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INTB 1209 with Carl Nelsonm Study Guide for Test 3

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ECON 1115
Peter Simon

1 INTB Study Guide CHAPTER 12: 1. What’s a firm’s strategy? Actions managers take to attain the firm’s goals. For most firms, the preeminent goal is to maximize the value of the firm for its owners, its shareholders as long as it’s legal. 1.AWhat does a firm need to do to maximize the value of a firm? To maximize the value of a firm managers must pursue strategies that increase the profitability of the enterprise and its rate of profit growth over time. 2. What is profitability? Aratio or rate of return concept. The rate of return that the firm makes on its invested capital (ROIC) can be calculated by diving the net profits of the firm by total invested capital. 3. What if Profit Growth? “The percentage increase in net profits over time.” The higher profitability and a higher rate of profit growth will increase the value of an enterprise and thus the returns garnered by its owners, the shareholders. 4. How can Managers increase the profitability of a firm? Managers can increase the profitability of the firm by pursuing strategies that lower costs or by pursuing strategies that add value to the firm’s products, which enables the firm to raise prices. 5. How Managers increase the rate of profit growth of a firm? Managers can increase the rate at which the firm’s profits grow over time by pursuing strategies to sell more products in existing markets or by pursing strategies to enter new markets. 6. How do you add value to a product? The amount of value a firm creates is measured by the difference between its cost of production and the value that consumers perceive in its products. 2 The more value consumers place on a firm’s products, the higher the price the firm can charge for those products. The price a firm charge for a good or service is typically less than the value placed on that good or service by the customer. Consumer capture some of that value in the form of what economists call a consumer surplus. It is impossible to charge customers a price that reflects the value of a product; economists call this customer’s reservation price. The consumer surplus per unit is equal to V (the value of a product on average)-P (the average price a firm can charge a consumer for a product); the greater the consumer surplus the greater the value for their money the consumer gets. 7. What is Value Creation? “Performing activities that increase the value of good or services to consumers” Afirm’s Value Creation is measured by the difference between V and C (the unit cost of production) (V-C). Acompany creates value by converting inputs that cost C into a product on which consumers place a value of V. Acompany can create more value either by lowering production cost, C, or by making the product more attractive through superior design, styling, functionality, features, reliability, after-sale service, and etc.All of these things make costumers place a greater value on a firm’s product. 8. What is strategy focused primarily on lowering costs called? Low-cost strategy 9. What is a strategy that focuses on primarily increasing value called? Differentiation strategy Superior value creation relative to rivals does not necessarily require a firm to have the lowest cost structure in an in industry, or to create the most valuable product in the eyes of consumers. However, it does require that the gap between value and cost of production be greater than the gap attained by competitors. 10. What are the two basic strategies needed to create value and attain a competitive advantage in an industry? 3 Michal Porter has argued that low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry. Strategic Positioning: According to Porter a firm has to configure its internal operations to support its strategic emphasis (differentiation or low cost). 11. What is the Efficiency Frontier? The efficiency Frontier shows all the different positions that a firm can adopt with regard to adding value to the product and low cost assuming that its international operations are configured efficiently to support a particular position. 12. Why is the Efficiency Frontier downward slopping? Because of the law of increasing opportunity cost. Diminishing returns imply that when a firm already has significant value built into its product offering, increasing value by relatively small amount requires significant additional costs. 13. What three things does a firm have to do to maximize its profitability? 1. Pick a position on the Efficiency Frontier that is viable in the sense that there is enough demand to support that choice. 2. Configure its internal operations, such as manufacturing, marketing, logistics, information systems, human resources, and so on, so that they support that position, and 3. Make sure that the firm has the right organizational structure in place to execute is strategy. 14. What do operations mean in this context? The various value creation activities a firm undertakes. 15. What’s another way of looking at operations? The Operations of a firm can be though of as a value chain composed of a series of distinct value creation activities, including: 1. Production 2. Marketing and sales 3. Materials management 4. R&D (Research and Development) 5. Human Resources 6. Information Systems 4 7. And the firm infrastructure These activities can be categorized as support and primary activities. 16. What are support activities? 1. Information Systems: When coupled with the communications feature of the Internet, can alter the efficiency and effectiveness with which affirm manages its other value creating activities. 2. Logistics: Controls the transmission of physical material through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly reduce cost. 3. Human Resources: The HR function can help create more value by: a. Ensuring that the company has the right mix of skilled people to perform its value creating activities effectively. b. Ensures ppl are trained, motivated, compensated to perform their value creation tasks. 4. Infrastructure (Top Management is part of this): The context within which all the other value creation activities occur. The infrastructure includes: a. The organizational structure b. Control systems, and c. Culture of the firm. 17. What are PrimaryActivities? 1. R&D: Concerned with the design of products and production processes. Many service companies also undertake R&D. Through superior product design, R&D can increase the functionality of products, which make them more attractive to consumers raising value. 2. Production: Creates value by performing its activities efficiently so lower cost result (lower C) and/or by performing them in such a way that a higher –quality product is produce (which results in higher v). 