Digression2: Shifting industrial boundaries (Special case: the convergence between

Silicon Valley and Detroit)

The vertical boundaries of the firm
o The pros and cons of outsourcing

As auto & technology IP

converge, will Detroit & Silicon
Valley unite?
As technology steers the automotive industry and Silicon Valley onto
the same track, big players find themselves at a crossroads – are they
on the cusp of the next IP battleground or at the forefront of a new
kind of collaboration? Technology and automotive company reps at
the “IP in the Auto Industry” conference in Detroit on May 3 trumpeted
the latter path. At a session titled “Challenges and Opportunities in a
Converging World,” reps from relevant firms discussed how
convergence presents opportunities for the two sectors – not just in
banding together to protect assets – but in developing new capabilities
as well.
This is true particularly in the development of cutting-edge automotive features, including
high-tech instrument clusters, sensory capabilities, and breakthrough battery technologies
that could overcome some of the biggest hurdles in the widespread acceptance of electric
cars. The overlap between the sectors also could grow considerably as self-driving cars move
from the experimental phase to the mainstream. Big Silicon Valley firms already have
invested heavily in this arena, which is projected to reach $87 billion in value by 2030,
according to one research estimate.

As the field expands, the natural reaction for both the auto and tech industries is to defend
their patents vigorously, but speakers at the conference emphasized the benefit that lies in
considering what the other side can bring to the table, and in some cases, working together.
In May, a technology giant announced plans to open a self-driving technology center in
Detroit – the home base for the U.S. auto industry – to tap talent in vehicle development
and engineering. The same company also recently entered a “first of its kind” partnership
with a car manufacturer, to experiment in bringing self-driving technology into a limited
number of the firm’s minivans. Likewise, German original equipment manufacturers
recently acquired software and mapping abilities from a tech firm for its own vehicles. Many
more deals likely are in the works.

Despite a new era of collaboration, convergence may be a cautionary tale.

Opportunistic non-practicing entities looking only to clean up in licensing revenues have
sized up the space, and there are indications they are in for a good fight. Here the two
industries have joined together already to defend legitimate players and their assets. Allied
Security Trust, a membership-based organization that includes major technology and
automotive companies, just launched the IP3 portal, an industry patent purchase program,
in which the banded-together entities offer to buy high-quality patents at the seller’s non-
negotiable price. The stated goal of the group is to acquire patents that could be asserted
against group members, and then provide members with a license to those patents, to
mitigate litigation risk. Sellers were able to offer patents from May 25 to June 8, and the
group will now decide which patents to acquire by July 29. All transactions are anticipated
to close by the end of September.

The takeaway message from the convergence of these industries is that stakeholders in both
sectors should tread carefully as they build out their portfolios, and be aware that on an
overly crowded race track, not every player will survive. Separating friends from foes could
be the key to finding the right path forward and overcoming the inevitable bumps in the
road

https://www.hoganlovells.com/en/blogs/limegreen-ip-news/as-auto-and-technology-ip-converge-will-
detroit-and-silicon-valley-unite

As the race to get autonomous vehicles on the road revs up, there has been
much discussion in the auto industry about who will lead the charge. Because
of the new technologies involved in the development of self-driving cars, many
initially assumed that Silicon Valley would take the driver’s seat instead of
Detroit.

But it’s becoming increasingly clear that it will take the unique strengths of
both Silicon Valley and Detroit to make self-driving cars a reality.

Manufacturing cars is no simple task, in part because of the many safety

regulations governing the fabrication and operation of automobiles. Plus, there
are supply chains, rigorous testing, and an infrastructure of dealerships to
contend with. Silicon Valley’s “move fast and break things” culture is perhaps
ill-suited to the laborious process of designing, manufacturing, and selling
vehicles—Tesla notwithstanding.

Meanwhile, the combination of state-of-the-art technologies—sensors, big

data, machine learning algorithms, and more—required to replace the human
behind the wheel is beyond the in-house capacity of most legacy auto
manufacturers.

Collaboration between these two distinct innovation industries, each with its
own culture and historic expertise, looks like the way forward. Ford recently
bet big on that type of collaboration when it invested $1 billion in Argo
AI, a robotics and machine learning startup founded by former Uber and
Google engineers. Ford says Argo will be responsible for developing the
“brain” of autonomous vehicles while Ford focuses on the hardware side of
production. (More on that in a minute.)

Tom Kelly, executive director of the Automation Alley business association,

feels we’re at a turning point.

There has long been a battle between Detroit and Silicon Valley to lead the
creation of self-driving cars, and while Silicon Valley may have the traditional
auto industry beat on software innovations, Detroit knows best how to make
safe, reliable, enduring hardware products that inspire high rates of customer
satisfaction, he says.
“Besides Apple, there are very few successful hardware companies in Silicon
Valley,” Kelly says. Where he sees a convergence between Detroit and the
Bay Area—common ground where they can work together for the benefit of
both—is in the development of autonomous vehicles. The auto industry’s
response to incursions from Silicon Valley has helped position Michigan to be
a tech hub going forward, he adds.

Automation Alley’s recently released annual industry and technology

outlook highlights that we’re on the brink of a fourth industrial revolution,
signaled by the convergence of physical and digital technologies that are
already transforming manufacturing. However, Kelly says Michigan is at risk of
a diminishing role in the development of autonomous vehicles if it doesn’t
properly prepare for digitization. (Automation Alley’s digitization strategy is
called Industry 4.0, which encompasses cloud computing; big data; additive
manufacturing; industrial Internet of Things; cybersecurity; modeling,
simulation, and visualization; autonomous robotics; and advanced materials.)

Automation Alley’s outlook report is the result of a nationwide survey,

conducted last November, of senior technology and manufacturing executives
to determine their knowledge of Industry 4.0 technologies and whether they
are ready for the digitization of manufacturing.

The report found that 85 percent of manufacturing executives said they expect
their budget for technological advancements to increase in 2017. These
executives also said the top three barriers to technological advancement and
digitization were cost, uncertainty about which technology supplier has the
best solution, and reluctant employees.

