Name: Francesca Marie R.

De Vera
Course/Yr: BSBA - Marketing Management 1
Subject/Sched: Strategic Management, Monday, 9am to 12nn

Topic: Perspectives of Strategy

A perspective is a way of viewing things, and every business should use multiple
perspectives to form a holistic vision of the company.
A strategic perspective is important as it develops the competitive mindset. The
strategic perspective can develop a range of approaches to common business
obstacles, such as market penetration and brand recognition. A strategic perspective is
not necessarily easy. In business, most employees and owners are flooded with daily
tasks and responsibilities that are essential to operations. While working through daily
processes, it becomes easy to miss the big picture.
A strategy is multi-dimensional: a concept or mindset, an approach or process, or
people. For some organizations, people are their most effective strategy because these
individuals effectively motivate and “pull” their workforce to near optimal levels of
productivity and creativity. In this chapter, we will go over the popular and much-
discussed military, game, and economics strategies. 

Military Perspective of Strategy

Boardrooms are like battlefields. Doing business or running an organization is
like fighting a war where strategies are the guns and ammunitions used during any
engagement.
To date, there are two popular books written or warfare. These are Sun Tzu’s,
The Art of War and Miyamoto Musashi’s The Book of Five Rings; one being Chinese in
origin and other, Japanese. The beginning of strategy date back four to five thousand
years before Christ. During the early stages of ancient civilization, tribal clans were
characteristically unstable. Wars were common: one tribe trying to conquer and subdue
the other or groups of clans joining forces to fight a common foe. In these Neolithic
village conflicts in China, men were compelled to go to battles and win their small wars.
Later on, these wars became bigger that men had to develop their ingenuity to combat.
Subsequently, they invented and perfected weapons to make sure that they could harm,
if not kill the enemy, and in addition, plan both offensive and defensive tactics and
operations.
People trained to win. Winning became the sole goal of engaging in war. Once
they won a battle, the conquerors distributed the spoils to the victorious forces. The
chieftains imposed their power and ruled over the people they subjugated. Dynasties
were established. This entire gamut of going to combat and waging wars became too
frequent that commanding generals had to make sure that their successful formulae for
winning were intact and not forgotten. This started the writing of battlefield lessons and
combat experiences, spelling the beginnings of the science of military tactics.

1. The Art of War. This book is the oldest military classic in Chinese literature.
Written around 400 to 320 BC, the exact origin of this book has not been
established, neither has its authorship been identified. According to scholars of
military science, The Art of War is included in the Seven Military Classics. Since
then, the book underwent translations into different original versions. In all these
translations, judicious scholarship was applied to ensure that the true essence of
the writings is not deviated or unjustly modified. Historical writings show that Sun
Tzu was the commander-in chief of Ho Lu, the King of Wu of China in 500 BC.
As a general, he waged and won many battles. To document how successfully
he won these victories, his tactics and military advice were compiled for posterity.
Sun Tzu's The Art of War is the first book that formalized strategy. Some pieces
of advice to military leaders are the following:

Sun Tzu in Present-day Strategy

Sun Tzu’s Writings Present-day Strategy
On Planning: "War is a matter of vital Doing business is an activity that
importance to the State. It concerns the necessitates planning. Considering the
lives and deaths of people and affects capitalization infused in any
the survival or demise of the State. It organizational venture, careful
needs to be thoroughly studied. With preparations have to be done. There
careful and detailed planning, one can should be no room for mediocrity and
win; with careless and less detailed haphazard groundwork. Thorough and
planning, one cannot win. How much precise study and planning can make a
more certain is defeat if one does not business successful. If dis- regarded or
plan at all! From the way planning is planned sloppily, success will be
done beforehand, one can predict difficult to attain, if at all.
victory or defeat."
On the Business Environment: In any business venture, organizations
"Know your enemy, know yourself, and should competently know both the
your victory will be threatened. Know external (business, national, and
the terrain, know the weather, and your global) and internal (knowledge of
victory will be complete.” people, products, services, facilities,
and management) environments.
Knowledge of the business milieu
prepares a company to compete and
take the right strategies.
On Measurement: “Terrain gives birth Performance is essential, such as
to measurement; measurement precision in productivity, sales figures,
produces the estimation of forces. business expenses, it will find difficulty
Estimation of forces gives rise to making its moves toward The need for
calculating the number of men. accuracy in measurement of and
Calculating the number of men gives investments in technology, facilities,
rise to weighing strength. Weighing and others. Unless a company knows
strength gives birth to victory.” its resources, achieving its set goals
and objectives.
On Competence: "Generals should Officers and managers should possess
possess the following strengths: qualities that epitomize expertise,
wisdom, knowledge, credibility, leadership, strong character,
strictness, benevolence, courage, management skills, good values, and
Skillful, unconcerned by fame, ethical standards. This confluence of
 unconcerned by punishment, places traits propels organizations to attaining
army first, tranquil, obscure, upright, success.
self-disciplined, clever with all-
encompassing talents."
Other Lessons from Sun Tzu
“Compare the enemy's army with yours Continuously change your strategies.
to know your own strengths and They should not be predictable.
weaknesses."
“Whoever is the first in the field will be All men can see the tactics whereby
fresh to await the enemy. The second one conquers, but none can see the
will hasten and arrive exhausted.” strategy out of which victory evolved.
“When the common soldiers are too You can be sure of victory if you attack
strong and their officers are too weak, places that are not defended.
the result is insubordination. When the
common soldiers are too weak and
their officers are too strong, the result
is collapse.”

