Interview with Prof. Kathryn Harrigan, Columbia Business School(3)

2007-08-20 16:00:37 [ Big Normal Small ]    　Comment

Xing Zong: Many Chinese companies face the following dilemma: they have already made large investments to some particular business which later found to be in the declining industry. It is very risky if keep investing, but if withdraw, then previous investments becomes sunk costs. What do you suggest?

Harrigan: I believe that sunk costs are irrelevant when making a strategy change. Sunk costs did not score very high as an exit barrier in my research finding when it was time for a firm to shut down facilities or exit from a declining business.

Xing Zong: You also wrote a book entitled “Vertical Integration, Outsourcing, and Corporate Strategy”. Could you please introduce the concept of vertical integration to our readers and how can this concept be applied to the declining industry?

Harrigan: Vertical integration involves a range of decisions about whether to make components or buy them from outsiders as well as whether to distribute products using in-house assets (rather than through independent parties) or use them as inputs for subsequent in-house production. An extreme example in the steel industry would be whether to mine one’s own iron ore and coking coal as an input to steel-making, as well as whether to fabricate your steel into rods, sheets, or other forms (rather than sell the steel as molten slabs, ingots, or other unfinished forms). If a firm is thinking about exit, it reduces the vertical chain of integrated activities that it engages in. By contrast, if a firm is destined to be “The Last Iceman” because it has the very lowest cost structure among all competitors, then being vertically-integrated is not so bad. Indeed, the firm’s low cost structure may actually be created by its vertically-integrated structure. Once again, I remind you that in a declining industry situation, there can only be ONE “last iceman” that will run out demand until no more profits can be made in supplying laggard customers.

Xing Zong: You went to Beijing last Nov. What do you think of the large Chinese firms in declining business? Any closing thoughts to our readers?

Harrigan: Comparative advantage has currently shifted to Chinese firms in making steel and other metals, as well as textiles, petrochemicals, and other heavy industries. Chinese firms have long had comparative advantage in labor-intensive industries. Advantage is a very tenuous condition that is lost when operating costs go too high. With improved transportation technology, firms from around the world are all seeking the locations where the best operating costs exist. Capital flees from high-cost venues and takes jobs with it to new locations. Someday Chinese firms will be relocating their factories to Africa.

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