Chapter 7: Vertical Integration and Outsourcing Multiple Choice Questions

Chapter 7: Vertical Integration and Outsourcing
Multiple Choice Questions
1. The process where a firm contracts out a business process or activity to an external
supplier is known as _____.
A. outsourcing
B. vertical integration
C. horizontal diversification
D. market penetration
Answer: A
Level of Difficulty: Easy
Section reference: What Is Vertical Integration?
Learning Objective: 7.1
Bloom’s: Knowledge
AACSB: Analytical thinking
2. North Road LLC, an apparel company, found that its fashion supplies and accessories
section was not generating much profit. Thus, the company contracted this section of
its business to another company that designs and manufactures these products in a
better way. The management of North Road realized that the employees of North
Road could use the time to focus on other aspects that bring profit to the company.
This scenario best illustrates _____.
A. market penetration
B. vertical integration
D. outsourcing
Answer: D
Level of Difficulty: Hard
Bloom’s: Application
AACSB: Application of knowledge
3. Which of the following scenarios illustrates the concept of outsourcing?

A. TechOn Inc., a company that buys raw materials from a supplier company
B. BNX Corp., a company that procures raw materials and supplies them to a
different company
C. Virgo Corp., a company that contracts out a business activity to another company
D. Red Inc., a company that sells all its assets to another company
Answer: C
Copyright ©2016 John Wiley & Sons, Inc.

4. Vertical integration can be best defined as:

A. breaking a large process into smaller tasks that require specialized knowledge.
B. bringing business processes or activities previously conducted by outside
companies in-house.
C. a graphic representation of the relationship between cost per unit of a product and
its scale of production.
D. the sequence of all activities that are performed by a firm to turn raw materials into
a finished product.
Answer: B
5. Which of the following scenarios best illustrates the concept of vertical integration?
A. NZB Corp., a company that sells all its assets to another company
B. Hues Inc., a company that owns its supply chain for its raw materials and processes
C. Scorpio LLC, a company that buys raw materials from a supplier company
D. Blue Corp., a company that makes raw materials and supplies them to a different
company
Answer: B
6. Green Solutions Corp. is a washing machine manufacturing company. When it

initially started out, it had held contracts with a supplier who provided the company
with finished washing machine parts. However, Green Solutions later started
manufacturing the parts by itself and assembling its products within the company
without having to seek supplier intervention. This scenario best exemplifies _____.
A. vertical integration
B. market penetration

C. task specialization
D. horizontal diversification
Answer: A
7. The sequence of all activities that are performed by a firm to turn raw materials into a
finished product that is sold to a buyer best describes the term _____.
A. product line
B. task specialization
C. virtuous circle
D. value chain
Answer: D
8. BHG Corp. is a glass manufacturing company that specializes in float glasses. The
company manufactures float glass through various stages of melting and refining,
coating, and annealing. It is then inspected and cut according to customer
requirements. This manufacturing process performed by BHG Corp. is termed as
_____.
A. virtuous circle
B. value chain
C. task specialization
D. supply chain
Answer: B
9. Yellow Express LLC is a company in the computer hardware industry that solely
manufactures microchips. Yellow Express LLC is _____.

A. diagonally integrated
B. vertically integrated
C. horizontally diversified
D. vertically specialized
Answer: D
10. Activities closer to the beginning of the industry value chain are referred to as _____.
A. middle activities
B. forward activities
C. upstream activities
D. downstream activities
Answer: C
11. Coral Corp. is a company that initially used to manufacture handbags. It has now set
up a store in which it sells its own products rather than supplying them to different
stores. This initiation by Coral Corp. best illustrates _____.
A. forward integration
B. backward integration
D. market penetration
Answer: A
12. Browns Inc., a well-established suitcase brand, started manufacturing its own
suitcases. It added new features in its suitcases such as water-resistance and extra

storage space. The initiation by Browns Inc. to manufacture its own suitcases best
illustrates _____.
A. linked diversification
B. backward integration
C. forward integration
D. assisted development
Answer: B
13. In the context of the primary reasons for vertical integration in companies, what do
capabilities refer to?
A. Whether a company has the finances to handle and overcome organizational
criticism
B. Whether a company knows when it should establish and exercise strict rules and
regulations
C. Whether a company can economize on scarce inputs in order to reduce transaction
costs
D. Whether a company has the right resources to perform an activity better than other
firms
Answer: D
Level of Difficulty: Moderate
Section reference: Three Key Reasons to Vertically Integrate
Bloom’s: Comprehension
14. The chief executive officer (CEO) of Ecos Inc., a well-established firm in the real
estate industry states that the firm has the resources to outperform its competitors. In
the context of reasons for vertical integration, the CEO is referring to the firm’s
_____.
A. control
B. priorities
C. capabilities
D. coordination
Answer: C

