Chapter Nine Corporate Strategy Horizontal Integration Vertical Integration

Chapter Nine Corporate Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing

Corporate-Level Strategy should allow a company, or its business units, to perform the value-creation functions at lower or in a way that allows for differentiation and premium price. cost Corporate strategy is used to identify: 1. Businesses or industries that the company should compete in 2. Value creation activities that the company should perform in those businesses 3. Method to enter or leave businesses or industries in order to maximize its long-run profitability Companies must adopt a long-term perspective Consider how changes in the industry and its products, technology, customers, and competitors will affect its current business model and future strategies. Copyright © Houghton Mifflin Company. All rights reserved. 2

Corporate-Level Strategy: The Multi-Business Model A company’s corporate-level strategies should be chosen to promote the success of a company’s business model – and to allow it to achieve a sustainable competitive advantage at the business level. A multi-business company must construct its business model at two levels: 1. Business models and strategies for each business unit or division in every industry in which it competes 2. Higher-level multi-business model that justifies its entry into different businesses and industries Copyright © Houghton Mifflin Company. All rights reserved. 3

Repositioning and Redefining A Company’s Business Model Corporate-level strategies are primarily directed toward improving a company’s competitive advantage and profitability in its present business or product line: v Horizontal Integration • The process of acquiring or merging with industry competitors v 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 v Strategic Outsourcing • Letting some value creation activities within a business be performed by an independent entity Copyright © Houghton Mifflin Company. All rights reserved. 4

Horizontal Integration Single-Industry Strategy Horizontal Integration is the process of acquiring or merging with industry competitors in an effort to achieve the competitive advantages that come with large scale and scope. Staying inside a single industry allows a company to: v Focus resources Its total managerial, technological, financial and functional resources and capabilities are devoted to competing successfully in one area. v ‘Stick to its knitting’ Company stays focused on what it does best, rather than entering new industries where its existing resources and capabilities add little value. Copyright © Houghton Mifflin Company. All rights reserved. 5

Benefits of Horizontal Integration Profits and profitability increase when horizontal integration: 1. Lowers the cost structure • Creates increasing economies of scale • Reduces the duplication of resources between two companies 2. Increases product differentiation • Product bundling – broader range at single combined price • Total solution – saving customers time and money • Cross-selling – leveraging established customer relationships 3. Replicates the business model • In new market segments within same industry 4. Reduces industry rivalry • Eliminate excess capacity in an industry • Easier to implement tacit price coordination among rivals 5. Increases bargaining power • Increased market power over suppliers and buyers • Gain greater control Copyright © Houghton Mifflin Company. All rights reserved. 6

Problems with Horizontal Integration A wealth of data suggests that the majority of mergers and acquisitions DO NOT create value and that many may actually DESTROY value. v Implementing a horizontal integration is not an easy task. • Problems associated with merging very different company cultures • High management turnover in the acquired company when the acquisition is a hostile one • Tendency of managers to overestimate the benefits to be had in the merger • Tendency of managers to underestimate the problems involved in merging their operations v The merger may be blocked if merger is perceived to: • Create a dominant competitor • Create too much industry consolidation • Have the potential for future abuse of market power Copyright © Houghton Mifflin Company. All rights reserved. 7

Vertical Integration Entering New Industries A company may expands its operations backward into industries that produces inputs to its products or forward into industries that utilize, distribute or sell it products. v Backward Vertical Integration • Company expands its operations into an industry that produces inputs to the company’s products. v Forward Vertical Integration • Company expands into an industry that uses, distributes, or sells the company’s products. v Full Integration • Company produces all of a particular input from its own operations. • Disposes of all of its completed products through its own outlets. v Taper Integration • In addition to company-owned suppliers, the company will also use other suppliers for inputs or independent outlets in addition to company-owned outlets. Copyright © Houghton Mifflin Company. All rights reserved. 8

Stages in the Raw Material to Consumer Value Chain Figure 9. 1 Copyright © Houghton Mifflin Company. All rights reserved. 9

Raw Material to Consumer Value Chain in the Personal Computer Industry Figure 9. 2 Copyright © Houghton Mifflin Company. All rights reserved. 10

Full and Taper Integration Figure 9. 3 Copyright © Houghton Mifflin Company. All rights reserved. 11

Increasing Profitability Through Vertical Integration A company pursues vertical integration to strengthen the business model of its original or core business or to improve its competitive position: 1. Facilitates investments in efficiencyenhancing specialized assets • Allows company to lower the cost structure or • Better differentiate its products 2. Enhances or protects product quality • To strengthen its differentiation advantage through either forward or backward integration 3. Results in improved scheduling • Makes it easier and more cost-effective to plan, coordinate, and schedule the transfer of product within the value-added chain • Enables a company to respond better to changes in demand Copyright © Houghton Mifflin Company. All rights reserved. 12

Problems with Vertical Integration Companies may disintegrate or exit industries adjacent to the industry value chain when encountering disadvantages from the vertical integration: v Cost structure is increasing. • Company-owned suppliers develop a higher cost structure than those of the independent suppliers • Bureaucratic costs of solving transaction difficulties v The technology is changing fast. • Vertical integration may lock into old or inefficient technology • Prevent company from changing to a new technology that could strengthen the business model v Demand is unpredictable. v Creates risk in vertical integration investments. Vertical integration can weaken business model when: • Company-owned suppliers lack incentive to reduce costs • Changing demand or technology reduces ability to be competitive Copyright © Houghton Mifflin Company. All rights reserved. 13

Alternatives to Vertical Integration: Cooperative Relationships Strategic Alliances are long-term agreement between two or more companies to jointly develop new products or processes that benefit all companies concerned. v Short-term contracts and competitive bidding • May signal a company’s lack of commitment to its supplier v Strategic alliances and long-term contracting • Enables creation of a stable long-term relationship • Becomes a substitute for vertical integration • Avoids the problems of having to manage a company located in an adjacent industry v Building long-term cooperative relationships • Hostage taking – creating a mutual dependency • Credible commitments – a believable promise or pledge • Maintaining market discipline – power to discipline supplier • Periodic contract renegotiation Copyright © Houghton Mifflin Company. All rights reserved. Parallel sourcing policy 14

Strategic Outsourcing allows one or more of a company’s value-chain activities or functions to be performed by independent specialized companies that focus all their skills and knowledge on just one kind of activity. v Company is choosing to focus on a fewer number of value-creation activities Ä In order to strengthen its business model v Company’s typically focus on noncore or nonstrategic activities Ä In order to determine if they can be performed more effectively and efficiently by independent specialized companies v Virtual Corporation Ä Describes companies that have pursued extensive strategic outsourcing Copyright © Houghton Mifflin Company. All rights reserved. 15

Strategic Outsourcing of Primary Value Creation Functions Figure 9. 4 Copyright © Houghton Mifflin Company. All rights reserved. 16

Benefits of Outsourcing 1. Reducing the cost structure • The specialist company cost is less than what it would cost to perform the activity internally. 2. Enhanced differentiation • The quality of the activity performed by the specialist is greater than if the activity were performed by the company. 3. Focus on the core business • • Distractions are removed. The company can focus attention and resources on activities important for value creation and competitive advantage. Strategic outsourcing may be detrimental when: • Holdup – company becomes too dependent on specialist provider • Loss of information – company loses important customer contact or competitive information Copyright © Houghton Mifflin Company. All rights reserved. 17