“We’re hosting a series of ‘tech takeover’ events to educate manufacturers

about all these technologies that are changing the way they do business,”
Kelly says. “When I talk to manufacturers, they know it’s coming and they
understand how computerization has changed the front office, but they don’t
know what to focus on, how to deploy capital, and what to bet on. It’s tough.”
Kelly says the goal of the tech takeover events is to get Michigan’s technology
and manufacturing industries together so they can work through challenges
and remain at the forefront of autonomous vehicle development.

Ford seems to share Kelly’s view on collaboration between Detroit and Silicon
Valley, as evidenced by the Argo AI investment. Argo is based in Pittsburgh,
PA, and it also has engineers in Southeast Michigan and the Bay Area. The
company will be responsible for developing the virtual driver system, including
perception, path-planning, and decision-making software, says Ford
spokesman Alan Hall.

Ford, whose engineers will work side-by-side with Argo’s, will lead the
development of autonomous hardware—the actual vehicle—intended for use
in mobility services, such as ride-sharing or package delivery, Hall adds. Ford
will also take the lead on systems integration, manufacturing, exterior and
interior design, and regulatory policy management. The collaboration is in
support of Ford’s goal to have “fully autonomous vehicles for commercial
applications” by 2021.

What makes this arrangement especially innovative is the sovereignty Argo

will retain despite the hyper-competitive landscape of the auto industry. Argo
will still be able to potentially license its technology to manufacturers in other
sectors, and its employees have the option of receiving equity in Argo as part
of their salary and benefits package—the norm for tech startups, but less
common in the automotive world.

“Argo allows Ford to really move at the speed of a startup,” Hall says.
“Because Argo is able to operate like a startup, it’ll be able to recruit
aggressively for the type of talent needed, and they’ll be able to offer
competitive salaries and equity opportunities.”

Argo was founded by CEO Bryan Salesky and chief operating officer Peter
Rander. The pair are alumni of Carnegie Mellon’s National Robotics
Engineering Center and formerly led the self-driving car teams at Google
and Uber, respectively. Hall says Ford already has 30 fully autonomous test
vehicles on the road in Michigan, California, and Arizona.

https://www.xconomy.com/detroit-ann-arbor/2017/03/02/detroit-silicon-valley-collaborate-on-path-
to-self-driving-cars/?single_page=true

s automakers develop autonomous vehicles, it’s not the finish date that’s important — it’s
when the technology is ready for the road, Ford Motor Company F 0.9% Executive
Chairman Bill Ford said Tuesday.
“Every single piece” of the automotive business is changing, Ford said in remarks to the
Detroit Economic Club, including the ownership model; propulsion, from internal
combustion to electric; and the integration of 3-D printing, artificial intelligence and
autonomous systems in vehicles.

“I also don’t think in many of these cases it’s who’s first to market. It’s who’s most
thoughtful to market that I believe will win,” Ford, 60, said at the luncheon at Ford Field,
the Detroit Lions’ home turf.

The Blue Oval is “well-positioned” in its investments across the technology spectrum, Ford
said.
He singled out artificial intelligence as a technology with “the capability of either
transforming things in an incredibly positive way or not.”

In propulsion, Ford told outgoing Detroit Economic Club CEO Beth Chappell that his
company is focusing on electric vehicles.
“Right now — and I think it’s the right bet — most of us are betting hard on electrification.”

Detroit And Silicon Valley: ‘Frenemies’

Ford said he didn’t want to make negative comments about electric car manufacturer Tesla
Inc TSLA 0.4%, a 14-year-old company with a market cap of $55.14 billion, to 114-year-old
Ford's $48.72 billion.
“They’ve done a really nice job. My hat’s off to them,” he said. The executive chairman
added “you’re seeing them maybe struggle a little bit” with the “blocking and tackling”
work of the auto business.
When Chappell asked Ford about the Motor City’s relationship to Silicon Valley, he said,
“The term out there is frenemies.”

Ford must be “facile and nimble enough” to work with both legacy companies and startups,
the executive chairman said.
“I do think this notion of friends and competitors — that’s just the world we live in and
we’d better get used to it.”

‘A Lack Of Clarity’ In Automaker Valuations

After Ford left the stage, he told Benzinga his thinking on the relationship between
automakers’ stock valuations and their autonomous vehicle development.

“I think there’s perhaps a lack of clarity, because on the one hand you have a group of auto
analysts that look at the traditional side of the business. They will say ‘you’ve had a good
run for a number of years now, and we don’t see a lot of upside from here,’” Ford said.

“Then you’ve got another group saying, ‘well, there’s going to be winners and losers in this
new tech era and we’re not exactly sure where to place the bets yet.’

“Once there starts to be convergence of the two and also a little bit greater clarity, I think
you’ll start to see the valuations change.”

https://www.benzinga.com/news/17/10/10258332/bill-ford-says-detroit-and-silicon-
valley-are-frenemies-thinks-theres-lack-of-cl

Convergence of cars and

computers blurs the lines
between two industries
The result is both heated competition and unprecedented
co-operation between two industries that rarely spoke to
each other five years ago

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in Share
August 19, 2015
by Dee-Ann Durbin, The Associated Press

