Chapter 9 CORPORATE-LEVEL STRATEGY: HORIZONTAL INTEGRATION, VERTICAL INTEGRATION, AND STRATEGIC OUTSOURCING 2010 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 How do we sustain competitive advantages in our current business? What new businesses or industries do we wish to enter? Corporate strategy is used to identify: Businesses/industries firm should be in Value creation activities firm should perform Methods to enter/exit businesses/industries to maximize long-run profitability Companies must adopt a long-term perspective in formulating a corporate-level strategy. 2010 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 Multi-Business Model Company Must Construct: Business model & strategies for each business unit/division in every industry it competes Higher-level model- justifies entry into different businesses & industries Division Business Unit Dept. 2010 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.

Repositioning & Redefining A Business Model Corporate-level strategies primarily directed toward improving company’s competitive advantage and profitability in present business or product line. Horizontal Integration- acquiring/merging with industry competitors Vertical Integration- expanding operations backward into industry that produces inputs for company or forward into industry that distributes company’s products Strategic Outsourcing- letting some value creation activities within business be performed by independent entity 2010 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 Strategy Process of acquiring/merging with industry competitors in effort to achieve competitive advantages that come with large scale & scope. Staying in single industry allows firm to: Focus resources- resources devoted to competing successfully in one area ‘Stick to the knitting’- company stays focused on what it does best 2010 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.

Benefits of Horizontal Integration Profits/profitability increase if horizontal integration: Lowers cost structure Increases product differentiation Product bundling Cross-selling Replicates business model Reduces industry rivalry Increases bargaining power 2010 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.

Problems with Horizontal Integration Data suggests the majority of mergers/acquisitions DO NOT create value and many may DESTROY value. Implementing horizontal integration not easy task Problems with merging different company cultures High management turnover in acquired when acquisition is hostile Managers tend to overestimate benefits of merger Managers tend to underestimate problems in merging Merger may be blocked if perceived to: Create dominant competitor Create too much industry consolidation Have potential for future abuse of market power 2010 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.

Vertical Integration: Entering New Industries Backward Vertical- expands into industry that produces inputs to company Forward Vertical- company expands into industry that uses, distributes, sells company’s products 2010 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.

Stages in Raw-Materials-to-Customer Value-Added Chain Figure 9.1 2010 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.

Raw-Materials-to-Customer Value-Added Chain in PC Industry Figure 9.2 2010 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 “...strengthens the business model of the core business or... improves its competitive position. Facilitates investments in specialized assets- lowers cost structure or better differentiation. Enhances product quality- strengthens its differentiation advantage through either forward or backward integration Improved scheduling Easier & more cost-effective to plan, transfer of product in value-added chain Enables company to respond better to changes in demand 2010 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.

Problems with Vertical Integration Increased Cost Structure Company-owned suppliers develop higher cost structure than independent suppliers Bureaucratic costs of solving transaction difficulties Technological Change May lock into old/inefficient technology Prevent company from changing to new technology that could strengthen business model Unpredictable Demand Creates risk in vertical integration investments 2010 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.

Vertical Integration Limits Company-owned suppliers lack incentive to reduce costs Changing demand/technology reduces ability to be competitive 2010 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 Short-term contracts/competitive bidding- lack of commitment to supplier Strategic alliances/long-term contracting Enables creation of stable long-term relationship Becomes substitute for vertical integration Avoids problems of managing additional company Building long-term cooperative relationships Hostage taking – creating mutual dependency Credible commitments – believable promise/pledge Maintaining market discipline Periodic contract renegotiation Parallel sourcing policy 2010 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 Allows one or more of company’s value-chain activities/functions to be performed by independent specialized companies to focus all skills/knowledge on one activity. Focus on fewer value-creation activities Goal to outsource noncore/nonstrategic activities Virtual Corporation- companies that pursue extensive strategic outsourcing 2010 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 of Primary Value Creation Functions Figure 9.3 2010 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.

Benefits of Outsourcing Lower cost structure- specialist cost is less than performing activity internally Enhanced differentiation- quality of activity performed by specialist is greater than if activity were performed by the company Focus on the core business Distractions are removed Company can focus attention/resources on activities important for value creation/competitive advantage 2010 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.