15. White Flower Corp. and DLG Inc. are competitors in the crockery industry. Claude,
the head of operations at White Flower, says that the company is able to undertake its
in-house business processes and activities much better than DLG. This, Claude says,
helps White Flower produce better quality products that DLG. In the context of
vertical integration, Claude’s statements refer to the concept of _____.
A. coordination
B. networking
C. priorities
D. control
Answer: A
16. Which of the following best illustrates a vertically integrated company with control?
A. Runners Corp., a shoe manufacturing company, which has a say in how much of
its assets are divided among the company’s shareholders
B. Blueberry Inc., a confectionery company, which has a stronghold over an
important resource of the company that helps in differentiating its final product
C. Trendsetters LLC, an apparel manufacturing company, which has a stronghold
over the number of employees that the company can afford to recruit, train, and retain
D. Coders Corp., a software development company, which successfully deflects any
possibilities of hostile takeovers
Answer: B
17. A supplier that is contracted to create and provide a customized input to a local firm is
called a(n) _____.
A. acquirer
B. coordinator
C. subcontractor

D. advocate
Answer: C
18. Which of the following statements is a characteristic of subcontractors?

A. They are responsible for bringing in key functions to regulate a company.
B. They have to assign and coordinate various projects of a company.
C. They have 10 percent share in the profits accrued by a company.
D. They create made-to-order contributions for a company.
Answer: D
19. In the context of the primary reasons for vertical integration in companies, which of
the following statements is true of coordination?
A. The greater the interdependence between activities, the more a company should
vertically integrate.
B. Activities that require high levels of coordination are known to be modular in
nature.
C. The greater the interdependence between activities, the more a company should
rely on outsourcing.
D. Activities that require low levels of coordination are known to be reciprocal in
nature.
Answer: A
20. In this context of the three Cs of vertical integration, which of the following scenarios
accurately depicts capabilities?

A. BagMore Inc., a handbag company, decides to engage in backward integration and
manufacture all of its products and accessories in the company house.
B. GoSpeed Corp., an automobile manufacturing company, evaluates itself by asking
if it can perform the vertically integrated activity better than its rivals.
C. StyleRight LLC, an apparel company, manufactures eco-friendly, organic, and
sustainable clothes.
D. HDC Inc., an electronics company, decides to effectively regulate its new
technologies.
Answer: B
21. DHC Inc. is a television manufacturing company. The components of the televisions
are manufactured separately by different companies around the globe. Later, these
components are tested and then assembled to get the finished products in house by
DHC Inc. In the context of the degree of coordination, this scenario best illustrates
_____.
A. sequential interdependence
B. reciprocal interdependence
C. modular interdependence
D. extensive interdependence
Answer: C
22. A car has to go through several different levels of manufacturing processes before it
can be painted. The painting process cannot be initiated until a car is externally
assembled and then inspected. This type of interdependence can be best termed as
_____.
A. extensive interdependence
B. modular interdependence
C. reciprocal interdependence
D. sequential interdependence
Answer: D

23. Apex Electronics LLC requires many teams to work together intensively and in
tandem with each other in order to effectively produce its products. A high level of
coordination between the working teams is essential for the company to maintain the
high quality of its products. This type of interdependence can be best termed as
_____.
A. sequential interdependence
B. reciprocal interdependence
C. limited interdependence
D. modular interdependence
Answer: B
24. Sport Soles Inc., a sports footwear manufacturing company, makes athletic shoes with
rubber soles. In order to maximize its value and profit, Sport Soles sets up its
operations right next to rubber tree fields. This way, the company gets easy access to
its main raw material. In the context of vertical integration, this scenario illustrates
that Sport Soles Inc. is exercising _____.
A. control
B. coordination
C. extensive focus
D. modular interdependence
Answer: A
25. Which of the following is a primary characteristic of a transaction-specific asset?

A. It has the ability to generate value only when used for several purposes together.
B. It is an intangible asset whose value is very hard to evaluate.
C. It is an asset that can be transported or transferred with ease.