The Art of War is necessary reading for any successful corporate

individual. He should have read or at the very least, should be familiar with this
book. Filled with comparisons and implications to any organization, its practical
applications are gleaned as one reads through the pages.

2. The Book of Five Rings. The author, Musashi Miyamoto, was born in 1584. His
lifetime witnessed Japan's history where feudal lords called "daimyos" were
fighting each other for land and power under weak emperors. Before Musashi's
birth in 1573, Oda Nobunaga rose to power to become Shogun in Japan. A
military dictator, he crushed all rebellions and tried to unify Japan. Hideyoshi,
who revived the power of the samurai, succeeded him. The samurai were
privileged to wear two swords: the long sword and the short one for everyone.
Commoners were not allowed to wear the long sword. Thereafter, Tokugawa
leyasu succeeded Hideyoshi and became Shogun of Japan.
 Musashi Miyamoto was a samurai. The samurai demanded the highest
esteem in Japan. They were an elite group that included rich young men,
government officials, warriors, lords, and soldiers. They fought and won wars.
However, when provincial armies were not necessary, they were disbanded
leaving Musashi and the other samurai with nothing to do. Some of these
samurai became artisans while others went back to their lands and castles.
Nonetheless, Musashi continued to pursue his ideal of a warrior. He searched for
enlightenment and perfect understanding by following the path of Kendo the Way
of the Sword. The Way of the Sword is the moral teaching of the samurai, a
combination of Zen, Confucian philosophy, and the Shinto religion.
The Book of Five Rings discusses the Way of Strategy. Musashi says that
there are four ways by which men pass through life. They are as (1) gentlemen
and samurai, (2) farmers, (3) artisans or carpenters, and (4) merchants. The
gentlemen belonged to the highest category and included officials and wealthy
people. The farmers were next because they provided the rice crops followed by
the artisans or carpenters. The last group was the merchants who later rose to
prominence because of the wealth they accumulated.

Musashi Miyamoto in Present-day Strategy

Musashi Miyamoto’s Four Ways Present-day Strategies
The Way of the Gentleman Warrior: An executive/businessman has to learn
"The way of the warrior is to master the how to appreciate the worth of his
virtue of his weapons. If a gentleman expertise capabilities, and skills. He has to
dislikes strategy, he will not appreciate the value the resources at his disposal:
benefits of weaponry." people, capital, technology, facilities,
equipment, and other assets. This is
valuing.
The Way of the Farmer: "Using With valuable and adequate information on
agricultural instruments, he sees springs developments, an executive/businessman
through autumns with an eye on the can manage an organization successfully
changes of the season." by being attuned to the changes in the
milieu. This is observing.
The Way of the Carpenter: "The way of Organizations have to be adept in the use
the artisan is to become proficient in the of business tools, models, and resources,
use of his tools; first to lay his plans with a such that plans are accurate and
true measure, and then to perform his achievable. Then can goals be concretized
work according to plan." and achieved. This is doing.
The Way of the Merchant: "The Every executive/businessman should
winemaker obtains his ingredients and optimize his human potentials and
puts them to use to make his living. The resources. His goal is to make profit,
way of the merchant is always to live by create opportunities for growth, and gain
making profits." every advantage or benefit available. This
is creating.
These four ways, referred to as the Way of Strategy, summarize the essentials of doing
business. Corporate executives, businessmen, and ordinary people should be able to
value human, financial, and technological resources; observe the business, corporate,
organizational, local, and global environments; possess the necessary skills and
expertise to actualize the plans they have laid, and consequently, create profits.

The Way of Strategy of Musashi is shown as five books called The Book of Five
Rings or Go Rin No Sho. Go Rin refers to the five parts of the human body, namely, the
head, left and right elbows, and left and right knees. The five books are Ground, Water,
Fire, Wind, and Void.

a. The Ground Book is the roadmap to strategy. It shows the Way of Strategy.
b. The Water Book explains the methods in attaining victory in strategy.
c. The Fire Book shows how to fight to attain victory.
d. The Wind Book explains the other ways in strategy.
e. The Void Book explains the true spirit of strategy. It is the penultimate book.

Each of these five books discusses strategy in different ways.