Risks of Outsourcing Holdup – company becomes too dependent on specialist provider Loss of information – company loses important customer contact or competitive information 2010 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: RELATED AND UNRELATED DIVERSIFICATION Chapter 10 CORPORATE-LEVEL STRATEGY: RELATED AND UNRELATED DIVERSIFICATION

Diversified Company “...makes and sells products in two or more different or distinct industries…”

Why Diversify? When company is generating free cash flow with resources in excess of those needed to maintain competitive advantage.

Corporate-Level Strategy Allow company to perform value creation functions at lower cost or in way allowing differentiation & premium price. Used to identify: Businesses/industries in which company should compete Value creation activities company should perform in those businesses Method to enter or leave businesses or industries in order to maximize its long-run profitability

Strategy of Diversification Types of diversification: Related diversification Unrelated diversification Methods to implement diversification strategy: Internal new ventures Acquisitions Joint ventures

Ways to Diversify = Increase Profitability Transfer competencies Leverage competencies Share Resources & Capabilities Product bundling General organizational competencies

Transferring Competencies Taking a distinctive competency developed in one industry and implanting it in EXISTING business unit in another industry Competencies transferred must involve activities important to establish competitive advantage

Transfer of Competencies at Philip Morris Figure 10.1

Sharing Resources at Procter & Gamble Figure 10.2

Product Bundling Differentiate products/expand product lines to satisfy customers’ needs for package of related products. Allows customers to reduce suppliers for convenience & cost savings Examples Telecommunications Medical equipment

Types of Diversification Related - entry into new business in different industry: Related to company’s existing business/activities Has commonalities between one or more components of each activity’s value chain Based on transferring/leveraging competencies, sharing resources, & bundling products Unrelated - entry into industries with no connection to any of company’s activities in present industry or industries Based on only general organizational competencies to increase profitability of all business units

Commonalities Between Value Chains of 3 Business Units Figure 10.3

Disadvantages/Limits of Diversification Conditions = diversification disadvantageous: Changes in Industry/Company Unpredictable future Willing to divest business units Diversification for the Wrong Reasons Clear vision of how value will be created. Extensive diversification can reduce profitability. Bureaucratic Costs of Diversification Costs are function of number of business units portfolio Extent coordination is required to gain benefits.

Factors Ignored in Pooling Diversification Risk Stockholders can diversify own portfolio Business cycles of different industries are difficult to predict – economic downturn affects all

May pursue both strategies simultaneously Choosing Strategy Depends on comparison of benefits of each strategy versus cost of pursuing it: Related Competencies can be applied across greater number of industries Superior capabilities to control bureaucratic costs Unrelated Functional competencies have few uses across industries Organizational design skills to build competencies May pursue both strategies simultaneously

Sony’s Web of Corporate-Level Strategy Figure 10.5

Internal New Ventures Pitfalls: Scale of Entry Commercialization Process of transferring/creating new business unit/division in new industry. Pitfalls: Scale of Entry Commercialization Poor Implementation

Successful Internal New Venturing Place funding for research in hand of business unit managers Effective use of R & D competency Foster close links between R & D and marketing Large-scale entry leads to greater long-term profits

Attractions of Acquisitions Principle strategy to start horizontal integration: Lack of distinctive competencies Need to move quickly Perceived as less risky than internal new ventures Attractive way to enter new industry protected by high barriers to entry

Acquisition Pitfalls Integrating the acquired company Overestimating economic benefits Expense of acquisitions Inadequate preacquisition screening

Guidelines for Successful Acquisition Identification and screening Bidding strategy Integration Learning from experience

Joint Ventures Attractions: Pitfalls: Avoid risks/costs of building new operation Sharing complementary skills/assets increase probability of success Pitfalls: Sharing profits if new business succeeds Venture partners must share control – conflicts can cause failure Risk of giving know-how away to joint venture partner

Restructuring Why Restructure? Process of divesting businesses and exiting industries to focus on core distinctive competencies to increase company profitability. Why Restructure? Diversification discount- investors see highly diversified companies as less attractive Response to failed acquisitions Innovations in strategic management have diminished advantages of vertical integration or diversification