FOUNDATIONS OF INTERNATIONAL STRATEGY 2019-2020

EXERCISE 1 – Business level strategy applications

The goal of this exercise is to discuss main frameworks of Business strategy.

The profitability of different industries

The following table enlists different industries sorted by their median profitability during the seven
years from 1999 to 2005. Let us focus on two industries with the highest performance and the lowest
performance – Tobacco industry and Airlines industry.

Profitability of US industries - Median return on equity (ROE) (%), 1999-2005

Tobacco 21.6 Food and Drug Stores 10.0

Food Consumer Products 19.6 Motor Vehicles & Parts 9.8
Securities 18.9 Hotels, Casinos, Resorts 9.7
Diversified financials 18.3 Railroads 9.0
Beverages 18.8 Insurance: Life and Health 8.6
Mining & crude oil 17.8 Packaging & Containers 8.6
Petroleum Refining 17.3 Insurance: Property & Casualty 8.3
Medical Products & Equipment 17.2 Building Materials, Glass 8.3
Commercial Banks 15.5 Metals 8.0
Scientific & Photographic Equip. 15.0 Food Production 7.2
Apparel 14.4 Forest and Paper Products 6.6
Computer Software 13.9 Semiconductors & Electronic Comp. 5.9
Publishing, Printing 13.5 Telecommunications 4.6
Health Care 13.1 Communications Equipment 1.2
Electronics, Electrical Equipment 13.0 Entertainment 0.2
Specialty Retailers 13.0 Airlines -22.0

1. What are the forces that according to M. Porter determine the industry profitability?
Name them and briefly explain each of them.

According to Michael Porter there are five forces which determine the industry profitability:
“The threat of new entrants” (low entry barriers, new firms will promote low-cost services
which will affect the initial firm’s profitability), “The bargaining power of suppliers”
(suppliers can take advantage and increase the prices of their delivered products or decrease
the quality), “The bargaining power of buyers” (buyers can demand lower prices and better
quality at the same price), “The threat of substitutes” (there is the same qualitative product
produced by another industry but cheaper), “Competition among rivals” (intensity of
competition within an industry).

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2. Using your general knowledge about the Tobacco and Airlines industries, apply
Porter’s Five forces framework to explain the profitability of these two industries.

2A. Tobacco industry

Using Five forces model, explain the high performance of Tobacco industry. What is the most
important force(s) that determines the Tobacco industry profitability?
2. Threats of substitutes
products and services

 The threat is high

because of the other
devices/products that
have been created
and are sold at a
lower price (nicotine-
free/ E-/ rolled
cigarettes)

4. Power of suppliers 1. Rivalry among competing 5. Power of buyers

sellers in the industry
 The threat is  The buyers’ power is
moderate and  Because of the high relatively low because
depends on the number of smokers on there will always be
number of suppliers the market, the rivalry smokers on the
and the scarcity of within the industry is market that will buy
resources high cigarettes no matter
what the price will be

3. Potential new entrants

 Easy to enter, but

hard survive
 Many existing
companies within the
industry
 Hard to promote the
new brand (no
advertising)

The most important force that determines the Tobacco industry profitability is the threat of
substitutes products and services because nowadays more and more people will try to find an
alternative of this expensive hobby and eventually quit.

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2B) Airline industry

Using 5 forces model, explain the low performance of Airline industry. What is the most important
force(s) that determines the Airline industry profitability?
2. Threats of substitutes
products and services

 The threat is low

because there are not
many alternatives
which can achieve
what the planes can
(trains aren’t capable
of crossing an ocean)

4. Power of suppliers 1. Rivalry among competing 5. Power of buyers

sellers in the industry
 The suppliers’ power  The buyers have
is high because many  Rivalry is high bargaining power
airline companies rely because the plane because planes have
on external tickets are in general become a necessity,
transactions the same for all being a time- and
companies money-savior

3. Potential new entrants

 The entry barriers are

high because a big
amount of capital,
labor and knowledge
is needed

The most important forces that determines the Airline industry profitability are the
bargaining power of suppliers (high prices for the materials) and the rivalry among the
competing sellers in the industry.

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3. Let us focus on the Airlines industry. Apply the concept of strategic groups to this
industry.
3 A) What is a strategic group in an industry?

The concept of a strategic group in an industry indicates a strategy which is more or less
followed by many firms in the same industry, plenty of similitudes being created among
firms and they will also have the approximate profitability due to this fact.

3 B) What strategic groups can you identify in the Airline industry? You can use examples of
companies from European airline markets. Please explain you answer.