Musashi Miyamoto’s Ground Book in Present-day Strategy

 Business strategies vary in types and concerns. Some strategies are influenced
and determined by functionality; others are profit-oriented in nature, while others are
focused on community benefits. While some successful strategies are spontaneous,
there are standard, tested and proven approaches. Hence, they should be a
combination of both novel and traditional techniques More importantly, strategies need
to be adopted by the right people in the right environment and during the right time.

Musashi Miyamoto’s Water Book in Present-day Strategy

The essence of strategy is the spirit of the business strategist. The spirit of a
successful strategist is like water that flows naturally and without difficulty. He adapts to
the shape of the strategy, sometimes, simple and at other times, complex. Like water,
the spirit of a strategist is confident, clear, energetic, fearless, and decisive.

Musashi Miyamoto’s Fire Book in Present-day Strategy

Strategizing is a complex business and organizational activity. It requires

business intelligence in terms of having a complete big picture of the industry, knowing
the idiosyncrasies of the situation, adopting suitable strategies to stay afloat, at the
least, and using these strategies correctly and to one's benefits and organizational
progress. It needs ongoing training to ensure readiness to make quick decisions.
Continuing training is necessary in strategizing. There is no room for complacency.
Preparedness and competence are the rules of the game in business.

Musashi Miyamoto’s Wind Book in Present-day Strategy

An accomplished and successful strategist should not use only one strategy in
running an organization, a company, a small business unit, or a department. He has to
know other cutting-edge strategies.

These differentiated and forward-looking strategies come in different forms.

Ahead of its time, they should be simple enough to be readily understood, markedly
versatile to be easily adapted, wide-ranging to be useful and effective, and innovative to
create that needed impact on all customers.
Musashi Miyamoto’s Void Book in Present-day Strategy

In summary, the greatest strategists are generals or individuals engaged in

warfare. When physical life is greatly at stake, preservation is the greatest motivator of
winning. As a result, the significance of winning drives these people to exhaust all
means to win their enemy and succeed.

Game Perspective of Strategy

Aside from viewing strategy from a military perspective, it can likewise be viewed
from the standpoint of playing games. This outlook is based on a mathematical model
called game theory. In the early twentieth century, mathematicians began to study
simple games, which graduated to more complex games like chess. Thus, we had the
beginnings of the so-called game theory. It was John von Neumann, a mathematician,
who extended this theory to include poker. Game theory even gained prominence with
the winning of John Nash as the 1994 Nobel Memorial Prize in Economics.

Game Concepts and Techniques

Game theorists consider and treat all situations of strategy choices as strategies
for games. Game theory is essentially linked to neoclassical economics. Their
commonality is the concept of rationality. The assumption of neoclassical economics is
that human beings are rational when making economic choices. In short, a person
makes a decision in the light of aiming to maximize his rewards.

Rewards may be in the form of income and returns. Thus, strategy from the
game theorist's perspective considers a person's best response to the strategies
chosen by others and this is in terms of maximum payoff. Furthermore, game theory
carries certain assumptions. It assumes rationality that is full knowledge in calculating
and pursuing the strategy, common knowledge of rules of the game, and a framework of
equilibrium or using the strategy that best responds to the strategies of the other
players.

Players have strategies. Outcomes with different

A game strategy is a payoffs are expressed as
expectations if outcomes
plan of action.
are random or involve
some risks.

Strategic games are situations characterized by

interactions among players and are classified.
according to the timing of the play, common or
conflicting interests of players, number of interaction amount of information available,
type of rules, and feasibility of coordinated action.

Game strategies are calculated and purposive and may be based on complete
information, incomplete information, or no information at all. They have the following
characteristics:

1. Considers the environment

2. Involves intuitive skills
3. Contains the element of reciprocal fear of surprise attack
4. Continuous and not absolute

The implementation of game strategies does not assume expertise. It is a skill,

and it can be learned by experience; it is dynamic and evolving. Payoffs can be
intangible. Even with definite payoffs, errors are inevitable. As a whole, game strategies
give a framework for reality check. Games may be classified into those which are
played with the following moves: sequential, simultaneous, and strategic.

1. Games with Sequential Moves. Sequential moves are steps taken

chronologically where an action is a consequence of a previous move. For
example, Congressman Rodriguez currently occupies a congressional seat.
 In the next three years, a candidate, Mr. Zulueta is a potential. challenger. In
this race, Rodriguez must decide whether to launch a defensive advertising
campaign to ensure his congressional seat or not. If one is to depict this
decision-making, there will be different outcomes vis-à-vis different
combinations of moves by both Rodriguez and Zulueta. There will be four
Will enter the race
possible combinations of moves:

1,1
Zulueta
3,3
Will advertise Will not enter the race
Rodriguez

Will not advertise

2,4

4,2

a. Rodriguez will advertise; Zulueta will enter

b. Rodriguez will advertise; Zulueta will not enter the race.

c. Rodriguez will not advertise; Zulueta will enter the race.
d. Rodriguez will not advertise; Zulueta will not enter the race.