PALO ALTO, Calif.—The office has all the trappings of a high-tech startup. There’s a giant
beanbag in the foyer and erasable, white board walls for brainstorming. Someone’s pet dog
lounges happily on the sunny balcony.
Welcome to the Palo Alto home of the Ford Motor Co., six miles from the headquarters of
Google.
Meanwhile, in a squat, industrial building in suburban Detroit, a short drive from Ford’s
headquarters, workers are busy building a small fleet of driverless cars.
The company behind them? Google.
The convergence of cars and computers is blurring the traditional geographical boundaries
of both industries. Silicon Valley is dotted with research labs opened by automakers and
suppliers, who are racing to develop high-tech infotainment systems and autonomous cars.
Tech companies—looking to grow and sensing an industry that’s ripe for disruption—are
heading to Detroit to better understand the auto industry and get their software embedded
into cars.
The result is both heated competition and unprecedented co-operation between two
industries that rarely spoke to each other five years ago.
“It’s a cross-pollination. We’re educating both sides,” says Niall Berkerey, who runs the
Detroit office of Telenav, a Sunnyvale, Calif.-based firm that makes navigation software.
There’s also plenty of employee poaching. Apple recently hired Fiat Chrysler’s former
quality chief. Ride-sharing service Uber snagged 40 researchers and scientists from
Carnegie Mellon’s Pittsburgh robotics lab. Tesla’s head of vehicle development used to
work at Apple.
For years the fast-paced tech industry showed little respect for the plodding car industry.
Google and Palo Alto-based Tesla, with its high-tech electric sedans, helped change that.
“People think it’s shiny Silicon Valley versus grungy Detroit, but that’s garbage,” says Chris
Urmson, who leads Google’s self-driving car program. “If you look at the complexity of a
vehicle, it’s an engineering marvel.”
Dragos Maciuca, a former Apple engineer who’s now the technical director of Ford’s Palo
Alto research lab, says he’s seeing a new excitement about the auto industry in Silicon
Valley. For one thing, cars provide a palpable sense of accomplishment for software
engineers.
“If you work at Google or Yahoo, it’s hard to point out, ‘Well, I wrote that piece of code.’ It’s
really hard to be excited about it or show your kids,” Maciuca he says. “In the auto industry,
you can go, ‘See that button? The stuff that’s behind it, I worked on that.”’
But cocky tech companies have had to adapt to the tough standards of the auto industry,
which requires technology to work perfectly, for years, in all kinds of conditions. Maciuca
spends much of his time educating software and app developers about the industry’s
needs.
“Silicon Valley goes toward this model of a minimum viable product. It’s easy to throw
things out there and try them and see if they work,” Maciuca says. “We can’t do that.”
Santa Clara, California-based Nvidia was best known for making chips for computer games
before it got into the car business. Now, it makes the computer processors that power
Tesla’s 17-inch touchscreen dashboard and Audi’s experimental self-driving cars, among
other products. It had to develop new manufacturing techniques and higher levels of
certification for the auto business, such as tests to make sure its computer chips would still
work in subzero temperatures, says Danny Shapiro, Nvidia’s senior director of automotive.
For their part, the automakers are learning that rolling out cars that remain static for years
until the next model comes out is no longer practical. At the insistence of tech companies
such as Telenav and Nvidia, they’re learning to make cars with navigation, infotainment
and other features that can be constantly updated. Mercedes-Benz, Tesla, Toyota, BMW,
and others can now update vehicle software wirelessly to fix problems or add more
capability
Shapiro says the cost-conscious auto industry has had to learn to spend a little more _
maybe $10 to $20 per car _ on computer hardware. Automakers would often go with the
cheapest option but then spend even more fixing bugs, or be forced to replace processors
that didn’t have enough power to add updates.
Nvidia now has eight permanent engineers at various automakers in Michigan.
“We’ve helped them adopt more of a computer industry mindset, which is not to reinvent
what they’re doing every five to seven years,” Shapiro says.
Even with that new spirit of collaboration, automakers and tech companies also use their
local labs to do a little spying.
Frankie James, a former NASA researcher who now runs General Motors’ Palo Alto office,
says spotting trends and potential threats is one of the most important parts of her job. Her
team alerted GM to the car-sharing trend, for example, and the automaker invested $3
million in Relay Rides in 2011.
Now, she’s watching companies that could potentially disrupt the auto business, such as
Google and Apple. Google has promised a self-driving car within five years, and Apple has
hired people from Tesla, Ford and other car companies for its own top-secret project.
“We need to say, ‘OK, if we think Apple is going to build something like this because they’ve
got this vision of the future,’ if we take that same vision of the future, what can we do? How
can we continue to play?” James says.
The tech industry is also watching its back. Telenav is making a new navigation system for
the 2016 Tacoma pickup and other Toyota vehicles, but Apple and Google are also vying for
the car’s dashboard with their CarPlay and Android Auto systems, which give drivers
access to certain smartphone apps.
Telenav’s Berkery says automotive accounts for 70 per cent of its business, up from just 10
per cent when its 10-person Detroit office opened four years ago. Its success in Detroit led
to new offices in Berlin, Shanghai and Tokyo.
“A huge amount of disruption is going to take place in this landscape, and new players will
come in,” Berkery says. “There’s no reason why traditional players will succeed.”
https://www.canadianmanufacturing.com/manufacturing/convergence-of-cars-and-computers-blurs-
the-lines-between-two-industries-153124/

High-tech cars bring Detroit, Silicon Valley face

to face
August 18, 2015 byDee-Ann Durbin
In this photo taken Thursday, Aug. 13, 2015, technical director Dragos Maciuca poses in the lobby of the Ford
Motor Company Research and Innovation Center in Palo Alto, Calif. Maciuca left Apple this year to become the
technical director of …more
The office has all the trappings of a high-tech startup. There's a giant beanbag in the foyer and
erasable, white board walls for brainstorming. Someone's pet dog lounges happily on the sunny
balcony.
Welcome to the Palo Alto home of the Ford Motor Co., six miles from the headquarters of Google.
Meanwhile, in a squat, industrial building in suburban Detroit, a short drive from Ford's headquarters,
workers are busy building a small fleet of driverless cars.
The company behind them? Google.
The convergence of cars and computers is blurring the traditional geographical boundaries of both
industries. Silicon Valley is dotted with research labs opened by automakers and suppliers, who are
racing to develop high-tech infotainment systems and autonomous cars. Tech companies—looking
to grow and sensing an industry that's ripe for disruption—are heading to Detroit to better
understand the auto industry and get their software embedded into cars.
The result is both heated competition and unprecedented cooperation between two industries that
rarely spoke to each other five years ago.
"It's a cross-pollination. We're educating both sides," says Niall Berkerey, who runs the Detroit office
of Telenav, a Sunnyvale, California-based firm that makes navigation software.
There's also plenty of employee poaching. Apple recently hired Fiat Chrysler's former quality chief.
Ride-sharing service Uber snagged 40 researchers and scientists from Carnegie Mellon's Pittsburgh
robotics lab. Tesla's head of vehicle development used to work at Apple.

