The main reason that firms diversify is to achieve economies of scope

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The main reason that firms diversify is to achieve economies of scope

Distribution End Customer Two issues that should be considered when deciding whether to vertically integrate is cost and control. The cost aspect depends on the cost of market transactions between firms versus the cost of administering the same activities internally within a single firm.

The second issue is the impact of asset control, which can impact barriers to entry and which can assure cooperation of key value-adding players. The following benefits and drawbacks consider these issues. Benefits of Vertical Integration Vertical integration potentially offers the following advantages: Reduce transportation costs if common ownership results in closer geographic proximity.

Improve supply chain coordination. Provide more opportunities to differentiate by means of increased control over inputs. Capture upstream or downstream profit margins. Increase entry barriers to potential competitors, for example, if the firm can gain sole access to a scarce resource.

Gain access to downstream distribution channels that otherwise would be inaccessible. Facilitate investment in highly specialized assets in which upstream or downstream players may be reluctant to invest. Lead to expansion of core competencies.

Drawbacks of Vertical Integration While some of the benefits of vertical integration can be quite attractive to the firm, the drawbacks may negate any potential gains. Vertical integration potentially has the following disadvantages: For example, the firm may need to build excess upstream capacity to ensure that its downstream operations have sufficient supply under all demand conditions.

The main reason that firms diversify is to achieve economies of scope

Potentially higher costs due to low efficiencies resulting from lack of supplier competition. Decreased flexibility due to previous upstream or downstream investments.


Note however, that flexibility to coordinate vertically-related activities may increase. Decreased ability to increase product variety if significant in-house development is required. Developing new core competencies may compromise existing competencies. The following situational factors tend to favor vertical integration: Taxes and regulations on market transactions Obstacles to the formulation and monitoring of contracts.

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Strategic similarity between the vertically-related activities. Sufficiently large production quantities so that the firm can benefit from economies of scale. Reluctance of other firms to make investments specific to the transaction.

Factors Against Vertical Integration The following situational factors tend to make vertical integration less attractive: The quantity required from a supplier is much less than the minimum efficient scale for producing the product.

The product is a widely available commodity and its production cost decreases significantly as cumulative quantity increases. The core competencies between the activities are very different.Economies of scope occurs when the cost of producing several products in a multi product firm is lower than the cost of producing the same products by individual firms e.g.

Banc assurance model, British banking and issuance giant Lloyds TSB acquired Scottish Widows in June for 7bn. Sep 25,  · The firms must, he surmises, be doing this for a good reason. New tools: “Managers in big firms have extraordinary online and mobile tools now available to help them achieve their tasks.

The office management firm is hoping to a. achieve economies of scope. Firms that have selected a related diversification corporate-level strategy seek to exploit b. economies of scope between business units. Firms seek to create value from economies of scope through all of 98%(87).

This study examined the performance effects of information asymmetry and economies of scope in diversified service firms. Tests using both accounting- and stock-market-based measures of performance revealed that information asymmetry improved performance more than economies of scope. Skip to main content.


The main reason that firms diversify is to achieve economies of scope

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Vertical Integration. The degree to which a firm owns its upstream suppliers and its downstream buyers is referred to as vertical leslutinsduphoenix.come it can have a significant impact on a business unit's position in its industry with respect to cost, differentiation, and other strategic issues, the vertical scope of the firm is an important consideration in corporate strategy.

Achieving Economies of Scale – Strategy Tools From