Sequential games are usually illustrated using three diagrams referred to as the
extensive form of a game. They consist of nodes and branches. The first node,
Rodriguez, is the decision node or more particularly, the initial node. The nodes
containing the respective payoffs are called terminal nodes. The lines are the branches.
In the payoff, the first number written is that of the individual who makes the first move.
In this example, it is Rodriguez. This game of strategy includes the following:

a. The players (ie, Rodriguez and Zulueta)

b. The information they possess about the play of the game
c. Their actions
 d. Their payoffs and possible outcomes of the game

Each of them has complete information of what he can do and what his opponent
does or can do. Each player has two possible actions at each node and four terminal
payoffs. In sequential games, the order of action is given. The action of one individual is
dependent on the first move. In some instances, the first mover has an advantage. In
other instances, the second mover has the advantage. Note that there can be more
players in sequential games. The game tree then becomes more complex.

2. Games with Simultaneous Moves. These are taken concurrently under

conditions of incomplete or imperfect information. Here, the players must
move without knowledge of what their co-players have decided to do.
Examples of this type of gaming consist of zero-sum games, dominant
strategies, and Nash equilibrium. Games with simultaneous moves use a
payoff table.
A zero-sum game is a game where any benefit gained by one is lost to
another. In this game, the sum of the payoffs is always zero where one player
loses whatever the other players win. An example is shown in Table 10.8.
The rock-paper-scissors game is a common children's game. Two children,
Maxine and Maureen are playing this game. The rules for winning and losing
are as follows: scissors cut paper, rock breaks scissors, and paper covers
rock. The payoff table shows that whenever Maureen wins, Maxine loses and
whenever Maureen ties, Maxine must tie.

Zero-Sum Payoff

Maureen
Rock Paper Scissors
Rock Tie (tie, tie) Lose (lose, win) Win (win, lose)
Maxine Paper Win (win, lose) Tie (tie, tie) Lose (lose, win)
Scissors Lose (lose, win) Win (win, lose) Tie (tie, tie)
 Dominant strategies give the highest payoff:

a. If one strategy yields a higher payoff than a second strategy regardless of

which strategies the other players choose, the first strategy is said to
dominate the second.
b. If one strategy dominates all other strategies for a particular player in the
game, it is said to be a dominant strategy for that player and the second
strategy is the dominated strategy.

Another example is the dumping game. Supposing Lizza and Rose are
two property owners. Both own vacation houses in Tagaytay. Their properties are
situated side by side. Unfortunately, there are no garbage collectors. They can
either contract collection and pay P1,200.00 a year or choose to dump the
garbage in each other's property.

Dumping Game

Rose Lizza

Lizza dumps
garbage near
Rose’s house.

Rose’s house
Lizza’s house

Rose dumps
garbage near
Both vacation house owners will make their decisions at the same time. They will
Lizza’s house.
choose two strategies: pay a garbage collector or simply dump the garbage on the
neighbor's property. What are the payoffs in this game? Although the benefits are
subjective, they can be expressed in monetary values.

Both Rose and Lizza personally value their rest and relaxation at P400,000.00
per year with garbage collection, and P300,000.00 per year if there is dumping. In other
words, if there were no dumping, neither Lizza nor Rose would give up a year of
occupancy for less rent than P400.000.00; but if there is dumping on the property, each
of them would give up the year of occupancy or P300,000.00. To ilustrate the dumping
game:

Dumping Game Payoff

Lizza
Dump Garbage
Collection
Rose
Dump 300,000; 300,000 400,000; 250,000
Garbage Collection 250,000; 400,000 350,000; 350,000

Referring to the table, each player chooses her best response to the strategy the
other player has chosen or can be expected to choose. The first number and second
number are Rose and Lizza, respectively. In both cases, dump is always the best
response. The strategy dump is an example of a dominant strategy while garbage
collection is the dominated strategy. When each player in a game chooses dominant
strategy, the result is a dominant strategy equilibrium.

Dominant Strategies in Dumping Game

If Rose’s strategy The best response If Lizza’s strategy The best response
is: for Lizza is: is: for Rose is:
Dump Dump (300,000) Dump Dump (300,000
Garbage Collection Dump (300,000) Garbage Collection Dump (400,000)
 Mathematically, the dominant strategy equilibrium is the solution to the game.
However, in the dumping game example, it is more of the problem itself. In this case,
this example is considered a social dilemma. A social dilemma is a game with dominant
strategy equilibrium where the dominant strategy solution is different from the
cooperative solution to the game.