In this photo taken Thursday, Aug. 13, 2015, technical director Dragos Maciuca, right, talks with
lab director Dave Kaminski, left, at the Ford Motor Company Research and Innovation Center in
Palo Alto, Calif. Maciuca left Apple this year …more
For years the fast-paced tech industry showed little respect for the plodding car industry. Google and
Palo Alto-based Tesla, with its high-tech electric sedans, convinced many to give the industry
another look. The average car now processes more than 4,200 signals—from the engine and
transmission to the backup camera to the radio—using 40 electronic control units, according to
Boston Consulting Group. Those units can contain up to 100 million lines of computer code, more
than in a fighter jet. The average number of control units has climbed from 30 in 2007; some luxury
cars have as many as 100.
"People think it's shiny Silicon Valley versus grungy Detroit, but that's garbage," says Chris Urmson,
who leads Google's self-driving car program. "If you look at the complexity of a vehicle, it's an
engineering marvel."

In this photo taken Thursday, Aug. 13, 2015, technical director Dragos Maciuca poses in the
entryway of the Ford Motor Company Research and Innovation Center in Palo Alto, Calif.
Maciuca left Apple this year to become the technical director …more
Dragos Maciuca, a former Apple engineer who's now the technical director of Ford's Palo Alto
research lab, says he's seeing a new excitement about the auto industry in Silicon Valley. For one
thing, cars provide a palpable sense of accomplishment for software engineers.
"If you work at Google or Yahoo, it's hard to point out, 'Well, I wrote that piece of code.' It's really
hard to be excited about it or show your kids," Maciuca he says. "In the auto industry, you can go,
'See that button? The stuff that's behind it, I worked on that.'"
But cocky tech companies have had to adapt to the tough standards of the auto industry, which
requires technology to work perfectly, for years, in all kinds of conditions. Maciuca spends much of
his time educating software and app developers about the industry's needs.
"Silicon Valley goes toward this model of a minimum viable product. It's easy to throw things out
there and try them and see if they work," Maciuca says. "We can't do that."
Santa Clara, California-based Nvidia was best known for making chips for computer games before it
got into the car business. Now, it makes the computer processors that power Tesla's 17-inch
touchscreen dashboard and Audi's experimental self-driving cars, among other products. It had to
develop new manufacturing techniques and higher levels of certification for the auto business, such
as tests to make sure its computer chips would still work in subzero temperatures, says Danny
Shapiro, Nvidia's senior director of automotive.

In this photo taken Thursday, Aug. 13, 2015, a research engineer works on image processing at
the Ford Motor Company Research and Innovation Center in Palo Alto, Calif. The convergence
of cars and technology is blurring the traditional …more
For their part, the automakers are learning that rolling out cars that remain static for years until the
next model comes out is no longer practical. At the insistence of tech companies such as Telenav
and Nvidia, they're learning to make cars with navigation, infotainment and other features that can
be constantly updated. Mercedes-Benz, Tesla, Toyota, BMW, and others can now update vehicle
software wirelessly to fix problems or add more capability
Shapiro says the cost-conscious auto industry has had to learn to spend a little more—maybe $10 to
$20 per car—on computer hardware. Automakers would often go with the cheapest option but then
spend even more fixing bugs, or be forced to replace processors that didn't have enough power to
add updates.
Nvidia now has eight permanent engineers at various automakers in Michigan.
In this photo taken Thursday, Aug. 13, 2015, technical director Dragos Maciuca poses while
sitting in a driving simulator in the immersion lab of the Ford Motor Company Research and
Innovation Center in Palo Alto, Calif. Maciuca left Apple …more
"We've helped them adopt more of a computer industry mindset, which is not to reinvent what they're
doing every five to seven years," Shapiro says.
Even with that new spirit of collaboration, automakers and tech companies also use their local labs
to do a little spying.
Frankie James, a former NASA researcher who now runs General Motors' Palo Alto office, says
spotting trends and potential threats is one of the most important parts of her job. Her team alerted
GM to the car-sharing trend, for example, and the automaker invested $3 million in Relay Rides in
2011.
Now, she's watching companies that could potentially disrupt the auto business, such as Google and
Apple. Google has promised a self-driving car within five years, and Apple has hired people from
Tesla, Ford and other car companies for its own top-secret project.
In this photo taken Thursday, Aug. 13, 2015, Nitin Bandaru, right, works on a hackathon project
at the Ford Motor Company Research and Innovation Center in Palo Alto, Calif. The
convergence of cars and technology is blurring the traditional …more
"We need to say, 'OK, if we think Apple is going to build something like this because they've got this
vision of the future,' if we take that same vision of the future, what can we do? How can we continue
to play?" James says.
The tech industry is also watching its back. Telenav is making a new navigation system for the 2016
Tacoma pickup and other Toyota vehicles, but Apple and Google are also vying for the car's
dashboard with their CarPlay and Android Auto systems, which give drivers access to certain
smartphone apps.
In this photo taken Thursday, Aug. 13, 2015, is the foyer of the Ford Motor Company Research
and Innovation Center in Palo Alto, Calif. The convergence of cars and technology is blurring
the traditional geographical boundaries of both …more
Telenav's Berkery says automotive accounts for 70 percent of its business, up from just 10 percent
when it opened its 10-person Detroit office four years ago. Its success in Detroit led to new offices in
Berlin, Shanghai and Tokyo.
"A huge amount of disruption is going to take place in this landscape, and new players will come in,"
Berkery says. "There's no reason why traditional players will succeed."

Read more at: https://phys.org/news/2015-08-high-tech-cars-detroit-silicon-valley.html#jCp

https://phys.org/news/2015-08-high-tech-cars-detroit-silicon-valley.html

Industry Boundaries
Why is a definition of industry boundaries important?

First, it helps executives determine the arena in which their firm is competing.

Second, a definition of industry boundaries focuses attention on the firm’s

competitors. Defining industry boundaries enables the firm to identify its
competitors and producers of substitutes products. This is critically important to
t6the firm’s design of its competitive strategy.

Third, a definition of industry boundaries helps executives determine key factors for
success.

Finally, a definition of industry boundaries gives executives another basis on which

to evaluate their firm’s that forecast, they can determine whether those goals are
realistic.