In general, there are two big strategic groups: WizzAir, Ryanair, EasyJet, BlueAir which
represent the low-cost companies with the same strategy, small prices with almost the same
benefits and services; Lufthansa, KLM, AirFrance are the more costly flight services, which
function, however, on the same strategy, better quality, higher prices.

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EXERCISE 2 - COSWORTH

In 1958, two young very enthusiastic engineers, Keith Duckworth and Mike Costin, who worked
for the manufacturer of racing car Lotus Cars, founded Cosworth Engineering, where they worked
at night. At first, they worked in a small garage in Shaftesbury Mews, West London, but by 1964
Cosworth Engineering had established itself as a producer of racing car engines and the company
moved to Northampton. Both men were now working full time for the company and in 1966 they
signed a contract with Ford to put their DFV engines in Ford’s racing cars. The deal turned
Cosworth into a world leader and in the following years the DFV engine gathered numerous Grand
Prix victories. Critical to the success of a racing car engine is the quality of the engine block casting
(i.e., the fixed parts of the engine that are made of advanced materials). Only the highest-quality
castings will allow the engine block to be machined to a width that will resist the required
pressures, at the same time weighing less than a conventional car engine. Grand Prix racing not
only involves frequent changes in engine design, but also race track success demands that each
new engine block casting be as near perfection as possible.

In 1979, Cosworth Engineering decided that only by vertically integrating to produce their own
castings could they achieve both the flexibility and the care and attention they demanded to remain
amongst the leaders in racing car engine design and Grand Prix racing.

The objective of this exercise is to apply the framework proposed by Transaction Cost Economics
to the decision of Cosworth to vertically integrate the casting production. You will be asked to
analyze this decision using the concepts of TCE and explain whether or not it is in accordance with
the predictions of Transaction Cost Economics.

1. According to TCE, how does Asset Specificity affect the decision of a firm to perform an
activity in-house or through a buyer-supplier relationship? Explain.

According to TCE, Asset Specificity leads to hold-up situations for the suppliers because
they produce assets which will be bought only by one buyer. Therefore, the buyer has a
higher bargaining power, having the possibility to dictate the price which is inconvenient
for the supplier. Because of the high level of asset specificity, the suppliers’ risk increases
and as a consequence the suppliers will chose to perform activity in-house.

2. According to TCE, how does Uncertainty affect the decision of a firm to perform an activity
in-house or through a buyer-supplier relationship? Explain.

Uncertainty is the result of bounded rationality and opportunistic behavior, which lead
markets to inefficiency. Uncertainty means most of the time incomplete information,
therefore the firms will be reticent to take decision and make transactions. In market
transactions (buyer-supplier relationship) the level of uncertainty is low, while in the
internalization processes (in-house), the uncertainty level is high.

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3. According to TCE, how does Frequency affect the decision of a firm to perform an activity
in-house or through a buyer-supplier relationship? Explain.

If the Asset Specificity and Uncertainty levels are high in a buyer-supplier relationship
which occurs frequently, it will increase drastically the risk that the suppliers have to face
while doing transactions (price adjustments, constraints regarding production). For this
reason, Frequency affects the firm’s decision-making process only if the Asset Specificity
and Uncertainty levels are taken into consideration.

4. According to TCE, what is a “hold-up” situation? Explain how it affects the decision of a
firm to perform an activity in-house or through a buyer-supplier relationship.

A “hold-up” situation materializes when the assets produced by suppliers are specific and
they cannot be sold to more than one buyer. As a result, the buyer will have more
bargaining power than the supplier, having the advantage to impose the price at which the
asset will be bought. This will lead to more expensive buyer-supplier contracts, in-house
production becoming the alternative.

Apply the TCE concepts to the case of Cosworth

5. Does TCE’s Asset Specificity concept suggest that Cosworth should produce castings
internally, or conversely, that Cosworth should outsource castings production to
specialized suppliers? Explain.

The high level of Asset Specificity indicates that the optimal solution would be to produce
castings internally. As it is stated above, the employees are specialized in producing this
specific kind of castings, therefore there will be a human capital specificity within the firm.

6. Does TCE’s Uncertainty concept suggest that Cosworth should produce castings internally,
or conversely, that Cosworth should outsource castings production to specialized
suppliers? Explain.

Bounded rationality and opportunistic behavior lead to high levels of Uncertainty. In this
situation, it is better if Cosworth produces the castings internally because they will diminish
the risk of opportunistic behavior (suppliers will try to charge the company higher prices
or the company will try to obtain the castings at a lower price).

