9 CHARLES W. L. HILL / GARETH R. JONES Strategic Management An Integrated Approach 10th ed. Corporate-Level Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing Chapter 9 Student Version © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Prepared by C. Douglas Cloud , Professor Emeritus of Accounting, Pepperdine University

CORPORATE-LEVEL STRATEGY AND THE MULTIBUSINESS MODEL Learning Objective: After reading this chapter you should be able to discuss how corporate-level strategy can be used to strengthen a company’s business model and business-level strategies. CORPORATE-LEVEL STRATEGY AND THE MULTIBUSINESS MODEL Corporate-level strategies drive a company’s business model over time. It determines which types of business- and functional-level strategies managers will choose to maximize long-term profitability. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

CORPORATE-LEVEL STRATEGY AND THE MULTIBUSINESS MODEL Only when a company selects the corporate-level strategy can a company choose the pricing option that will allow it to maximize profitability. When a company decides to expand into new industries, it must construct a business model at two levels. It must develop a business model and strategy for each business unit or division in every industry in which it competes. It must develop a higher-level business-level model that justifies its entry into these businesses. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Learning Objective: After reading this chapter you should be able to define horizontal integration and describe the primary advantages and disadvantages associated with this corporate-level strategy. HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY An advantage of staying within one industry is that it allows a company to focus all of its managerial, financial, technological, and functional resources and capabilities on competing successfully in one area. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY A second advantage is that a company “sticks to the knitting,” meaning that it stays focused on what it knows and does best. Even when a company stays within one industry, it is easy for strategic managers to fail to see the changing nature of the industry because they are focusing only on how to position current products. A focus on corporate-level strategy can help managers anticipate future trends. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Horizontal integration is the process of acquiring or merging with industry competitors to achieve the competitive advantages that arise from a large size and scope of operation. An acquisition occurs when one company uses its capital resources, such as stock, debt, or cash, to purchase another company. A merger is an agreement between equals to pool their operations and create a new entity. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Benefits of Horizontal Integration Lower Cost Structure Horizontal integration can lower a company’s cost structure because it creates increasing economies of scale. A company can lower its cost structure when horizontal integration allows it to reduce the duplication of resources between two companies. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Increased Production Differentiation: HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Benefits of Horizontal Integration Increased Production Differentiation: By increasing the flow of innovative new products that a company sales force can sell to customers at premium prices. Product bundling involves offering customers the opportunity to purchase a range of products at a single combined price. (continued) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Benefits of Horizontal Integration Cross-Selling Cross-selling is when a company takes advantage of or “leverages” its established relationship with customers by way of acquiring additional product lines or categories that it can sell to customers. Cross-selling provides a “total solution” and satisfies all of a customer’s specific needs. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Reduced Industry Rivalry: HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Benefits of Horizontal Integration Reduced Industry Rivalry: Acquiring or merging with a competitor helps to eliminate excess capacity in an industry, thus creating a more benign environment in which prices might stabilize—or increase. Horizontal integration often makes it easier to implement tacit price coordination between rivals. Increased Bargaining Power © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY Problems with Horizontal Integration Implementing a horizontal integration strategy is not an easy task for managers. There are problems associated with merging very different company cultures. When the acquisition is a hostile one, there is high management turnover. Using horizontal integration to grow, companies face conflict with the FTC due to antitrust laws. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective: After reading this chapter you should be able to define vertical integration and describe the primary advantages and disadvantages associated with corporate-level strategy. A company pursuing a strategy of backward vertical integration expands it operations backwards into an industry that produces inputs for the company’s products. If it pursues this strategy forward into an industry that uses, distributes, or sells the company’s product, it is known as forward vertical integration. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

INCREASING PROFITABILITY THROUGH VERTICAL INTEGRATION A specialized asset is one that is designed to perform a specific task and whose value significantly reduced in its next-best use. A company might invest in specialized assets to lower their cost structure or to better differentiate their product. It is often necessary that suppliers invest in specialized assets to produce the inputs that a specific company needs. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

INCREASING PROFITABILITY THROUGH VERTICAL INTEGRATION By entering industries at other stages of the value-added chain, a company can often enhance the quality of the products in its core business and strengthen its differentiation advantage. Sometimes important strategic advantages can be obtained when vertical integration makes it quicker, easier, and more cost-effective to plan, coordinate, and improve scheduling of transferring the product between adjacent stages of the value-added chain. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