Going back to the dumping game example, if both Rose and Lizza agree on the
strategy, garbage collection, then the outcome is a cooperative solution. The
cooperative solution of a game is the list of strategies and payoffs that the players would
choose if they could commit themselves to a coordinated joint strategy like agreeing to
have the garbage collected. If there is no possibility to commit themselves to a
coordinated joint strategy so that each assumes the other will choose a best response
strategy, the outcome is called a non-cooperative solution. Lastly, Nash equilibrium is
the equilibrium of a non-cooperative game where each player's strategy is best for him,
given that each player is satisfied with the strategy of his choice.

An illustration of Nash equilibrium is the textbook writing game. Gener and De

Jesus are authors of rival textbooks in strategic management. Both their books are of
quality and they both know that the marketability of their books will be dependent on
their respective book's number of pages. To capture a wider readership audience, each
author can choose among three strategies: write a book of 200 pages, 250 pages, or
300 pages.

Textbook Writing Game Payoff

De Jesus
200 pages 250 pages 300 pages
200 pages 55, 55 25, 60 20, 50
Gener 250 pages 60, 25 50, 50 25, 55
300 pages 50, 20 55, 25 45, 45

Referring to the table, each player chooses his best response to the strategy the
other player has chosen or can be expected to choose. The first number and second
number are Gener and De Jesus, respectively.
 Strategies in the Textbook Writing Game

If Gener’s strategy The best response If De Jesus’s The best response

is: for De Jesus is: strategy is: for Gener is:
200 pages 250 (60) 200 pages 250 (60)
250 pages 300 (55) 250 pages 300 (55)
300 pages 300 (45) 300 pages 300 (45)

In this example, if Gener chooses to write 200 pages, De Jesus will respond by
writing 250 pages; if Gener chooses to write 250 or 300 pages, De Jesus will respond
by writing 300 pages. Considering that Gener's idea is to choose to write a number of
pages longer than De Jesus, there is no one strategy that is his best response to each
of the different strategies De Jesus might choose. Since the game is symmetrical as
shown above, there is likewise no dominant strategy for De Jesus either. Hence, the
textbook writing game has no dominant strategy.

The textbook writing game is an example where there is no dominant strategy but has a
Nash equilibrium. If there are two strategies such that each strategy is a best response to the other
strategy, then the strategies are called Nash equilibrium strategies. If Nash equilibrium strategies
exist in a game and the players choose those strategies, then a Nash equilibrium in the game results.
In the textbook writing game, the list of strategies is (300, 300), 300 for both Gener and De Jesus.
Since 300 is the best response to 300 from the perspective of both players, this list of strategies is a
Nash equilibrium.

3. Games with Strategic Moves. These are devices applied to work to one's
advantage. To adopt this mode, the action should be observable and
irreversible. There are three types of strategic moves, namely, commitment,
threats, and promises. Threats can be a deterrent while promise can bring
about compliance. To acquire and enhance credibility in strategic moves, the
following can be implemented:
a. Reducing freedom of action by automatic fulfillment and delegation
b. Burning bridges and cutting off communications
c. Changing payoffs
 d. Dividing the game into small steps
e. Espousing teamwork
f. Rationalizing irrationality

Applications to specific strategic situations include brinkmanship, voting,

bidding, auction, bargaining, markets, competition, policy setting, and labor
arbitration.

4. Styles in Game Strategies. There are certain styles in undertaking game

strategies. They include use of surprise, rational irrationality, collection of
information, a deliberate study of previous moves undertaken, an earnest
move to go back to the root problem, effort to monitor moves, collaborative
action, sometimes not doing anything, and abandonment.
In essence, the game perspective of strategy focuses on winning and
achieving a reward. Basically, information is a critical component in winning a
game. Game moves can follow one another, be at the same time, or simply
smart. While payoffs can be intangible, dominant strategies give the highest
payoff. Thus, the applications of game strategies necessitate consideration of
the environment, the use of intuitive skills, and the use of the element of
surprise.

Economic Perspective of Strategy

In addition to looking at strategy from a military and game perspective, strategy

from the angle of economics must be analyzed. Although different strategic situations
continually evolve due to inevitable variables of growth and change, there are durable
principles that are applicable to these emerging scenarios. Such theories can guide
strategists in understanding better how firms compete, thereby providing them bases
when making strategic decisions.
 For a start, let us try to demonstrate the applicability of these principles at three
points in time, namely, 1840, 1910, and today. Economists deliberately choose these
dates for the following reasons: the year 1840 was typified by small local markets, while
from 1840 to 1910 saw the rise of big corporations, and today, information technology is
changing the business landscape.

