How Insurance Works


in this video we’re discussing
diversification so far in this class we’ve mostly talked about how firms
compete in a single product market whether that’s through a differentiation
strategy or cost leadership strategy how they create that competitive advantage
and how they interact with one another now we’re turning our attention to how
and why firms engage in multiple markets or businesses this could include
spanning multiple stages of the industry value chain or offering multiple
products and services which could be related or completely unrelated and
serving multiple geographic markets so put yourselves back in the shoes of a
manager at coca-cola when coca-cola was deciding to purchase its bottlers that
was an example of vertical integration a backward vertical integration where they
were acquiring a supplier if coca-cola were to merge with say PepsiCo unlikely
but that would be an example of horizontal integrate integration when
one competitor purchases another diversification although I’ve used it
here a general sense to incorporate all these phenomena whether it’s vertical
integration horizontal integration or actual pure diversification is usually
used to describe the purchasing of an unrelated company whether it serves a
different market but with the same competency or has a completely different
competency and serves a different market or same market different competency so
let’s talk a little bit about vertical integration the question we’re moving
forward or backward in your supply chain is simply what is more beneficial to
make or buy a product but that kind of begs the question of how do firms
determine what they do and what they don’t do why does coke
or why did coca-cola not both make it soft drink and bottle it and then why
did it later choose to bottle its own soft drinks where are the boundaries of
the firm so there is an economic theory called transaction cost theory which
basically states it’s more efficient to do some activities as a firm than to
transact through the market you read an article earlier that said that it’s most
beneficial to integrate vertically integrate when there’s a market failure
that you can address the coca-cola case we saw this in terms of integration
giving a competitive advantage or staving off a competitive disadvantage
but you can apply a more detailed analysis to why you would integrate
vertically or not using transaction theory you can see that there’s some
benefits to doing performing activities in house at the firm versus performing
them through market transactions if you’re to buy a product or service on
the market so if coca-cola has to actually go contract out and get someone
to bottle their drinks there are higher powered incentives this means that
company has more at stake they could lose that contract so they’re more
likely to perform whereas if those bottlers are coca-cola employees they
probably have a year-long contract or feel a bit more steady giving employment
law that they might be able to slack a little bit markets are more flexible
coca-cola could bottle more when they’re producing more and bottle s when they’re
producing less whereas if they own the assets in house they lose a lot of that
flexibility if you’re transacting in the market you face search costs you have to
go find a vendor we’re transacting in-house you have
administrative costs so essentially you’re paying these people whether
they’re working or not you have to deal with managing them so there is some cost
there on market in market transactions you also have to worry about the
enforcement of contracts and information asymmetries but that bottler might know
more about their own capabilities than coca-cola knows if they were taken in
house coca-cola would be able to open up their books and learn all about the
bottling process and so there would be less information asymmetry inherent in
the process however there is a principal-agent problem when you
transact in a firm that means simply that the folks actually managing the
bottling if they’re salaried employees might have their own set of priorities
where the owners and managers of the company might have a different set of
priorities that thing said there are more ways to integrate than simply
transacting on the market or taking a business completely in-house there’s an
entire spectrum along which organizations might structure themselves
this might include short-term contracts licensing or franchising arrangements
jv’s strategic alliances or actually purchasing a company taking it in-house
so each of these various manifestations along that spectrum kind of has a
different level of trade-off between the benefits of firm and market transactions
and then there’s the idea of taper integration where some firms choose to
combine some of the elements of integration with market-based solutions
so for example Apple retails its products through both its own stores so
it is vertically integrated with its a retail channel and its menu
acting as well as other channels you can purchase Apple products at target at
electronic stores virtually anywhere under the Sun this does seem a bit
redundant but it could also be beneficial well you might be
cannibalizing some sales from the apple stores you might actually be able to
address a bigger market and you might have increased flexibility and
competition you might keep those Apple stores more efficient because they know
if they’re not doing a good job serving customers needs those customers will go
get those same products at a different storm now let’s turn our attention
briefly to horizontal integration so once again this is when a company
purchases a competitor or combines with a competitor there are a few reasons why
companies do this and we’ll talk a little bit more about M&A at the process
by which they tend to do it in the next video but companies combined
horizontally to reduce competitive activity to lower their costs you
probably heard the term synergies to increase differentiation perhaps they’re
buying a direct competitor but that competitor also offers a suite of
products and services that are complementary to the ones you offer then
there’s diversification companies typically diversify when they want to
gain access to new markets or distribution channels such as when
Walmart bought as a German retailer they wanted a presence in the German market
and didn’t want to wait to build it organically so they purchased Asda which
served a market that they had previously not served access to new capabilities or
competencies like when Facebook bought oculus prime and entered the virtual
reality space some argue that diversification might reduce risk
if a business moves in two unrelated markets or products for example a
business that is very cyclical might choose to purchase a fairly counter
cyclical business so a high-end luxury retailer that’s somewhat sick cyclical
might purchase a discount retailer but modern management Theory kind of calls
that into question and you can read a little bit about that in some of the
assigned readings game theorists might say you diversify in order to change the
game if you’re entering a market that is served by one of your competitors in
your current market you’re essentially broadening the game and now by competing
in multiple markets you might be able to reach it it Hans in the US market but
compete very fiercely in Mexico and it essentially adds just a much richer
dimension to the game not all diversification is created equal we are
we talk about diversification along two main axes that’s of core competences of
business and markets whether that’s a product market or a geographic market so
of course it’s not truly diversification if a business has is relying on the same
core competence in the same market but there’s various level of risk depending
on how far from that comfort zone a business goes in the past there was this
idea of portfolio theory not just in the financial sense but in the corporate
sense that a business should have a healthy mix of businesses at various
stages in the industry life cycle they should have some high growth rate
performers in some cash cows which were mature companies
but this idea has largely fallen out of favor in modern management theory you
might see this matrix come up in business literature but it’s not
typically applied which begs the question is the conglomerate debt is
this portfolio of managed businesses dead you had a reading by Montgomery
about the kind of capabilities and resources you need in order to create an
effective corporate strategy and manage a diversified business I leave it up to
you to form an opinion on that

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