D. It can generate maximum value only when used for a particular purpose.
Answer: D
26. Which of the following examples correctly depicts a company that uses a transaction-
specific asset?
A. Indigo Inc., a company that manufactures faucets
B. Eclipse Corp., a company that manufactures pens and sells them through
distributors
C. BLC Corp., a company that uses heavily customized software to manufacture
airplane seats
D. Vertigo LLC, a company that sources raw material from suppliers to manufacture
dinnerware
Answer: C
27. The country of Lydania has a complex network of pipelines that transports natural gas
for millions of people. These pipelines are specifically designed for the transportation
of natural gas and have limited uses outside the natural gas industry because of
inherent industry regulations. These pipelines exemplify a(n) _____.
A. sunk cost
B. transaction-specific asset
C. intangible asset
D. greenfield entry
Answer: B
28. Having more flexibility, or being less vertically integrated, is more valuable when:

A. a firm can create its own raw materials.
B. technology used is outdated.
C. the cost to perform an activity remains the same.
D. new technologies are innovated.
Answer: D
Section reference: Dangers of Vertical Integration
29. Pulse Corp., a vertically integrated company, is finding it difficult to adapt to current
technology that is capable of speeding up its manufacturing process. The company is
used to performing work in a specific manner using the old technology. However, in
order to maintain competitive advantage, it has to upgrade itself to the current
technology. This scenario is an example of _____ that is one of the disadvantages of
vertical integration.
A. loss of frequency
B. loss of focus
C. loss of flexibility
D. loss of facility
Answer: C
30. Violet Inc. has been undertaking a lot of responsibilities as a company in order to be
the best in its industry. Over time, however, these responsibilities become tough to
handle and the company finds it difficult to efficiently manage the time and effort to
perform its activities. In contrast, other firms in the industry that outsource some of
their activities to smaller companies find it easier to generate more profit than Violet
Inc. The situation faced by Violet Inc. in this example illustrates one of the important
disadvantages of vertical integration that is _____.
A. loss of flexibility
B. loss of frequency
C. loss of focus
D. loss of facility
Answer: C

31. Teal Motors Inc., an automobile company, outsources the manufacturing of most of
the automobile parts to several other companies that specialize in making parts such
as ignition boxes, coil wires, and grills. Teal Motors makes sure to get these parts
manufactured at a much lesser rate than it would if it manufactures its own parts. In
this scenario, Teal Motors Inc. is effectively avoiding a _____.
A. loss of identity
B. loss of frequency
C. loss of facility
D. loss of focus
Answer: D
32. Saturn LLC., a computer manufacturer, uses outdated technology to build specialized
graphic cards for its computers. The company finds it difficult to upgrade its graphic
card building technology to a newer version. However, Sun Products Inc., one of its
competitors, upgrades itself to the new version with lesser difficulty. In this scenario,
Saturn LLC is facing a _____.
A. loss of frequency
B. loss of focus
C. loss of flexibility
D. loss of facility
Answer: C
33. Nate, the managing director of Juniper Inc., believes that instead of making auto parts
on its own, it should rather outsource these tasks to other companies so that the
company can focus only on the critical aspects of the final product. His colleague,

Salma, believes that the company would have more competitive advantage if it made
its own auto parts. Which of the following statements strengthens Nate’s belief?
A. Outsourcing will minimize the capital investment Juniper Inc. requires to grow.
B. Outsourcing will lessen the pressure of crowdsourcing so that lesser and more
stable options are sought.
C. Outsourcing will help minimize Juniper Inc.’s need to innovate its assets or
activities.
D. Outsourcing will minimize suppliers’ bargaining power as Juniper Inc. chooses its
suppliers.
Answer: A
Section reference: Advantages of Outsourcing
Bloom’s: Analyze
AACSB: Reflective thinking
34. Which of the following companies is most likely to experience the benefits of
outsourcing?
A. Pulsar Corp., a shoe manufacturer, which has invested huge an amount of capital in
order to afford its suppliers
B. Black Inc., a consumer electronics company, which has been importing its supplies
from other companies and focuses only on the critical aspects of its work
C. Carbon LLC, an automobile manufacturer, which has the capability to produce
more of its raw materials in house
D. Beta Corp., a computer manufacturer, which has been trying hard to adapt new
technologies in order to gain competitive edge in the industry
Answer: B
35. Which of the following scenarios supports the view that a company should engage in
outsourcing?
A. Zenith Corp., a publishing house, which needed a high capital investment to grow
because it contracted most of its peripheral activities to other companies
B. FRC Inc., an apparel company, which fears the loss of a strong hold over its prime
activities if it does not perform them in house
C. AutoLuxe LLC, an automobile company, which has the flexibility to contract
processes to another company at a fast rate

