Corporate Strategy I: Vertical Integration and diversification

MGO403 Strategic Management

Corporate Strategy I: Vertical Integration and

diversification

Dr. Yong Li

Topics

• Announcements • Feedback on HW4 • Corporate-Level Strategy

• READ: Chapter 8 – Corporate-Level Strategy

Feedback on HW-4 • HW – 4 (Business strategy & Value chain)

• What business strategy? • “current strategy puts emphasis on JCP’s online shopping”

• Justify your answer

• Differentiation: unique features→ premium price relative to competition • Cost leadership: lower costs→ lower price with acceptable quality • Blue ocean: both at the same time by opening a new market space

The AFI Strategy Framework

✔class notes

Strategy Formulation and Implementation Across Levels: Corporate, Business, and Functional Strategy

Corporate Strategy

• Corporate strategy concerns the scope or boundaries of the firm along three dimensions:

➢ In what stages of the industry value chain should the firm participate? (vertical integration)?

➢What range of products and services should the firm offer (horizontal integration and product diversification)?

➢ In what geographic markets (regional, national, and/or global) should the firm compete (geographic diversification)?

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Corporate Strategy versus Business Strategy

Key Decision for Business Strategy • How to position the firm within an

industry? • How to develop resources and

capabilities that provide a competitive advantage?

Key Decisions for Corporate Strategy

• In what businesses should the firm engage?

• How should the firm diversify?

• What structure and administrative systems will lead to value creation for a multidivisional firm?

Corporate strategy addresses “where to compete.” Business strategy addresses “how to compete.”

Corporate strategy

• If you are the General Manager of a company with multiple businesses, what questions might you ask yourself?

• To gain and sustain competitive advantage, any corporate strategy must support and strengthen a firm’s strategic position, regardless of whether it is a differentiation, cost-leadership, or blue ocean strategy.

• Is there any synergy across businesses? • Are the individual businesses of the corporate worth more under its management than if

each were managed individually? → V(B1+B2)>V(B1)+V(B2) • If not, should I spin it off? sell it? keep as is?

• Does the company need to add a new business? In what industry?

Vertical Integration

• The ownership of inputs or distribution channels • “What percentage of a firm’s sales is generated within the firm’s boundaries?”

• Backward Vertical Integration • Owning inputs of the value chain

• Forward Vertical Integration • Owning activities closer to the customer

Backward and Forward Vertical Integration Along the Industry Value Chain

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e&j gallo winery company “from grape to glass” whole process vertical integration raw materials and marketing both focus
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apple in not vertical

The Vertical Value Chain of Your Cell Phone

• Raw materials • Chemicals, ceramics, metals, oil for plastic

• Intermediate goods and components • Integrated circuits, displays, cameras, and batteries

• Original equipment manufacturing (OEM) firms • Assembly

• After-Sales Service and Support • AT&T, Sprint, T-Mobile, Verizon, etc.

Backward and Forward Vertical Integration Along the Industry Value Chain

“from grape to glass.”

Forward and Backward Integration: The Smartphone Industry

Benefits of Vertical Integration

• Lowers costs • Improves quality • Facilitates scheduling and planning • Facilitates investments in specialized assets

• Co-located assets, unique equipment, human capital • Secures critical supplies and distribution channels

Risks of Vertical Integration

• Increasing costs ➢ Internal suppliers lose incentives to compete

• Reducing quality ➢Single captured customer can slow experience effects

• Reducing flexibility ➢Slow to respond to changes in technology or demand

• Increasing the potential for legal repercussions ➢FTC carefully reviewed Pepsi plans to buy bottlers

Vertical Integration: Sources of Value Creation and Costs

Corporate Strategy

Sources of Value Creation (V) Sources of Costs (C)

Vertical Integration

• Can lower costs • Can improve quality • Can facilitate scheduling and

planning • Facilitating investments in

specialized assets • Securing critical supplies and

distribution channels

• Can increase costs • Can reduce quality • Can reduce flexibility • Increasing potential for legal repercussions

Firms vs. Markets: Make or Buy?

• Should a firm do things in-house (to make)? Or obtain externally (to buy)?

