organization