3. Marketing and Sales: Through brand positioning and advertising, the marketing function can increase the value that consumers perceive to be contained in a firms’ product, If these create a favorable impressions of the firm’s product in the minds of consumers, they increase the price that can be charged for the firm’s product. Marketing and sales can also create value by discovering consumer needs and communicating them back to the R&D function of the company. 4. Customer Service: Provide after-sale service and support. This function can create a perception of superior value in the minds of consumers by solving problems and supporting customers after they have purchased the product. 18. What do primary activities have to do with? Primary activities have to do with the design, creation, and delivery of the product; its marketing, and its support and after-sale service. 5 Organization: The implementation of Strategy 19. How is a firm’s strategy implemented? Afirms’strategy is implemented through its organization: 20. What does the term OrganizationalArchitecture mean? “The totality of a firm’s organization, including: 1. Formal organizational structure: a. These means three things: i. The formal division of the organization into subunits such as product divisions, national operations, and functions ii. The location of decision-making responsibilities within that structure iii. The activities and subunits including cross-functional teams and or pan –regional committees. 2. Control systems and (In book controls and Incentives is one category): “The metrics used to measure the performance of subunits and make judgments about how well managers are running those subunits”. 3. Incentives: “The devices used to reward appropriate managerial behavior” 4. Organizational culture: “The values and norms shared among an organization’s employees”. 5. Processes, and: “The manner in which decisions are made an work is performed within any organization”. 6. People: Not just employees of the organization, but also the strategy used to recruit, compensate, and retain those individuals and the type of people that they are in terms of their skills, values, and orientation. View figure 12.5 to look at OrganizationArchitecture (page 341). 21. If a firm want to maximize its profitability, what most it do? If a firm want to maximize its profitability it must pay close attention to achieving internal consistency among the various components of its architecture, and the architecture must support the strategy and operations of that firm. 22. What happens if a firm’s strategy no longer fits the market? In such circumstances, the firm must change its strategy, operations, and organization to fit the new reality-which can be an extraordinary difficult challenge. 6 Global Expansion, Profitability, and Profit Growth: 23. What does a firm have to consider when pursuing strategies to increase its profitability and profit growth? Such strategies are constrained by the need to customize its product offering marketing strategy, and business strategy to differing national conditions-that is, by the imperative of localization. 24. What is one thing a company can do to increase its growth rate? Acompany can increase its growth rate by taking goods or services developed at home and selling them internationally. The returns from such a strategy are likely greater if indigenous competitors in the nations that a company enters lack comparable products. 25. What are firms that operate internationally able to do? Look at page 343. 26. What else besides the goods or services that a firm sells in a foreign market matters when talking about expanding the market by taking goods or services developed at home and selling them internationally? The success of many multinational companies also depends upon the core competencies that underlie the development, production, and marketing of those good or services. The term Core Competence refers to skills within the firm that competitors cannot easily match or imitate. 27. What do services based companies have to do to succeed when expanding their market? Expanding the market for their services often means replicating their business model in foreign nations (with some changes to account for local differences) 28. What can firms that pursue an expanding market strategy realize? Firms that pursue an expanding market strategy can realize what we refer to as location economies, which are the economies (cost advantages) that arise form performing a value creation activity in the optimal location for that activity, wherever in the world that might be. 29. What is one possible outcome of realizing location economies? 7 One of this kind of thinking is the creation of a global web of value creation activities, with different stages of the value chain being dispersed to those locations around the globe where perceived value is maximized or where the cost of value creation is minimized. 30. What things (caveats) complicate the picture of Location Economies? Transportation cost and trade barriers complicate this picture.Another thing (caveat) concerns the importance of assessing political and economic risks when making location decisions. If a country’s gov is unstable or totalitarian, the firm might be advised not to base production there. If the gov appears to be pursuing inappropriate economic policies that could lead to foreign exchange risk, that might be another reason to not base production in that country. 31. What is the experience curve? “Systematic production cost reductions that occur over the life of a product.”A number of studies have observed that a product’s production costs decline by some quantity about each time cumulative out doubles. 32. What does an experience curve graphs show? It shows the relationship between unit production costs and cumulative output (the relationship is for cumulative output over time, and not output in any one period, such as a year). 33. What are Learning Effects? “Cost saving form learning by doing”. Learning effects tend to be more significant when a technologically complex task is repeated. No matter how complex the task, learning effects typically disappear after a while. It has been suggested that they are important only during the start-up period of new processes and that they cease after two or three years.” 34 What are Economies of Scale and what are its sources? “Cost advantages associated with large-scale production”. Sources: 1. Fixed cost: Costs required to set up a production facility, develop a new product, and the like. The only way to recoup such high fixed costs may be to sell the product worldwide, which reduces average unit costs by spreading fixed costs over a larger volume. 2. Afirm many not be able to attain an efficient scale of production unless it serves global markets. By serving domestic and international markets form its production facilities, a firm may be able to utilize those facili
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