Parameters, Time Periods, and Adaptive Strategy Principles

Parameters Time Period Adaptive

Strategy
Principles
1840 1840 – 1910 Today
Conditions Characterized Saw the rise Witnessed the Conditions in
by small local of big development of the environment
markets/family corporations information continuously
-run technology change.
businesses
Infrastructure
Transportation Development Railroads Automobile and The need to
of the modern dominated air travel are very transfer people,
railroad came passenger popular. products and
about due to and freight services
the harnessing transportation hastened
of steam . development
power. and mobility.
Communicatio The primary The Instantaneous Communication
n mode of long- telephone transmission and plays a
distance was growing reception of significant role
communicatio in information due to in bringing
n was the importance. development in ideas and
public mail; telecommunicatio information to
the first n like fax, business
modern form cellphone, and IT. entities, agents
of and markets.
 communicatio
n was the
telegraph.
Financing Businesses Active There is a The role of
were security separation of financing
partnerships. markets commercial from dictates the
publicly investment strategies to be
traded the banking. adopted by
shares of firms.
large firms.
Production Technology Production Technological While
Technology was relatively technology innovations, technology has
undeveloped. promoted the advances in catalyzed
growth of computerization, production,
mass and quality strategies for
production. management competitiveness
characterize , cost
production effectiveness
capabilities and and profitability.
processes.
Government Government Government Government As businesses
resolved regulated bureaucracy and grow in size and
disputes and antitrust laws, scope of operations,
set the rules disability government governments
under which insurance, regulation of regulate
businesses worker economic business
operated. safety, and activities has activities.
widows or increased.
children
insurance.
Given these three different time periods, one can see that growth is a reality of
development. Conditions transform and mature, bringing corresponding adjustments
and modifications. However, adaptive strategy principles have always been consistent
given these changing parameters.

Vertical Boundaries of the Firm

The production of any product or operation of any service involves a whole range
of activities. It begins with the acquisition of raw materials and ends with the distribution
and sale of finished goods. In business, this is referred to as vertical chain or supply
chain management. Vertical chain consists of both major and support tasks.

Examples of major activities may include production, distribution, and sales, while
support activities may include market research, promotion, and janitorial and security
services. These activities are categorized as upstream and downstream. Upstream
activities are those conducted in the early processes of the vertical chain while those in
the latter stages are called downstream activities shown below is an example of vertical
chain in the production confectionary.

Vertical Chain in the Production of Confectionary

Major Activities:

 Purchasing of Raw Input: Support Activities

(Sugar, Glucose)
 Delivery, Transportation,  Marketing
and Warehousing  Finance
 Cooking  Research
 Packaging  Promotion
 Storage and Handling
 Distribution

For any business, there are two important general strategies that a company can
choose from: either for the company itself to perform the activity or for it to buy the
activity from specialized providers in the market called market firms. Both strategies
have their respective benefits and costs. They are enumerated as follows:
 Perform or Buy the Activity Costs and Benefit Matrix
Perform the Activity
Operations can be smooth,
thereby avoiding
discontinuity or process
problems in terms of quality
standards and technical
efficiency.
Firms can save on
transaction costs and other
Benefits
additional costs that are
paid to market firms.
Intellectual property in the
form of private and
confidential information like
pricing, promotion,
production, and others can
be guarded to the interest
of the company.
Prices may become more
expensive due to the
Costs absence of economies of
scale.
entire production process.
Products of companies may There is the possibility of
not undergo differentiation
and innovation if market
conditions are overlooked.
Buy the Activity from
Market Firms
Generally, market firms can
produce the activity at a
lower average cost due to
so-called economies of
scale.
Market firms are subject to
the so-called discipline of
the market. Hence, they
need to innovate to survive.
In as much as the firm buys
the activity from a market
firm, there is a possibility
that a gap or coordination
problem may occur when
the activity is incongruous
or not aligned with the
leaking out hidden or
private information to
market firms.
 Transaction costs incurred
when dealing with the
market firms can be
avoided.

Given these mentioned benefits and costs, the decision to perform or buy the
activity is dependent on whether a company will choose to perform or buy. Going back
to the example of a vertical chain in the production of confectionery, the decision is
either for the company itself to distribute finished candy products to its wholesalers and
retailers or distributors or to create a distribution system and assign distributors to do
the selling to the customers.

Alternatives to Vertical Integration

While vertical integration is not the best strategy, a variety of in-between

strategies can be adopted and implemented to take advantage of the benefits of both
worlds. There are four popular ways to reach a better, if not the best outcomes. They
are a mixture of "perform and buy" strategies called tapered integration, strategic
alliances and joint ventures, collaborative relationships, and implicit contracts and long-
term relationships.