INDUSTRY BOUNDARIES
An industry is a collection of firms that offer similar products or services. By “similar products,” we
mean products that customers perceive to be substitutable for one another. Why is a definition of industry
boundaries important? First, it helps executives determine the arena in which their firm is competing.
Second, a definition of industry boundaries focuses attention on the firm’s competitors. Defining industry
boundaries enables the firm to identify its competitors and producers of substitute products. Third, a
definition of industry boundaries helps executives determine key factors for success. Finally, a definition of
industry boundaries gives executives another basis on which to evaluate their firm’s goals.

Defining industry boundaries is a very difficult task. The difficulty stems from three sources:
1. The evolution of industries over time creates new opportunities and threats.
2. Industrial evolution creates industries within industries.
3. Industries are becoming global in scope.

To realistically define their industry, executives need to examine five issues:

1. Which part of the industry corresponds to our firm’s goals?
2. What are the key ingredients of success in that part of the industry?
3. Does our firm have the skills needed to compete in that part of the industry? If not, can we build
those skills?
4. Will the skills enable us to seize emerging opportunities and deal with future threats?
5. Is our definition of the industry flexible enough to allow necessary adjustments to our business
concept as the industry grows?

http://cstl-hcb.semo.edu/wredmond/nibs/Porter's-Five-Forces.htm
Vertical Boundaries of a firm

The vertical boundaries of the firm illustrate which activities the firm would perform itself and which
it would leave to the market.

Vertical Boundaries of a Firm

The production of any good or service usually requires a wide range of activities organized in a
vertical chain. Production activities are said to flow from upstream suppliers of raw inputs to
downstream manufacturers, distributors and retailers.

Activities in the chain include processing and handling activities, which are associated directly
with the processing and distribution of inputs and outputs, and professional support activities,
such as accounting and planning. Another set of questions that may arise when managers/firm
operators attempt to define their firm is to ask: What activities do we do? What do we leave to
the market? This is known as the “make-or-buy” problem.

http://onediscuss.blogspot.com/2013/05/vertical-boundaries.html

Disclaimer: This essay has been submitted by a student. This is not an example of the
work written by our professional essay writers. You can view samples of our professional
work here.

Any opinions, findings, conclusions or recommendations expressed in this material are

those of the authors and do not necessarily reflect the views of UK Essays.

Businesses, though self-motivated, are social mission and their services to continue
allocation of economic resources to best serve the end-user rests on their successful and
profitable operations. Therefore, the firms keep trying to reduce their risks and
uncertainty arising within the interaction of firms in a market and ensure a continued
provision of good and services not only for their production facilities but also to the
consumers. One of the answers in this regard comes form the choice of firms to
integrate in the vertical chain of their market.

A market refers to an arrangement whereby different firms are strategically dependent

upon one another in order to procure their raw material from their suppliers and sell
their final product to the customers. All activities taking place from the procurement of
raw material to the sales comprises the vertical chain in the market (Coase 1988, pp.38;
Niehans 1987, pp.678; Cheung 1983, pp.21).

In such integrated markets comprising interdependent firms goods and services get
transferred across the entire vertical chain. Transaction costs, whereas, are all the
expenditure that incur along the vertical chain. Thus, these costs are elementary to all
trades and investments and may include both the internal as well the external costs of
firms. These costs bear critical and revolutionary impact on the firms 'marginalization'
and 'substitution' decisions (Coase 1988, pp.38; Niehans 1987, pp.678; Cheung 1983,
pp.21).
Transaction costs have assumed such an important place in the modern-day business
world that it is argued that they explain why firms exist or in other word they determine
the structure of firms which are motivated by the principles of self-interest and
opportunism especially to the extent firms will embrace vertical integration. Thus, the
concept of opportunism is central to the concept of Transaction cost economics and is
conducive to economic activity (Williamson 1979, pp.234).

Opportunism defines active markets which serve as platforms where individual firms buy
and sell and compete. The concept of opportunism, nevertheless, dictates that firms
interact with each other on the platform of the market in ways to maximize their gains
within the paradigms of their strengths and weaknesses. Thus, there are always
incentives for the firms to capitalize on their strengths and curtail their weaknesses
through inter-firm interactions which give rise to undertaking of mutual activities by
firms resulting in three key characteristics of transaction costs: (1) there exists strong
mutual interdependence among firms when they reach a contract, (2) every firm tries to
snatch the biggest piece of the share and (3) it is often difficult to put each and every
contingency enforceable in the contract (234).

The existence of transaction costs, hence, forms the institutional basis for the
explanation of vertical mergers. Thus, according to Williamson firms rarely integrate for
technological reasons rather most of the drivers of such changes are economic in
nature, mostly relating to anticompetitive effects of vertical integration. The vertical
integration, thus created, often results in preservation of a complex contracting
relationship. However, the root causes of vertical integration can be traced to
transaction costs and the conditions of asset specificity (Ben Porath, 1980, pp. 4;
Winston 2000, pp.4).

Assets specificity takes place when firms develop their core competencies by investing in
general purpose or specific purpose assets. The assets specificity may take several
different forms in terms of site specificity, physical asset specificity, human asset
specificity, dedicated assets and brand name capital. The specific purpose assets,
nonetheless, are normally durable assets that happen to possess greater risk because
their use is dependent majorly upon the life of contracts and there are lesser alternatives
courses of action where these assets can be put to use. Consequently, the value of
specific assets falls in transactions other than the purpose for which they are meant.
Resultantly, a seller is unable to sell a specific asset to a buyer with a purpose not
suitable for the use of the asset (Williamson 1985, pp. 55).

In order to avoid the fall in the value in specific assets, there arises a need for vertical
integration which enhances the chances of the continuation of the purpose for which a
specific asset is meant. As a consequence of the continuity of relationships, at first, the
requirements of acquiring specific assets are reduced. Secondly, vertical integration
increases the continuity of specific transactions providing certainty to the life of specific
transaction. Thirdly, it results in contractual and organizational safeguards (Ben Porath,
1980, pp. 4). In addition to these, asset specificity becomes important for firms in
matters relating to bounded rationality, opportunism and uncertainty. Whereas
bounded rationality is the intended rationality of firms but only limitedly so (Simon,
1961, pp. xxiv). All in all, transaction cost economics considers human behavior subject
to an economizing rationality without cognitive constraints.