• If Costsin-house < Costsmarket • The firm should vertically integrate

• Own production of the inputs or • Own output distribution channels

• Example: Google hires programmers to write code in-house rather than contracting out

• If Costsmarket < Costsin-house • The firm should consider purchasing instead

Oliver Williamson

Transaction Costs • Associated with an economic exchange • External transaction costs

• Searching for contractors • Negotiating, monitoring, and enforcing contracts

• Internal transaction costs • Recruiting and retaining employees • Paying salaries and benefits • Setting up a shop floor • Providing office space and computers, etc.

Organizing Economic Activity: Firms vs. Markets

Alternatives on the Make-or-Buy Continuum

Alternatives to Vertical Integration

• Taper Integration • Backward or forward integrated • Plus reliance on outside firms

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make and buy are in the same time

Alternatives to Vertical Integration

• Strategic outsourcing • Moving one or more internal value chain activities outside the firm’s

boundaries to other firms in the industry value chain

• Example: Offshoring

• Most active sectors of offshoring: – Banking and financial services – Information Technology (IT) – Health Care

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e.g. oravle peoplesoft

Types of Diversification

• Product Diversification • Increase in variety of products / services

• Active in several product markets

• Geographic Diversification • Increase in variety of markets / geographic regions

• Regional, national, or international markets

• Product-Market Diversification • Pursue both a product and geographic diversification

strategy simultaneously

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more than one product
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peopsico is diversification
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highly diversification

Types of Corporate Product Diversification

1. Single business • Low level of diversification

2. Dominant business • Additional business activity pursued

3. Related diversification A. Constrained: all businesses share competencies B. Linked: some businesses share competencies

4. Unrelated diversification (conglomerate) • No businesses share competencies

Different Types of Product Diversification

Source: Adapted from R. P. Rumelt (1 974), Strategy, Structure, and Economic Performance (Boston, MA: Harvard Business School Press).

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no diversification, becuse only produce one product e.g. wriglty company
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The Tata Group: Integration at the Corporate Level

• A multinational conglomerate in Mumbai, India • Activities: tea, hospitality, steel, IT, communications, power,

and automobiles

• Tata Motors • Bought Jaguar and Land Rover from Ford (2008) • Created the Tata Nano a small, no-frills car

• 50% cheaper than their next-lowest cost car • Pursue differentiation & low cost strategies simultaneously

• Integration at the Corporate level

Motivations For Diversification • Value Enhancing Motives:

• Increase market power • Multi-point competition

• R&D and new product development • Developing New Competencies (Stretching) • Transferring Core Competencies (Leveraging)

• Utilizing excess capacity (e.g., in distribution) • Economies of Scope • Leveraging Brand-Name (e.g., Haagen-Dazs to chocolate candy)

• The core competence–market matrix (next slide) ➢Provides guidance to executives on how to diversify in order to achieve

continued growth

Source: Adapted from G. Hamel and C. K. Prahalad (1 994), Competing for the Future (Boston, MA: Harvard Business School Press).

E.g., BoA acquisition of commercial banks E.g., BoA acquisition of Merrill Lynch

E.g., Coca-Cola’s Powerade E.g., Salesforce from SaaS to PaaS

The core competence–market matrix: Leveraging Core Competencies For Corporate Diversification

Other Motivations For Diversification

• Motivations that are “Value neutral”: • Diversification motivated by poor economic performance in current

businesses.

• Motivations that “Devaluate”: • Agency problem • Managerial capitalism (“empire building”) • Maximize management compensation • Sales Growth maximization

• Professor William Baumol

Corporate Diversification • Internal capital markets ➢Source of value creation in a diversification strategy ➢Allows conglomerate to do a more efficient job of allocating capital

• Coordination costs ➢A function of number, size, and types of businesses linked to one

another • Influence costs ➢Political maneuvering by managers to influence capital and

resource allocation • Bandwagon effects ➢Firms copying moves of industry rivals

8–44

Diversification: Sources of Value Creation and Costs

Corporate Strategy

Sources of Value Creation (V) Sources of Costs (C)

Related Diversification

• Economies of scope • Economies of scale • Financial economies

• Restructuring • Internal capital markets

• Coordination • Influence costs

Unrelated Diversification

• Financial economies • Restructuring • Internal capital markets

• Influence costs

Corporate Diversification and Firm Performance

SOURCE: Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2000), “Curvilinearity in the diversification-performance linkage: An examination of over three decades of research,” Strategic Management Journal 21: 155–174.

