IIA Certified Internal IIA-CIA-PART4 Questions & Answers

• Question 21:

  Which of the following is achieved by acquiring a minority common stock interest in a supplier?

  A. Quasi-integration.

  B. Tapered integration.

  C. Downstream integration.

  D. Forward integration.

  Correct Answer: A

  Quasi-integration is something more than a long-term contract and less than full ownership. It may be achieved by a minority common stock interest, debt guarantees, cooperation in RandD, an exclusive dealing arrangement, etc. Buyer and seller may, as a result, have a special community of interest leading to lower costs, smoothing of supply/demand fluctuations, or mitigating against bargaining power. Quasi-integration may avoid commitment to an adjacent business with its investment and management requirements. But many benefits of full integration may not be achievable in this way.

• Question 22:

  Forward integration most likely results in:

  A. Product standardization.

  B. Reduced access to distribution channels.

  C. Obtaining less information about demand.

  D. Higher price realization.

  Correct Answer: D

  Forward integration may permit higher price realization, for example, by moving into businesses in which the price elasticity of demand is relatively high and lower prices must be set. When demand is elastic, raising prices decreases revenue. Thus, the firm may benefit by acquiring customers with highelasticitywhile selling to customers with lowelasticity.

• Question 23:

  The advantages of vertical integration include:

  A. Increases in incentives.

  B. The ability to apply the same managerial methods to all subunits.

  C. The need to balance the operations of subunits.

  D. Stable relationships between internal sellers and buyers.

  Correct Answer: D

  Stable relationships between internal sellers and buyers create economies because they need not fear loss of the related buyers and sellers. They also need not fear undue economic pressure from each other. Furthermore, because the relationship is locked in, more efficient procedures for their relationship (e.g., dedicated controls and records) may be implemented. Another advantage is that internal sellers and buyers may more fully adapt to each other's needs than they would or could in dealings with outsiders.

• Question 24:

  The generic strategic costs of vertical integration include:

  I . Reduction of operating leverage

  II. Need to overcome mobility barriers Ill. A decrease in exit barriers

  IV.

  Loss of access to supplier technology

  A.

  I and Ill only.

  B.

  II and IV only.

  C.

  II, Ill, and IV only.

  D.

  I, II, Ill, and IV.

  Correct Answer: B

  Integration is a special case of entry into a new business. Thus, the firm must incur costs to overcome mobility barriers to enter the adjacent business:economies of scale, proprietary technology, capital investment, sources of materials, etc. Integration also increases fixed costs and operating leverage, which is in itself a cause of increased business risk. Thus, an integrated firm is exposed to fluctuations affecting any of its components. For example, sales of an upstream component depend on sales of downstream components. Moreover, integration may increase the difficulty of leaving the industry (exit barriers). Finally, integration may foreclose access to supplier or customer technology. The integrated firm may have to create its own technology rather than taking advantage of supplier/customer expertise.

• Question 25:

  What is the most likely generic strategic benefit of upstream vertical integration?

  A. It eliminates input cost distortion caused by the bargaining power of a strong customer.

  B. The supplier has returns exceeding the opportunity cost of capital.

  C. It eliminates the sales price distortion caused by the bargaining power of a strong supplier.

  D. The customer has returns lower than the firm's opportunity cost of capital.

  Correct Answer: B

  Integration benefits include offsetting the bargaining power of strong suppliers and customers. If such parties have returns greater than the firm's opportunity cost of capital, the firm benefits even if no other advantages accrue from integration.

• Question 26:

  The most likely generic benefit of vertical integration is:

  A. Lowering entry barriers.

  B. Increasing demand.

  C. Avoiding market transactions.

  D. Lowering mobility barriers.

  Correct Answer: C

  Economies of vertical integration result from avoiding some market transactions. Transaction costs of dealing with outside parties are greater than those of dealing with inside parties.

• Question 27:

  A firm has become vertically integrated by acquiring a supplier. However, throughput of thesupplier is greater than the firm's needs. Accordingly, the firm most likely has acquired:

  A. A capability less than the efficient scale.

  B. An efficient capability that provides excess output.

  C. An efficient capability that creates excess demand.

  D. An efficient capability that does not achieve economies of scale.

  Correct Answer: B

  Upstream (backward) or downstream (forward) integration is the acquisition of a capability that otherwise would be performed by external parties that are suppliers or customers, respectively, of the firm. Whether integration should occur depends on the firm's volume of transactions with the external parties (throughput) and the magnitude of the capability required to achieve necessary economies of scale. If the integrating firm's need is for a capability less than the efficient scale, one of its options is to acquire a capability with a costinefficient scale. The other option is to acquire an efficient capability that provides excess output (in the upstream case) or creates excess demand (from, for example, a distribution capability in the downstream case). This option will require the integrated firm to sell or buy in the open market. Thus, the second option carries the risk of having to deal with competitors.

• Question 28:

  Vertical integration is the acquisition of:

  A. A supplier or a distributor.

  B. A supplier but not a distributor.

  C. A distributor but not a supplier.

  D. A competitor.

  Correct Answer: A

  Vertical integration combines within a firm production, distribution, selling, or other separate economic processes needed to deliver a product or service to a customer. All such processes could in principle be performed through market transactions with outside firms. However, vertical integration uses internal or administrative transactions for these purposes in the expectation they will increase efficiency or decrease costs and risks.

• Question 29:

  Forward downstream integration most likely:

  A. Allows the firm to protect its proprietary knowledge from suppliers.

  B. Implies that the firm can fully support an efficient subunit but has additional needs to be met in the market.

  C. May allow the firm's subunit(s) to maintain constant production rates while external parties bear the risk of fluctuations.

  D. Improves access to information about demand.

  Correct Answer: D

  A strategic advantage of forward integration is that access to market information is improved. A forward subunit (the demand leading stage) controls the amount and mix of demand to besatisfied upstream. At the very least, forward integration improves the timeliness of (1) demand information, (2) production planning, (3) inventory control, and (4) the costs of being under- or over-stocked. It also may provide information about changing tastes, competitors' moves, and the ideal mix of products.

• Question 30:

  The most likely strategic benefit to a firm of upstream integration is:

  A. Avoidance of input cost distortion.

  B. Elimination of a customers' power to obtain an unjustifiably low price.

  C. Assurance of demand.

  D. An increase of incentives.

  Correct Answer: A

  Integration benefits include offsetting the bargaining power of strong suppliers and customers. If such parties have returns greater than the opportunity cost of capital, the firm benefits even if no other advantages accrue from integration. Thus, upstream integration eliminates input cost distortion caused by the supplier's power, and downstream integration eliminates the customer's power to obtain an unjustifiably low price. Moreover, the special costs of dealing with powerful parties will also be eliminated. Upstream integration also has the advantage of disclosing the true cost of the input provided by the powerful supplier. This information helps the firm to adjust its input mix and prices.