Alongside asset specificity, the nature of contract among firms also gains weight in the
discussion of transaction costs economics. Hart and Moore (n.d., pp.182) thus claim,
"firms are important when contracts are incomplete, and parties make large
relationship-specific investments." However, though the analysis of the incomplete
contracts is still not understood well, research carried out so far depicts that everything
can not be stated in a contract and as result the contract is termed as incomplete (Buhai,
2003, pp. 1-4).

The incompleteness of contracts is subject to several factors including denotation of

ownership, bounded rationality, asset-specificity, financial securities and several other
economic factors. Thus, resultantly contractual gaps stems out of these conditions or
shortcoming which allows the contracting parties to behave in uncertain ways regarding
their decision of make-or-buy (Buhai, 2003, pp. 1-4; Segal, I, 1999, pp. 57).

Before Williamson introduced the concept of transaction cost economics, firms had
been focusing on the weighing up of their cost and risks against the benefits of using
markets to buy their input as well as sell their outputs. However, the focus has now
shifted to transactions costs in order to make decisions in getting hold of firms' inputs
either by making them or buying them from the market. If a firm chooses to create its
inputs there occurs vertical integration whereas if it chooses to buy them from the
market there occurs vertical separations (Jacobides, Michael G.; Billinger, Stephan, 2006;
Tan 2009).

Resultantly, the extent of vertical integration rests on the aggregation of make-or-buy

decision of firms in an integrated market (Jacobides, Michael G.; Billinger, Stephan, 2006;
Tan 2009). According to Jacobides, Michael G. Billinger and Stephan (2006) transaction
cost economics, vertical scope and bounded rationality become the core considerations
in make-or-buy dilemma- with emphasis on the relationship of asset specificity to
vertical integration (Jacobides, Michael G.; Billinger, Stephan, 2006).

Recent research, however, signifies the complexity of the boundary decisions which
enable firms to deicide on in-house production within the confines of their vertical
boundaries. The vertical boundaries of firms within an industry are determined by the
capabilities of in-house production possessed by individual firms. The individual
capabilities are, in turn, determined by the nature and capabilities of the market or the
industry as a whole (Macchiavello, 2009, p. 1-4).

In addition to make-or-buy decision and vertical integration firms also exhibit certain
intermediate arrangements. According to Dyer (1996) and Powell (1990) there is,
therefore, growing recognition of forged alliances or participation in networks to
exchange inputs or outputs (qtd. in Jacobides, Michael G.; Billinger, Stephan, 2006).
Transaction costs economics theory labels these structures as "hybrids," which includes
long-term contracts, franchising, joint ventures and the like.

The overall success of firms' desires to integrates vertically heavily rests on the level of
coordination among the firms within an industry. Though vertical integration reaps
benefits for firms in terms of reduced costs of transaction along the vertical chain, there
are elements which may hamper the incidence of coordination. At first, firms are
motivated by opportunism which may result in breach of coordination. Secondly, in the
face of incomplete contracts firms may avail contingent activities jeopardizing the gains
from the vertical integration for the other firms (Jacobides, Michael G.; Billinger,
Stephan, 2006).

Nonetheless, there are several incentives for the firms to opt vertical integration. These
incentives for the firms to coordinate in a vertically integrated setup stem out of the
forces like dominance over market procurement, reduced transaction costs (TC) and
improved profitability, the fear of expropriation, the desire to increase incentive
alignment through integrated ownership, the need for superior monitoring or the
inability to educate outside suppliers about desired properties (Jacobides, Michael G.;
Billinger, Stephan, 2006). All in all, the vertical integration results in economies of scale,
reduced risk and uncertainty as well as increased profits.

Conclusion
Firms compete with one another for resources and share in the market full uncertainty
and risk. In order to maximize the gains from its operations, firms often resort to
activities that reduce their costs, the level of risk and uncertainty and improve profits.
Transaction costs Economics, thus, explain the very reasons how firms evolve and
integrates in the face of concerns like incompleteness of contracts, asset specificity,
property rights issues etc. However, the extent of the vertical integration rests heavily on
the vertical boundaries of the firms as well as vertical scope of the industry. Nonetheless,
vertical integration calls for coordination which is normally a difficult variable to control
in the presence of opportunism and self-interest. However, vertical integration, if
managed strategically, does pay off.

https://www.ukessays.com/essays/economics/transaction-cost-economics-and-vertical-boundaries-of-
firms-economics-essay.php

Vertical Boundaries of the Firm Revised: August 31, 2001

One of the defining characteristics of a firm is the extent of its activities. This includes its size, the range
of products it sells, and the extent of its control over distribution and production. Thirty years ago, an
airline would own planes, run its own reservation system, hire flight crews and so on. But if an airline
leases jets and outsources maintenance and reservations, is it still an airline? Even if it is, does it make
sense to have others run operations that seem inseparable from the airline business? Is a PC still a Dell
if all the parts are made by other firms? Apparently the answers to all of these questions are “yes,”
since they’re standard practice. The boundaries of what’s done inside a firm and what’s done outside
are one of the most interesting developments in modern business and worth a closer look.

Today we'll look at the firm's vertical boundaries: the extent to which it expands upstream into its
supply chain or downstream into distribution. Virtually all firms face a recurring issue of whether to
assume ownership and control over suppliers or distributors; what we term “vertical integration.” How
does a firm decide whether to produce inhouse or outsource: whether to make or buy? The answer: It
depends. There are advantages to producing in-house, and other advantages to outsourcing.
Depending on the circumstances, one or the other might be better. And in some cases, firms have
figured out ways to get most of the benefits of both.

Examples

Dell. Known for its ability to manufacture PCs to order from parts made by others, an extreme case of
vertical separation. Monitors made by Sony and Philips, processors by Intel, and motherboards by
Solectron.