D. Innovator Inc., a software company, which foresees that its employees will have
less work and more time under their disposal for leisure activities if it lets other
suppliers help perform its activities
Answer: C
36. A production house called Script Creations Inc. initiated a strategy for making its next
movie. It invited a mass of people to create short documentaries on a social theme. As
per the terms and conditions, Script Creations would select top three short stories to
create an overall complete movie. This initiation by Script Creations Inc. is an
example of _____.
A. crowdsourcing
B. insourcing
C. offshoring
D. benchmarking
Answer: A
37. Lupus LLC is a company that sells personalized gift items. It reduces the cost of
employing professional artists, designers, photographers, salespeople, and retailers by
letting its members and other people submit their ideas for designs, quotes, and
phrases on its e-commerce website. Which of the following types of crowdsourcing
does Lupus LLC use?
A. Crowdvoting
B. Crowdinnovation
C. Crowdtasking
D. Crowdcreating
Answer: D

38. Cygnus Bank is a banking and financial services company. It offered a large sum of
money and a chance to receive employment to the programmers who could create a
software that would help enhance employee productivity. Which of the following
types of crowdsourcing did Cygnus Bank use?
A. Crowdvoting
B. Crowdinnovation
C. Crowdtasking
D. Crowdcreating
Answer: B
39. Adia, the chief executive officer (CEO) of Touch Works Corp., believes that
outsourcing would be a disadvantage to her company. She states that she would not be
able to control the finances and assets of her company if work gets outsourced. Which
of the following statements strengthens Adia’s belief?
A. Outsourcing would maximize the capital investment that Touch Works Corp.
would require to grow.
B. Outsourcing would prevent Touch Works Corp. from contracting out activities to
industry specialists.
C. Touch Works Corp. would be forced to focus on a wide range of activities.
D. Touch Works Corp. would lose the ability to innovate and create competitive
advantage.
Answer: D
Section reference: Dangers of Outsourcing
Bloom’s: Analyze
AACSB: Reflective thinking
40. Hydrus Corp. contracted most of its business processes to various other companies.
This helped the company generate immediate profits, but Hydrus was losing
competitive advantage over its rivals in the long run due to its lack of innovation.
Which of the following is a danger of outsourcing that Hydrus Corp. experienced?
A. Lack of control
B. Loss of capabilities
C. Lack of focus

D. Loss of technology
Answer: B
Fill in the blanks
41. When one firm tries to take advantage of another firm that has made a transaction-
specific investment, by causing a brief delay in business because a product has no
other use is known as a(n) _____.
Answer: hold-up
42. As a danger of vertical integration, a(n) _____ refers to the fact that the more different
types of activities a firm needs to manage, the harder it is to be world class in all of
those activities.
Answer: loss of focus

Short Answers
43. Briefly state the difference between outsourcing and insourcing.
Answer: Outsourcing is the process where a firm contracts out a business process or
activity to an external supplier, whereas, vertical integration or insourcing brings
business processes or activities previously conducted by outside companies in-house.

44. What is the main difference between a company that is vertically integrated and a
company that is vertically specialized?
Answer: Companies that participate in many or all stages of the industry value chain
from exploration to final sale are vertically integrated. Companies that participate in
only one activity are vertically specialized.
45. In the context of vertical integration, when is flexibility most valuable?
Answer: Having more flexibility—that is, being less vertically integrated—is

particularly valuable when new technologies are being developed or if the cost to
perform an activity can change quickly.
Essay Questions
46. In the context of coordination, what is modular interdependence?
Answer: In the context of coordination, modular interdependence is one of the three

types of interdependence. Some activities in a vertically integrated firm require low
levels of coordination because the activities are modular in nature. This means the
results are pooled together but the individual activities can be conducted without
coordinating with other activities. The members of such teams may share information
about the activity with each other, but in the final analysis, the activity is done by the
individual performer. In this case, team performance is based on individual
performances or activities that are pooled together. This is typically referred to as
modular or pooled interdependence, meaning that the degree of coordination required
is relatively low.