• Does corporate diversification lead to superior performance? – High and low levels of diversification = lower performance – Moderate levels of (related) diversification = higher firm performance

Restructuring

• Reorganizing and divesting business units and activities • Helps refocus a company • Helps leverage core competencies more fully • Helpful restructuring Tool: BCG growth-share matrix:

• Guides portfolio planning • Each category warrants a different strategy

Boston Consulting Group (BCG) Growth-share Matrix

Oracle Corporate Strategy: Combining Vertical Integration and Diversification

Dynamic Corporate Strategy: Nike vs. Adidas • Corporate strategy needs to be dynamic over time

Learning Objectives

• Define corporate strategy and describe the three dimensions along which it is assessed. • Explain why firms need to grow, and evaluate different growth motives. • Describe and evaluate different options firms have to organize economic activity. • Describe the two types of vertical integration along the industry value chain: backward and

forward vertical integration. • Identify and evaluate benefits and risks of vertical integration. • Describe and examine alternatives to vertical integration. • Describe and evaluate different types of corporate diversification. • Apply the core competence–market matrix to derive different diversification strategies. • Explain when a diversification strategy creates a competitive advantage and when it does not.

Implications for Strategic Leaders

• Executives Make Important Choices Along Three Dimensions • Degree of vertical integration

• In what stages of the industry value chain to participate. • Type of diversification

• What range of products and services to offer • The geographic scope

• In what geographic regions to compete

• Corporate Strategy is Dynamic • As firms grow, they tend to diversify and globalize

• This helps capture growth opportunities • Related diversification leads to superior performance

• Taps into multiple sources of value creation • If it can overcome additional sources of costs

DIY: How Diversified Are You?

• We choose how we spend our time & energy • Example: school, work, family, sleep, and play • Can be thought of as personal diversification

• Using the types of diversification as a guide: • List your major activity areas • List the percentage of time you spend doing them • Assess your degree of related and unrelatedness

• What conclusions do you derive? • Do you need to make adjustments? • How has this changed over time?

Next Class (10/11)

• READ: Chapter 9 – Strategic Alliances, Mergers and Acquisitions • READ: Class Notes on Organizational Structure, Culture and Control (up to

slides on structure) (UBLearns)

  • MGO403�Strategic Management
  • Topics
  • Feedback on HW-4
  • The AFI Strategy Framework
  • Slide Number 5
  • Slide Number 6
  • Corporate Strategy
  • Corporate Strategy versus Business Strategy
  • Corporate strategy
  • Vertical Integration
  • Backward and Forward Vertical Integration Along the Industry Value Chain
  • The Vertical Value Chain of Your Cell Phone
  • Backward and Forward Vertical Integration Along the Industry Value Chain
  • Forward and Backward Integration: �The Smartphone Industry
  • Benefits of Vertical Integration
  • Risks of Vertical Integration
  • Vertical Integration: Sources of Value Creation and Costs
  • Firms vs. Markets: Make or Buy?
  • Transaction Costs
  • Organizing Economic Activity: �Firms vs. Markets
  • Alternatives on the Make-or-Buy Continuum
  • Alternatives to Vertical Integration
  • Alternatives to Vertical Integration
  • Types of Diversification
  • Types of Corporate Product Diversification
  • Different Types of Product Diversification
  • The Tata Group: Integration at the Corporate Level
  • Motivations For Diversification
  • The core competence–market matrix: �Leveraging Core Competencies For Corporate Diversification
  • Other Motivations For Diversification
  • Corporate Diversification
  • Diversification: Sources of Value Creation and Costs
  • Corporate Diversification and Firm Performance
  • Restructuring
  • Boston Consulting Group (BCG) �Growth-share Matrix
  • Oracle Corporate Strategy: �Combining Vertical Integration and Diversification
  • Dynamic Corporate Strategy: Nike vs. Adidas
  • Learning Objectives
  • Implications for Strategic Leaders
  • DIY: How Diversified Are You?
  • Next Class (10/11)