THE LIMITS OF VERTICAL INTEGRATION When the disadvantages of vertical integration are so great that vertical integration reduces profitability, a company is engaged in vertical disintegration. What are the disadvantages of vertical integration? Vertical integration can raise costs if, over time, a company makes mistakes. Company-owned suppliers do not have to compete with independent, outside suppliers for orders, thus they have less incentive to look for ways to reduce operating costs or improve component quality. (continued) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

THE LIMITS OF VERTICAL INTEGRATION When technology is changing fast, vertical integration locks a company into an old, inefficient technology and prevents it from changing to a new one that would strengthen its business model. If the demand for a company’s product wildly fluctuates and is unpredictable, the firm may find itself burdened with warehouses full of component parts it no longer needs, which is a major drain on profitability. When demand is unpredictable, vertical integration makes it hard to manage volume flow. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

THE LIMITS OF VERTICAL INTEGRATION Vertical integration may weaken when: Bureaucratic costs increase company-owned suppliers lack the incentive to reduce operating costs, and Changing technology or uncertain demand reduces a company’s ability to change its business model to protect its competitive advantage. Companies should be as willing to vertically disintegrate as they are to vertically integrate, to strengthen their core business model. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COOPERATIVE RELATIONSHIPS Learning Objective: After reading this chapter you should be able to describe why, and under what conditions, cooperative relationships such as strategic alliances and outsourcing may become a substitute for vertical integration. ALTERNATIVES TO VERTICAL INTEGRATION: COOPERATIVE RELATIONSHIPS Companies have found that they can realize many of the benefits associated with vertical integration by entering into long-term cooperative relationships with companies in industries along the value-added chain. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COOPERATIVE RELATIONSHIPS Strategic alliances are long-term agreements between two or more companies to jointly develop new products or processes that benefit all companies concerned. Short-Term Contracts and Competitive Bidding Many companies use short-term contacts that last for a year or less to establish the price and conditions under which they will purchase raw materials or sell their final products to distributors or retailers. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS Short-Term Contracts and Competitive Bidding Short-term contracting does not result in the specialized investments that are required to realize differentiation and cost advantages because it signals a company’s lack of long-term commitment to its suppliers. When there is a need for cooperation, the use of short-term contracts and comprehensive bidding can be a serious drawback. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS Strategic Alliances and Long-Term Contracting A strategic alliance becomes a substitute for vertical integration because it creates a relatively stable long-term partnership that allows both companies to obtain the same kinds of benefits that result from vertical integration. Component suppliers benefit from strategic alliances because their business and profitability grow as companies they supply grow. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS Building Long-Term Cooperative Relationships There are several strategies companies can adopt to promote the success of a long-term cooperative relationship and lessen the chance that one company will renege on its agreement and cheat the other. Hostage taking is essentially a means of guaranteeing that each partner will keep its side of the bargain. (continued) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS Building Long-Term Cooperative Relationships A credible commitment is a believable commitment or pledge to support the development of a long-term relationship between companies. A company that forms a strategic alliance with an independent component supplier runs the risk that its alliance might become inefficient over time. (continued) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS Building Long-Term Cooperative Relationships Because long-term contracts are renegotiated every 3-5 years, the supplier knows that if it fails to live up to its commitments, its partner may refuse to renew the contract. Many companies use parallel source policies—they enter into long-term contracts with two suppliers for the same component. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STRATEGIC OUTSOURCING Strategic outsourcing is the decision to allow one or more of a company’s value-chain activities or functions to be performed by independent specialist companies that focus all of their skills and knowledge on just one kind of activity. It may encompass an entire function or it may be just one kind of activity that a function performs. There has been a clear move to outsource activities that managers regard as “noncore.” © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STRATEGIC OUTSOURCING Benefits of Outsourcing Outsourcing has several advantages: It can help the company lower its cost structure. It can increase product differentiation. It can help a company focus on the distinctive competencies that are vital to its profitability. Risks of Outsourcing Outsourcer’s holdup refers to specialist raising prices if a firm becomes too dependent. A company could suffer loss of important information. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.