7. Does TCE’s Frequency concept suggest that Cosworth should produce castings internally,
or conversely, that Cosworth should outsource castings production to specialized
suppliers? Explain.

Considering the fact that the Cosworth has high levels of Assets Specificity and
Uncertainty, the Frequency level will boost even more these 2 critical dimensions.
Cosworth was already facing the AS and U risk, which will be multiplied if the transactions
take place frequently.

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8. Describe a possible “hold-up” situation in the castings production business.

The “hold-up” situation might occur because Cosworth will be coerced to buy the castings
at an overprice, suppliers taking advantage of the situation that they produce vital
components for the cars’ forgery. If Cosworth would focus to produce the castings
internally, the risk will be eliminated.

9. Evaluate whether Cosworth’s decision to internally produce castings is in conformity with

TCE predictions.

 Decision is in conformity with the TCE prediction regarding Asset Specificity

 Decision is in conformity with the TCE prediction regarding Uncertainty
 Decision is in conformity with the TCE prediction regarding Frequency

Explain.

The decision to internally produce castings is supported by the followings. First of all,
many “hold-up” situations can occur because the assets (castings and human capital) that
the Cosworth requires are specific. Secondly, Uncertainty is another factor that rises the
company’s risk (bounded rationality and opportunistic behavior) while making
transactions externally. Last but not least, if the frequency of the transactions is high,
Cosworth would face extremely big problems regarding the castings’ production.

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EXERCISE 3 – CANADAIR

The purpose of this exercise is to use an Organizational Learning lens to analyze and explain the
life history (since 1945) of the Canadian aircraft producer in the ‘fighter aircraft’ area of business.

Canadair was a Canadian aerospace firm that successfully introduced two fighter aircraft models
through in-licensing (it commercialized models which were previously developed by another
aircraft manufacturer): the CL-13 (a license-built F-86 Sabre from North American Aviation) in
1949 and the CL-30 (a license-built Lockheed P-80) in 1952. Encouraged by the success of these
two aircraft (sales eventually totaled 1,815 and 656 units, respectively), in 1955 Canadair decided
to develop its own design for a third aircraft, the CL-41 Tutor. The CL-41 project was plagued by
stability problems, stemming in part from a change in engines from the prototype stage to the
production stage. Problems with spin recovery forced Canadair to redesign the tail, changing from
a cruciform tail, which it had carried over from its licensed projects, to a more appropriate T-tail
design. Full production of the CL-41 was delayed until 1963, and orders never met projections. In
1966, Canadair terminated production of the CL-41 after building only 212 aircraft and returned
to in-licensing for its next aircraft, a version of the Lockheed F-104. Canadair never attempted to
independently develop another fighter and eventually exited the market.

Newspaper articles published in the 1950s and 1960s indicate that Canadair had initially
encountered challenges during the in-licensing programs. For the CL-13 project, North American
Aviation was unwilling to divulge details of its technologies, contrary to what Canadair expected.
The CL-30 program initially faced challenges in installing a powerful engine, challenges that could
not have been solved without the important help of Lockheed. Nonetheless, Canadair successfully
overcame these challenges with the in-licensed programs.

Newspaper articles also suggest that the independent CL-41 project faced at least two substantial
challenges. The first was an unfortunate choice of a heavy engine that required extensive design
changes to the plane—and in particular to the tail section of the plane—in order to accommodate
the extra weight. The second challenge was a slower than expected transition from prototype to
production scaling.

Key insights from the Organizational Learning literature

1. What is causal ambiguity? What is the relationship between levels of causal ambiguity and
a firm’ competitive advantage?

Causal ambiguity may protect a firm from undesired imitations. This means that it will be
hard for competitors to understand the firm’s strategy, outcomes and production processes,
therefore the firm will have competitive advantage regarding the production of
goods/services.

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2. Explain the relationship between the levels of causal ambiguity involved in a given task
and the task’s potential for experiential learning.

3. Is the potential for experiential learning greatest when firms successively undertake similar
tasks or dissimilar tasks?

4. How does causal ambiguity impact the potential for experiential learning when firms
successively undertake similar tasks?

5. How does causal ambiguity impact the potential for experiential learning when firms
successively undertake dissimilar tasks?

Apply these insights to analyze and explain the life history of the Canadian aircraft producer
(since 1945)

6. Does aircraft licensing generally allow for experience effects? Explain

7. Did Canadair benefit from its licensing experience accumulated with the CL-13 when it
introduced the CL-30? Explain.

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8. How would you explain the firm’s decision to switch from licensed production to
independent design?

9. How would you explain the poor performance of the independent CL-41 project? Draw
upon Organizational Learning Theory.

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