a. Tapered integration of the "perform and buy" strategies offers several

advantages. First, it can expand both the input and output channels of the
company without requiring monetary expenditures. Moreover, the company can
use information about the expenses and profitability of internal channels to help
negotiate contracts with independent channels. Lastly, the company can develop
internal capabilities to protect itself against independent input supplies. On the
downside, tapered integration may not allow for maximum efficiency due to
sharing of both internal and external channel processes. Shared production may
lead to coordination problems, thus the need for consistency and alignment.
Duplication of processes is a common possibility.
b. Strategic alliances result when two or more firms agree to collaborate on a
project or to share resources. A strategic alliance may be horizontal as when two
firms in the same industry collaborate or may be vertical when the partnership is
between a buyer and a supplier. A joint venture is a form of strategic alliance in
which two or more firms create and jointly own a new independent organization.
This joint venture may use the workforce of both companies or may use
employees from one company or none at all. In a strategic alliance, there is
cooperation, coordination, and information sharing. This kind of coalition is
desirable when the design, production, operation, and marketing of product
service require competence in functional areas and when engaging in any of
these functions has become excessively costly. Furthermore, the sharing of
database information cannot be overemphasized.

c. Implicit contract is an alternative for vertical integration. An implicit contract is a

tacit or unspoken understanding between parties in a business relationship.
Implicit contracts exist among members of a keiretsu. These contracts are not
explicitly drawn; thus, they are not enforceable. However, losing future business
is a subtle pressure to respect and maintain the implicit contract, most especially
if the business runs to big amounts. Hence, long-term relationships are
sustained.

d. Collaborative relationships are manifested in subcontract networks and keiretsu.

Generally, Japanese industrial firms are less vertically integrated compared to
Western counterparts. They are smaller in size and more specialized in focus.
Many Japanese companies maintain a high degree of collaboration and long-
term commitment with their subcontractors. Relationships usually last for
decades. On the other hand, the western counterparts are business-like with
their counterparts. Usually the relationships are entered into for specific tasks, so
they do not last as long the Japanese. However, the degree of quality expected
by both Japanese and Western buyers are stiff. Their subcontractors are
expected to be highly involved, perform sophisticated tasks, and essentially part
of the entire company.
 Keiretsus are closely related to subcontractor networks but involve a more
formalized set of institutional linkages. The leaders of these institutions are
sometimes members of the Board of Directors or act as Consultants. Examples
of keiretsus are Mitsubishi and Sanwa. Each has 80 members with a core bank
that facilitates their relationships. As shown in Figure 10.6, the company has
networks with institutions like banks, other financial institutions, and life insurance
companies that are formal organizational entities. Similarly, the company
partners with trading companies that help their products. These trading
companies have their own satellite companies. Furthermore, the company
networks with its suppliers that likewise have their respective satellite companies
to get their supply materials or to subcontract some activities. The bottom line for
both subcontractor networks and keiretsus is the collaborative relationships that
exists between and among the firm, its suppliers, buyers and support institutions.

Horizontal Boundaries of the Firm

Aside from the vertical boundaries of a firm, there are parameters that consider a
company's horizontal boundaries. Whereas vertical boundaries stress on the activities
that a company performs, the horizontal boundaries of a firm include two things: the
quantity of products produced, and services rendered, and the variety of these products
and services. Oftentimes, there are companies that produce the same products but sell
them at different prices at reasonable margins of profits. One reason for the difference
may be in the quantity of products sold. A company that produces few quantities
compared to one that manufactures large quantities will vary and depend critically on
economies of scale and scope. Both economies of scale and scope are generally
present whenever there is large-scale production and marketing due to cost advantage.
These so-called cost advantages affect and even shape business strategy decisions.
 A Simple Keiretsu Relationship

Economies of scale is a condition that is exhibited when the average cost (AC) or
the cost per unit of output declines over a range of output (product/ service). For AC to
decline as output increases, the marginal cost (MC) or the cost of the last unit produced
must be less than the overall average cost, MC< AC. Let us study this example.

 The total cost of five motorcycles is P150,000.00 Hence, AC is P30,000.00.

 If the MC of the sixth motorcycle is P20,000.00 then the total cost of the six
motorcycles is P170,000.00 or (P150,000.00+P20,000.00) and AC is P28,333.00
or (P170,000.00/6). Here, MC < AC. As a rule, when MC < AC, AC falls as
production increases.
 If the MC of the sixth motorcycle is P35,000.00 then the total cost of the six
motorcycles is P185,000.00 or (P150,000.00+P35,000.00) and AC is P30,333.00
or (P185,000.00/6). Here, MC > AC. As a rule, when MC > AC, AC rises as
production increases.

Based on the example,

 If AC is constant, then MC = AC. It can then be said that production exhibits

constant returns to scale.
 If AC is increasing, then MC> AC. It can then be said that production exhibits
diseconomies of scale.
 If AC is decreasing, then MC < AC. It can then be said that production exhibits
economies of scale.

To visualize economies of scale, let us go back to our motorcycle example. The

following costs data are shown below in manufacturing a motorcycle. The costs
components are fixed costs and its average fixed costs, variable costs and its
average variable costs, and the total costs and the corresponding average total fixed
costs. Fixed costs are costs that must be expended regardless of total output. They
include expenses on property, machinery, equipment, and plant. Variable costs are
costs that increase as output increases. These include expenses on labor and
materials. Total cost is the sum of the fixed costs and variable costs.

