SEVI Test 1

Theory of the firm

a group of economic concepts that explain why businesses exist, how they make decisions, and how they interact with markets

The Puzzle of Firm Existence

organizing economic activity internally under managerial direction is often cheaper than using the open market

Most activity happens inside the firm

Coase

using the market is never free

Make-or-buy is one comparison

bring in-house when market costs exceed internal costs; outsource when they don’t.

Because transaction costs differ across firms and shift over time

firm boundaries are never settled — rivals can make opposite make-or-buy choices and both be right (Apple designs in-house, Foxconn assembles).

The Value Chain

breaks a firm into strategically relevant activities to reveal where cost and value are created.

Margin = value created for customers − cost of activities.

Advantage: Performing same activities cheaper, or in ways that create more value which can make hard to copy

Five primary activities trace the product’s path:

inbound logistics (
receiving, storing, distributing inputs) → operations (transforming inputs into the product or service) → outbound logistics (storing, distributing the finished product) → marketing & sales (reaching buyers, inducing purchase) → service (post-sale support that maintains or adds value) .

Support Activities

• Firm infrastructure — management, finance, legal, planning

• Human resource management — recruiting, training, compensating

• Technology development — R&D, process and product design

• Procurement — purchasing inputs used across the chain-

The hierarchy:

vision = aspirational future, mission = present purpose and scope, objectives = measurable targets connecting them. A vision is not a strategy — it says where, not how.

A mission…

Works as a decision filter — it’s what says no when an opportunity doesn’t fit. Effective missions name products, customers, and what distinguishes the firm.

Vision without mission

knows where it wants to be, no place to start.

Mission without vision

knows what it does today, nothing pulling it forward.

A business model is…

how a firm creates, delivers, and captures value.

Value creation flow

inputs → transformation (the act that actually creates value.) → outputs → value gap → value capture.

The value gap splits

the firm’s share is profit; the customer’s share is consumer surplus (willingness to pay − price)

Competitive Advantage

creating more economic value than rivals (larger gap between
willingness to pay and cost). It is always relative: a 15% margin is a disadvantage if
rivals earn 20%, and a whole industry can boom without any firm holding an
advantage.

Two sources: of competetive advantage

differentiation (premium exceeds the added cost; lives in perception
— Apple) and cost (below-rival costs at acceptable quality — Walmart’s scale,
supplier leverage, logistics)

Temporary vs. sustainable

temporary rests on things easily imitated or substituted;
sustainable rests on resources that are valuable, rare, costly to imitate, with the
firm organized to exploit them (Southwest’s culture)

Parity

matching rivals; not failure, but no edge. Valuable-but-not-rare resources
are table stakes and yield only p

Shareholder primacy (Friedman)

business’s only social duty is profit. Stakeholder
view: shareholders matter but are one group among many. The logic is practical —
ignore employees, suppliers, or community and the firm loses cooperation it needs
to survive (2019 Business Roundtable shift)

Two classification schemes

internal vs. external (inside vs. outside the firm’s
boundaries) and primary vs. secondary (essential to survival vs. not) — and a
secondary stakeholder can turn primary fast

Conflicts are inevitable

shareholders vs. employees (labor costs), shareholders
vs. managers (principal-agent), firm vs. customers (drug pricing), short-term
vs. long-term (cutting R&D). Firms resolve them by compromise — usually favoring
the most powerful and urgent claims, not the most legitimate

Strategy sits between vision and tactics:

an integrated set of deliberate choices
establishing where and how the firm will compete. A good strategy is a decision that
makes a thousand other decisions for you.

Strategy vs. tactics:

Strategy is the overarching long-term plan that defines what you want to achieve and why, while tactics are the specific, short-term actions you take to execute that plan

Assessment starts with the three financial statements and the distinct question
each answers

income statement (did we make money this period?), balance sheet
(what do we own and owe now?), cash flow (can we keep operating? — a profitable
firm can still run dry)

Ratios

(margin, ROA, ROE) benchmark against rivals — real advantage shows as
returns above rivals

Balanced Scorecard (Kaplan & Norton)

four perspectives — financial, customer,
internal process, learning & growth — forming a causal chain (financial results
follow from getting the others right).

Scarcity

every
resource committed to one initiative is unavailable for another, so every allocation
carries an opportunity cost whether it shows on the balance sheet or not.

Choosing a strategy means choosing…

what not to do (Porter). Trying to be all things
to all customers is a recipe for mediocrity; tradeoffs are a source of clarity and
focus.

Customers buy for one of two reasons:

better or cheaper. Differentiation answers
“better” — being different in ways customers pay a premium for that exceeds the
cost of creating the difference. If the cost of the difference exceeds the premium,
differentiation destroys value.

Cost advantage answers

cheaper”: producing below rivals’ cost on a product still
good enough for the typical customer — no-frills, standardized, built for the typical
customer, not the demanding one

A lower cost structure can be spent two ways

price below rivals to win share, or
match them to bank margin — and most cost leaders do both.

Law of experience:

unit costs decline by a constant percentage each time
cumulative output doubles.

Strategic uses:

first movers in fast-growing markets
secure widening cost advantages, forward-looking pricing, and benchmarking
against what costs should be

Four limits:

the cost of buying volume, flattening
gains, spillovers to rivals, aging equipment.

Not “bigger is better”

specific relationship between volume and cost per unit.
Four engines: spreading fixed production costs, spreading fixed non-production
costs (R&D, advertising, overhead), specialized people, specialized equipment

Differentiation and cost leadership are about _____ a firm
competes; focus is about _____

How, Where

The opposing tradeoffs:

the broad-market firm must compromise on every
dimension to appeal to diverse customers; the focused firm narrows the market to
tailor the product or streamline the operation. Some of the most profitable
positions serve not the most customers but the right customers

Three dimensions of focus

buyer group, product line segment (depth within a
narrow category, not breadth), geographic market. The more dimensions narrowed,
the smaller the market — but the deeper the potential advantage within it.

Two variants of focus strategies:

focused differentiation (uniquely suited to the segment, more tailored
than any broad offering) and focused cost leadership (lowest cost within the
segment by stripping features the segment doesn’t value). Cruise lines: a ship built
only for young singles or only for seniors tailors every design decision in ways Royal
Caribbean cannot.