Installment_04

They determine which activities the firm carries out in house and which activities it purchases in the market

You have to decide between two scenarios:

1. do you transport your goods on your own to the costumer, meaning you build up a warehouse and distribution center

2. Outsource this service to a transportation firm and pay a monthly check to this firm

To be more specific you have 4 options in this scenario:

1. own the building and use your own people

2. Own the building and use external staff

3. Rent the building and use your own people

4. Rent the building and use external staff

• Upstream > activities early in the value chain

• Downstream > activities late in the value chain

… which tasks are to be performed inside the firm

… which to be out-sourced

=> so you decide whether using your organization or using the market => Make or Buy decision

A fallacy is a statement or an argument which people believe to be true, but instead of being false it is not correct. In this context they use fallacy as a synonym for a misconception

Fallacy 1:

• argument is not correct

• A source which you can buy easily at the market is not a source of competitive advantage for a firm, because it is not rare. Other competitors can also buy them on the market

Fallacy 2:

• Argument is not correct

• Make or buy decision does not eliminate production costs, it only shifts wo bears them. Outsorcing doesn’t make these costs disappear - they are simply transferred to an external supplier

Fallacy 3:

• argument is not correct

• This decision shouldn't be based on avoiding a supplier’s profit margin. Economic profitability, not accounting profits, should guide this choice, as profits upstream dont automatically mean benefits downstream

Fallacy 4:

• argument not entirely correct

• Peak prices can be avoided by long term contracts with suppliers

• Insolvency risk of high input prices can be addressed by building a capital reserve

Fallacy 5:

• argument is valuable sometimes, but it is used to justify acquisitions on many other occasions when it lacks merit (merit = verdienst)

Firms should do what they do best, everything else should be sourced from the market

1. produce at lower cost (because of proprietary knowledge)

2. aggregate the demand of customer and therefore increase the scale of production

3. Pool the demand of customer accumulate experience and generate learning curve effects

• agency costs are costs associated with shirking

• Influence costs are costs associated with managers influencing head quarter decision in favor of their unit or department

Also reasons for vertical integration

• coordination costs

• Leakage of private information

• Transaction costs

They produce in-house when activities require complementary decisions that are costly to coordinate externally. Internal integration prodvides better control, mitigates risks from incomplete contacts and ensure affective coordination of critical activities

• information that no one else knows may be shared when coordination activities along the value chain

• Performing in house eliminates this threat

• transaction costs include the time and expense of negotiating, writing and enforcing contracts which would be eliminated if you produce in-house (if you make)