8

CHAPTER
McGraw-Hill/I rwin
Copyright 2013 by The McGraw-Hill Companies, I nc. All rights reserved.
Corporate Strategy:
Vertical Integration
and Diversification
What Is Corporate Strategy?
Corporate strategy
Quest for competitive advantage when competing in multiple
industries
Ex: Jeffrey Immelts initiative in clean-tech and health care industries

Corporate strategy concerns the scope of the firm
Industry value chain
Products and services
Geography
8-2
72
What Is Corporate Strategy? (cont'd)
Economies of scale
Average per-unit cost decreases as its output
increases
Ex: Anheuser-Busch Inbev largest global brewer
Economies of scope
Savings that come from producing more outputs or
providing different services at less cost
Ex: Amazon range of products & services
Transaction cost
The cost associated with economic exchange
"Make or buy" decision

8-3
73
Firms vs. Markets: Make or Buy
Should a firm do things in-house (to make)? Or
obtain externally (to buy)?

If Cin-house < Cmarket, then the firm should vertically
integrate
Ex: Microsoft hires programmers to write code
in-house rather than contracting out
Firms and markets have distinct advantages and
disadvantages (see Exhibit 8.2)
8-4
14
EXHIBIT 8.2 Organizing Economic Activity: Firm vs. Markets
8-5
15
Firms vs. Markets: Make or Buy?
Disadvantage of make in-house
Principal agent problem
owner = principal, manager = agent
Agent pursues his/her own interests
Disadvantage of buy from markets
Search cost
Opportunism
Incomplete contracting
Enforce legal contracts
Information asymmetries
One party is more informed than others
Akerlof Lemons problem for used cars

8-6
16
Repurchasing
PepsiCo
Bottle distributors
Gain merchandising control

GM
Purchased a minority stake in Delphi Automotive LLC
Ensuring supply

Boeing
Aggressively outsources parts
Purchased a 50% stake in a joint venture that
supplies parts for 787 Dreamliner jet

(Worthen, B., Tuna, C., & Scheck, J. 2009)


8-7
17
EXHIBIT 8.3 Alternatives along the Make or Buy Continuum
8-8
18
Vertical Integration along the Industry
Value Chain
In what stages of the industry value chain should
the firm participate?
Vertical integration
Ownership of its inputs, production, & outputs in the
value chain
Horizontal value chain
Internal, firm-level value chains (Chapter 4)
Vertical value chain
Industry-level integration from upstream to
downstream
Examples: cell phone industry value chain
Many different industries and firms
8-9
19
EXHIBIT 8.4
Backward and Forward Vertical Integration along an
Industry Value Chain
8-10
110
Types of Vertical Integration
Full vertical integration
Ex: Weyerhaeuser
Owns forests, mills, and distribution to retailers
Backward vertical integration
Ex: HTCs backward integration into design of phones
Forward vertical integration
Ex: HTCs forward integration into sales & branding
Not all industry value chain stages are equally
profitable
Zara primarily designs in-house & partners for
speedy new fashions delivered to stores


8-11
111
EXHIBIT 8.5
HTCs Backward and Forward Integration along the
Industry Value Chain in the Smartphone Industry
8-12
112
Benefits and Risks of Vertical Integration
Benefits of vertical integration
Securing critical supplies

Lowering costs

Improving quality

Facilitating scheduling and planning

Facilitating investments in specialized assets
Ex: HTC started as OEM & expanded to fully integrated
8-13
113
Strategic health system development
Vertical integration in managed health care
Shared information improved quality & facilitating
scheduling and planning

Hospital and Physician alliance against insurance
companies - lowering costs

Specialists - Facilitating investments in specialized
assets


(Nauert, R. C., 2002)
8-14
114
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
8-15
115
Alternatives to Vertical Integration
Taper integration
Backward integrated but also relies on outside
market firms for supplies
OR
Forward integrated but also relies on outside market
firms for some of its distribution
Strategic outsourcing
Moving value chain activities outside the firm's
boundaries
Ex: EDS and PeopleSoft provide HR services to many firms
that choose to outsource it.