47. Explain the three Cs of vertical integration.
Answer: The three Cs of vertical integration are capabilities, coordination, and control
are the primary reasons that companies choose to make versus buy. The first C is
capabilities, which refers to the question of whether a firm has—or can build—the
capabilities to perform an activity better than other firms. The firm’s leaders should
ask this question: To what extent are they, or could they be, the best in the world at
conducting that activity? If the firm can be one of the best in the world, then it is
probably an activity it should do. But, if it cannot be one of the best in the world, then
the firm is probably better off by outsourcing the function to a company that has
stronger capabilities.
The second C is coordination, which refers to the question of whether a firm is better
able to effectively coordinate an activity with other activities in the firm when both
are conducted internally. In this case, the firm isn’t necessarily more capable at
performing a particular activity, but it lowers the coordination costs associated with
two interdependent activities. A firm’s leaders should ask: To what extent will they
improve their ability to coordinate their business activities—and offer unique value—
by conducting this activity themselves? The fact of the matter is that some activities
or tasks require more coordination than others to be successful because of greater
interdependence with other activities. The greater the interdependence between
activities, the more it makes sense to vertically integrate and have these done within a
company where the team members can effectively coordinate their work.
The third C is control, which refers to a firm’s desire to maintain control over a
valuable activity or input in the value chain. In other words, an organization’s leaders
must ask: to what extent should they maintain control over a crucial step in the value
chain by conducting that activity themselves? A company may want to vertically
integrate in order to control some scarce and valuable resource, particularly if it is a
differentiator of its final product. The choice to backward integrate may be made in
order to control access to important raw materials or inputs that are highly customized
to downstream activities. In a similar vein, it might make sense to maintain control
over investments in assets or equipment that provide key inputs at lower cost.
48. What are the dangers of vertical integration?
Answer: There are two important dangers—a loss of flexibility and loss of focus—the
two Fs.

First, when many activities are managed in a value chain, the flexibility to quickly
make changes to the business is lost. This might be important when there are major
technological changes. In fact, research has shown that companies that are more
vertically integrated take a bigger hit to performance when there is a technological
change. Having more flexibility—that is, being less vertically integrated—is
particularly valuable when new technologies are being developed or if the cost to
perform an activity can change quickly.
A loss of focus refers to the fact that the more different types of activities a firm needs
to manage, the harder it is to be world class in all of those activities. It is just too
difficult for managers to focus on many different activities at once and be world class
at all of them. There is one more dimension to focus that is worth mentioning. When
firms are vertically specialized, they only stay in business when they can focus on
making profits. If they can’t make enough profits, they go out of business.
49. What are some of the advantages of outsourcing?
Answer: Outsourcing does give firms more flexibility to quickly move activities to
whatever company is the best at performing that particular activity. When there is
high technological uncertainty in an industry with lots of new leapfrog technologies
being developed, flexibility is valuable, and outsourcing is often preferred to vertical
integration. Outsourcing also allows firms to focus their attention on being good at a
narrower range of activities. Along with this benefit, outsourcing also minimizes the
capital investment required to grow. Also, outside suppliers can often produce at
much greater scale than in-house suppliers because in-house suppliers often have
difficulty getting outside customers.
50. What are the disadvantages to outsourcing?
Answer: There are two major dangers of outsourcing: a loss of capabilities

(particularly the capability to innovate) and a lack of control over critical assets or
activities. In addition to leading to a loss of innovation capabilities, outsourcing can
lead to a loss of control as suppliers that provide key inputs gain bargaining power.


Chapter 7: Vertical Integration and Outsourcing Multiple Choice Questions

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Chapter 7: Vertical Integration and Outsourcing Multiple Choice Questions

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Chapter 7: Vertical Integration and Outsourcing

Multiple Choice Questions

3. Which of the following scenarios illustrates the concept of outsourcing?

Copyright ©2016 John Wiley & Sons, Inc.

4. Vertical integration can be best defined as:

6. Green Solutions Corp. is a washing machine manufacturing company. When it

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

18. Which of the following statements is a characteristic of subcontractors?

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

25. Which of the following is a primary characteristic of a transaction-specific asset?

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

Fill in the blanks

Answer: loss of focus

43. Briefly state the difference between outsourcing and insourcing.

Copyright ©2016 John Wiley & Sons, Inc.

45. In the context of vertical integration, when is flexibility most valuable?

Answer: Having more flexibility—that is, being less vertically integrated—is

46. In the context of coordination, what is modular interdependence?

Answer: In the context of coordination, modular interdependence is one of the three

Copyright ©2016 John Wiley & Sons, Inc.

47. Explain the three Cs of vertical integration.

48. What are the dangers of vertical integration?

Copyright ©2016 John Wiley & Sons, Inc.

49. What are some of the advantages of outsourcing?

50. What are the disadvantages to outsourcing?

Answer: There are two major dangers of outsourcing: a loss of capabilities

Copyright ©2016 John Wiley & Sons, Inc.

Copyright ©2016 John Wiley & Sons, Inc.

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