Costs of Matrix in Manufacturing a Motorcycle

Number of Fixed Average Variable Average Total Average

Motorcycle Costs Fixed Costs Variable Costs Total
s Costs Costs Costs
1 ₱ 20,000 ₱ 20,000 ₱ 10,000 ₱ 10,000 ₱ 30,000 ₱ 30,000
2 20,000 10,000 20,000 10,000 40,000 20,000
20,000 6,666 30,000 10,000 50,000 16,666
20,000 5,000 48,000 12,000 68,000 17,000
20,000 4,000 66,000 13,200 86,000 17,200
20,000 3,333 86,000 14,333 106,000 17,666
20,000 2,857 110,000 14,571 130,000 18,571
20,000 2,500 140,000 15,000 160,000 20,000

Average Total Costs Curve for Motorcycle

 Based on the graph:

a. The average total costs started to decline as the number of motorcycles

manufactured increased. This corresponds to the range of economies of
scale from the first to the fourth motorcycle.

b. However, with the production of the fifth motorcycle, the average total costs
gradually increased from the fifth motorcycle and so on. This corresponds to
the range of diseconomies of scale.

Causes for diseconomies of scale may be due to increase in labor and material
costs, mismanagement costs, and other human resource problems. Thus, the graph
tends to be U-shaped in the long run. Not all manufacturing companies follow this U-
shaped curve. A company can have an L-shaped curve when it avoids the
diseconomies of scale. The causes for such occurrences can be avoided. In most
cases, use of technology can help in lengthening the economies of scale to the
advantage of the manufacturing company.

Economies of scope is a condition that is exhibited when a company achieves

savings by producing a variety of goods or rendering different services. Whereas,
economies of scale is measured in terms of unit-cost savings which is declining average
cost functions, economies of scope is calculated in terms of the relative total cost of
producing products or services that are lumped together as compared to producing the
items separately. For example:
 a. The total costs that a firm spends in producing a desktop computer, TC(Q) is
P28,000.00.
b. The total costs that another firm spends in producing a laptop computer, TC(Q) is
P35,000.00.
c. However, the total costs that a firm spends in producing both a desktop and
laptop computer, TC (Q,.Q) is P48,000.00.
d. If TC (Q,.Q) < TC (Q) + TC (Q), this production process exhibits economies of
scope.

Sources of Economies of Scale and Scope

There are different modes of achieving economies of scale and scope. Some of
these ways are spreading of indivisible fixed costs, increasing productivity of variable
costs, carrying fewer inventories, taking advantage of marketing and purchasing
economies, and undertaking research and development.

a. Indivisibilities are constant fixed costs that are present regardless of production.
To spread these indivisibilities is to optimize production. Then can economies of
scale be achieved.
b. Increasing productivity can minimize variable costs. Less wastes, more efficient
production and operation, maximum usage of materials, and less labor problems
are ways of coming up with efficient processes and operations.
c. Carrying few inventory stock units can minimize ordering and carrying inventory
costs. Expenses on storage, payments on interest rates, and costs on stockouts
can bring diseconomies of scale and scope.
d. Exploiting market economies, most specifically, marketing and advertising costs.
A firm will spend less if it carries and sells multi-products. In this manner,
distribution costs can be spent for more than one product. This is likewise true for
advertising costs. Given an umbrella structure, products can be promoted at the
same time.
 e. Procuring in bulk quantities can bring opportunities for quantity discounts, adding
to economies of scale and scope.
f. Conducting research and development. Research outputs from studies
conducted can be utilized for other existing and future products and services.

The Learning Curve

The concept of the learning curve is highly related to economies of scale.

Economies of scale refer to the cost advantages that are derived from producing
outputs over a period of time. As a process is repetitively implemented, the degree of
performance improves and efficiency increases. Hence, costs in producing the product
decreases due to higher capabilities, better experience, and expertise and less
mistakes, reworks, rejects, and other negative outcomes. The measure of learning
yields is generally expressed in terms of the progress ratio. It is calculated by computing
how far average costs decrease as the cumulative production output increases as seen
in Figure 10.8.

Based on the graph of Learning Curve, as cumulative production increases,

average costs decrease. Computing for the progress ratio, we have AC,/ AC, or
150/200 = 0.75 and so on. If AC,/ AC, is less than 1, then learning is taking place.

Learning Curve Progress Ratio

Cumulative Production Average Costs Progress Ratio

(Q) (AC)
100 200
200 150 0.75
300 100 0.67
400 50 0.50
500 40 0.80

Leaning Curve
 In summary, companies may adopt the economics perspective of strategy. They
can choose to implement vertical and horizontal integration depending on the objectives
they want to achieve. There are different forms of these downstream and upstream
activities and with the alternatives presented to them, including their financial capability,
such strategies can prove advantageous to them.