8-16
EXHIBIT 8.6 Taper Integration along the Industry Value Chain
Outside suppliers could
also be off-shored when
they are not located in the
home country
8-17
Corporate Diversification: Expanding Beyond a
Single Market
Degrees of diversification
Range of products and services a firm should offer
Ex: PepsiCo also owns Lay's & Quaker Oats.
Diversification strategies:
Product diversification
Active in several different product categories
Geographic diversification
Active in several different countries
Product market diversification
Active in a range of both product and countries
8-18
Types of Corporate Diversification
Single business
Google
Dominant business
Microsoft
Related diversification
Related constrained
ExxonMobil
Related linked
Disney
Unrelated diversification
GE
8-19
EXHIBIT 8.7 Different Types of Diversification
8-20
Richard Rumelt - UCLA

Business world diversification is done to
sustain top-line growth.


Companies begin thinking about diversification
when growth has leveled-out and opportunities
for expansion within their own business has
subsided.
(Lovallo & Mendonca, 2007)

721
Leveraging Core Competencies for
Corporate Diversification
Core competence
Unique skills and strengths
Allows firms to increase the value of product/service
Lowers the cost
Examples:
Walmart global supply chain
Infosys low-cost global delivery system
The core competence market matrix
Provides guidance to executives on how to diversify
in order to achieve continued growth

8-22
EXHIBIT 8.8 The Core Competence Market Matrix
BoA - NCNB BoA - Merrill Lynch
Pepsi - Gatorade Salesforce.com
8-23
Organizational Capabilities
Examples: marketing skill, distribution skills,
human resources skill at top and middle
management.

Heart of a companies value firms seek businesses
that are a good match for their capabilities.

Linked to diversification

When a business declines, should you liquidate your
organizational capabilities or transfer them into a new
business?
(Matsusaka, 2001)
724
EXHIBIT 8.9 The Diversification-Performance Relationship
8-25
Corporate Diversification
How does diversification enhance performance?

Economies of scale lower the cost

Economies of scope increase the value

Reduce cost and increase value simultaneously
8-26
Corporate Diversification
Restructuring
Process of reorganizing and divesting business units
To refocus a company to leverage its core
competencies

Boston Consulting Group growth-share matrix
Dogs
Cash cows
Stars
Question marks
8-27
EXHIBIT 8.11 BCG Matrix
8-28
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 cost
A function of number, size, and types of businesses
linked to one another
Influence cost
Political maneuvering by managers to influence
capital and resource allocation
Bandwagon effects
Firms copying moves of industry rivals

8-29
Chapter Eight Conclusion
Corporate-level strategy
Options for firms to organize economic activity..
Two types of vertical integration backward and
forward
Benefits and risks of vertical integration
Alternatives to vertical integration
Different types of corporate diversification
Core competence-market matrix for different
diversification strategies.
Diversification strategy competitive advantage or
not
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References

Lovalla, D. P. & Mendonca, L.T. (2007) Strategies strategist: An Interview with Richard
Remult. Strategy, The McKinsey Quaterly, August 2007. Retrieved from
http://www.mckinsey.it/storage/first/uploadfile/attach/139924/file/stst07.pdf

Matsusaka, J.G. (2001). Corporate diversification, value maximization, and organizational
capabilities. Journal of Business, 2001, 74 (3), 409-431. Retrieved from
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.122.5464&rep=rep1&type
=pdf

Nauert, R. C. (2002). Strategic health system development and managed care delivery. Journal
of Health Care Finance, 29(2), 5-17. Retrieved from
http://search.proquest.com/docview/235180431?accountid=28644


Worthen, B., Tuna, C., & Scheck, J. (2009, Nov 30). Companies more prone to go 'vertical'.
Wall Street Journal. Retrieved from
http://search.proquest.com/docview/399140920?accountid=28644






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