9 Corporate Strategy Horizontal Integration Vertical Integration and

9 Corporate Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing 1

Overview n Horizontal integration ¨ The process of acquiring or merging with industry competitors n n Acquisition and merger Vertical integration ¨ Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company’s products n Strategic outsourcing ¨ Letting some value creation activities within a business be performed by an independent entity 2

Benefits of Horizontal Integration Reducing costs n Increasing value n ¨ Product bundling ¨ Cross selling Managing industry rivalry n Increasing bargaining power n ¨ Market power (monopoly power) 3

Drawbacks and Limits of Horizontal Integration Majority of mergers and acquisitions do not create value n Implementing a horizontal integration strategy is not easy n Mergers and acquisitions often fail to produce the anticipated gains n Can bring the company into conflict with antitrust law n 4

Vertical Integration: Stages in the Raw Material to Consumer Value Chain 5

The Raw Material to Consumer Value Chain in the Personal Computer Industry 6

Full and Taper Integration 7

Increasing Profitability Through Vertical Integration Building barriers to entry n Facilitating investments in specialized assets n Protecting product quality n Improved scheduling n 8

Arguments Against Vertical Integration n Cost disadvantages ¨ Company-owned suppliers that have higher costs than external suppliers n Rapid technological change ¨ Tying a company to an obsolescent technology n Demand unpredictability ¨ Difficulty of achieving close coordination among vertically integrated activities n Bureaucratic costs 9

Alternatives to Vertical Integration: Cooperative Relationships n n n Short-term contracts and competitive bidding Strategic alliances and long-term contracting Building long-term cooperative relationships ¨ Hostage taking ¨ Credible commitments ¨ Maintaining market discipline n Parallel sourcing policy 10

Strategic Outsourcing of Primary Value Creation Functions 11

Benefits of Outsourcing n n Virtual Outsourcing Reducing costs ¨ The specialist company is less than what it would cost to perform the activity internally n Differentiation ¨ The quality of the activity performed by the specialist is greater than if the activity were performed by the company n Focus ¨ Distractions are removed; the company can focus attention and resources on activities important for value creation and competitive advantage 12

Identifying and Managing the Risks of Outsourcing n Holdup ¨ The company can become too dependent on the provider of the outsourced activity so that the provider can raise prices n Scheduling of activities ¨ Loss of control can result in distorted signals in the supply chain n Loss of information ¨ Contact with the customer may be lost 13