Cablevision. In addition to its cable business, Cablevision Systems Corp owns Rainbow Media Group
(which owns five national cable channels, including AMC, IFC, and Bravo, as well as the Knicks and
Rangers sports teams), Lightpath (a Long Island cable phone company), and The Wiz (electronics
retailer).
JP Morgan. Prior to its merger with Chase, JP Morgan outsourced its IT support to a four-firm alliance
headed by Computer Sciences Corp. Their 7-year deal was worth an estimated $2.1 billion.

Merck Medco. In 1993, Merck bought “pharmacy benefits manager” Medco to give it access to an
important retail distribution channel.

Firms and Markets Lecture Notes

Vertical Boundaries Page 2

IBM PCs. When IBM came out with its “personal computer” in 1982, it asked Intel to make the
microprocessors (the 8088), Microsoft to write the operating system (DOS), and Tandon to produce the
floppy disk drives.

Advantages of Outsourcing

Among the most important issues governing an outsourcing decision are:

• Production efficiency. If others can produce more at lower cost, let them do it! There are a variety of
reasons why one firm might have lower costs than another. The key reason is scale economies. If a firm
is too small to produce a particular input efficiently, it should probably buy it from a supplier who can.
That’s why the Stern School doesn’t make its own paperclips, write its own network software, or run its
own food services. Specialization is a variant of this idea: although most large firms have their own
legal departments, they often hire specialists for specific problems (M&A, for example). Core
competence is another. Sometimes a firm is large enough to produce its own inputs, but producing
inputs doesn’t play to its strengths.

• Competition among suppliers. The discipline of the market often provides an attractive price/quality
tradeoff. Obviously this is not the case if you face a monopoly supplier. Conversely, in-house
production typically faces less discipline, particularly in a large firm. (Anyone who has worked at a large
firm knows the hazards of dealing with the in-house “monopoly provider.”) This latter is often referred
to as the problem of “agency.”
Advantages of In-House Production

Among the important issues governing a decision to produce in-house are:

• Relationship-specific assets and the holdup problem. Sometimes the process of outsourcing involves
investments that are specific to the relationship. Once those investments are made, the investor is at
the mercy of the other party. The classic example is Fisher Body, now a subsidiary of GM. For years,
Fisher made chassis for GM. When the technology changed from wood to metal, however, production
required a large investment. Location was critical, and GM wanted the plant to be next to its assembly
plant. Fisher was hesitant to make the investment, which would put GM in a strong bargaining position
after it was made. GM, on the other hand, had difficulty writing an appropriate long-term contract,
since it could not forecast demand years ahead. The dispute was resolved when GM acquired Fisher
Body in 1926.

The problem, in this case, is the difficulty of writing a contract that would cover every contingency. If
Fisher and GM could have written a contract that assured Fisher it would not be exploited, they might
very well have continued as separate entities.

Vertical Boundaries Page 3

• Control over the supply chain. It’s generally more difficult to coordinate activities through markets
than within a firm, but how difficult it is depends on the product. There’s little difficulty in buying
commodity products like paperclips. But when fine details about the product are critical, it can be easier
to produce in-house. A good example is Spain’s Inditex, the private company that makes and sells
apparel under the Zara and other brand names. They argue that an integrated supply chain makes it
possible to respond more quickly than competitors to changes in fashion than if they outsourced
production to low-cost suppliers in Asia.

A variant of this argument applies to new products. The manufacturer of a novel product may need to
design specialized inputs, which can be easier to do in-house. In many examples, inputs move outside
the firm once the industry grows (so that scale economies kick in) and matures (so that the technology
settles down). Cell phones are a good example.

• Information. There are a couple of issues related to information. One is information about the
market. Integration into distribution provides useful and timely information about market conditions.
Zara is again a good example. By owning retailers, they get virtually instant feedback on market trends.
A second information issue is the ability to keep proprietary information confidential. This is particularly
important where such information is valuable (pharmaceuticals, perfume).

• Strong buyers or sellers. When faced with buyers or sellers who have strong market position, firms
may decide to integrate to protect themselves. An important special case is termed “double
marginalization”: If a monopoly producer has a monopoly supplier, the effect on the retail market is to
restrict production more than a single integrated monopoly would. A single integrated monopoly would
make higher profits at a lower price. Short of this, firms might well integrate to compete with a
monopoly supplier (Nielsen, Shimano). Or if they are concerned about access to supply or distribution
might very well acquire them. Eg, the battles between AOL/Time-Warner (which has cable and internet
distribution channels) and Disney (which does not). Similary, Orbitz is the response of several major
airlines that Travelocity and Expedia were gaining too much power over online sales of airline tickets.

Examples Revisited

It’s ridiculously easy to second-guess someone else’s decisions after the fact, but let’s see if we can
understand the logic behind the examples listed earlier.

Dell. Dell is a master of coordinating supply relations, but the extent raises some interesting questions.
What is the source of value Dell provides to customers? Can others imitate? Can (say) Sony sell directly
to customers and leave Dell out of the loop?

Vertical Boundaries Page 4

Cablevision. The standard explanations for integration don’t seem to apply here, with the exception of
the last one. Our guess is that Cablevision needs content, and since there are relatively few providers
(eg, movies, NY sport teams), and many of them are affiliated with potential rivals, the only way to
insure supply is to produce in-house. The biggest cost is the difficulty of managing such a diverse
portfolio of businesses. Do they really need The Wiz? Cable phone, of course, is a possible economy of
scope, which we’ll discuss in the next lecture.

JP Morgan. The difficulty of outsourcing IT is that it’s critical to the business yet hard to define precisely
what the service is that’s being outsourced. A classic case of market relationships being difficult to
manage. Many observers think that for large financial institutions, you should have strong internal IT
support. More basic services, though, might be outsourced. For example, some firms outsource
management of their web servers, which has become something of a commodity business
(homogeneous product, lots of suppliers).

IBM and Microsoft. The standard comment is that this was a dumb move by IBM. One
counterargument is that IBM was late to the market for microcomputers, and couldn’t have moved as
quickly if it had done everything in-house. Another is that they were operating under threat of anti-trust
action (a 13-year suit was dropped by the US after Reagan took office).

Merck Medco. This seems like another defensive purchase, in which Merck was protecting itself against
consolidation in distribution. It was apparently triggered by Clinton’s study of health care, which died
without trace. The question is whether it makes sense going forward. If you were Merck’s CEO and did
not own Medco, would you buy it?

Mixed Systems

So far, we have only considered two extreme options: make or buy. Some of the best solutions lie in
between.

One is “tapered integration,” in which firms integrate some operations but leave some to the market.
An example is Pepsi and Coca Cola, which own some of their bottling facilities but do not control the
entire value chain that gets the product to the consumer. In doing so, the firms can wield influence in
their input markets while also ensuring the existence of competition with respect to prices and service
quality.

Another popular solution is “franchising.” Franchising typically involves a firm owning some, but not all
of its downstream operations. Wendy’s, for example, might operate some of its own restaurants and
also sell licenses to third parties to operate others. The question is how to handle any specific assets.
Generally the franchise contract gives Wendy’s control over things that affect the brand (menu, image)
and the franchisee

Vertical Boundaries Page 5

control over non-specific assets (the lease). A third intermediate solution is the so-called “Japanese
system.” In Japan, firms have long-standing relationships with suppliers that seem to avoid the
problems of vertical integration and vertical separation. Toyota has very close control over its supply
chain, despite using outside suppliers extensively. The relative success of this system has let people to
ask how important cultural factors are in maintaining such system of relations among firms. Also, as we
consider the Japanese system, the exact definition of firm boundaries becomes less clear, which
ultimately begs the question of what a firm is. Finally, firms have become more sophisticated in terms
of the kinds of contracts they might write. Even without ownership, they might be able to control key
aspects of a relationship. “Vertical restraints” are arrangements among firms in a value chain that
effectively reinforce vertical relations without explicit integration. The purpose of such arrangements is
to induce more efficient pricing, output and advertising decisions for the value chain. For example,
Pepsi creates exclusive agreements to act as a monopoly supplier in some restaurants. In another
example, Ford may authorize dealers only to sell its vehicles. Why would it do this? Otherwise, it could
encounter the problem of training salespeople who then use these newfound skills to sell Chryslers.

Another contracting issue is “resale price maintenance.” What if you could travel to store A and receive
excellent service from staff in helping you choose a stereo, and then travel to store B to make your
purchase? At store B, a bargain basement outlet, no investment has been made in sales so prices are
lower. Service stinks, but you already made your decision based on Store A’s stellar service. In this case,
the store with lousy service is essentially free-riding off the store with better service. Store A loses sales,
and the manufacturer will probably lose in the end if it depends on consistently high-quality service for
its goods. (Not everyone, after all, will figure out the Store A/Store B trick). To prevent such behavior
without integrating into retail centers, manufacturers thus impose resale price maintenance –
establishing a minimum, standard price for retailers to prevent free riders from relying on other stores.
In other words, manufacturers ensure that prices will be more consistent from store to store; thus
quality of service and (higher) price guarantees can be delivered back to the manufacturer.

These issues will be explored at length in your Corporate Strategy course, next term.

Legal Issues
Government competition policy sometimes plays a role, as it has in the separation of film production
and distribution in the US from the 1940s until recently, the 1984 breakup of AT&T, the proposed but ill-
fated plan to separate Microsoft’s operating system and applications units, and the enforced separation
of UK brewing and pub ownership.

Vertical integration is not per se illegal (ie, illegal in and of itself). But it can be in practice if it’s used to
hinder competition. The question for policymakers is to decide

Vertical Boundaries Page 6

when vertical integration enhances efficiency and when it’s simply a device to hinder competition. It’s
not an easy call, ever, and the unclear state of the law reflects that.

Written by Chris Chamberlain under the direction of Luís Cabral and David Backu

pages.stern.nyu.edu/~dbackus/1303/notes_vertical.pdf

PROS AND CONS OF OUTSOURCING

What does outsourcing and offshoring mean?

Outsourcing is the process of assigning a company's business processes to an external agency in
lieu of enhancing service quality, driving innovation or deriving benefits of lower labor costs.
When outsourced to organizations located in other countries or to foreign subsidiaries,
Outsourcing often takes the form of offshoring, also known as offshore outsourcing.
 What are the effects of outsourcing?
The effects of outsourcing are subjective to the industry and the purpose for which the same was
undertaken. However across industries outsourcing is primarily undertaken to enable companies
to generate better revenue recognition and to provide them an added competitive differentiator.
While done with the best of intentions, outsourcing has a telling effect on quality of products and
services delivered as a consequence of this, either enhancing or lowering quality.

52 Second Guide to How We Work

While there could either be an increase or decrease in the turnaround time while outsourcing, it
could also result in improved or decried customer service. Outsourcing, primarily undertaken to
provide companies the competitive edge, can also result in easier management and better
productivity based on how effectively the process in managed.

What are the pros and cons of outsourcing?

Outsourcing is often undertaken to provide enterprises a competitive advantage by delegating
business process to external agencies and realizing the benefits of low labor, better quality and
improved innovation. While this provides a good picture of the fair side of the coin, most
managers however need to grope with the possible shortcoming of the process and the
corresponding impact on the company's core processes. To best analyze the opportunities
presented it is essential to reflect upon the advantages vis-à-vis the disadvantages of outsourcing.

The pros of outsourcing

The pros of outsourcing often positively reflected by enterprises across industries include -

 Better revenue realization and enhanced returns on investment

 Lower labor cost and increased realization of economics of scale
 Tapping in to a knowledge base for better innovation
 Frees management time, enabling companies to focus on core competencies while not being concerned
about outsourced routine activities
 Increases speed and the quality of delivery of outsourced activities
 Reduces cash outflow and optimizes resource utilization

The cons of outsourcing

Often weighed with the advantages before any decision on outsourcing is undertaken, the
following represents some of the possible disadvantages often dwelled upon -

 Possible loss of control over a company's business processes

 Problems related to quality and turnaround time
 Sluggish response times coupled with slow issue resolutions
 Shortcomings in performance vis-�-vis expectations
 Lower than expected realization of benefits and results
 Issues pertaining to lingual accent variation
 An irate customer base coupled with enraged employee unions

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