Vertical and Horizontal Integration Week 10

Agenda Examine the vertical/horizontal scope of the firm Explore the principles of transaction cost economics. Identify the advantages and disadvantages of Vertical/Horizontal Integration

Ansoff's Matrix of Growth Choices Products Existing New Market Penetration Product Development Existing Markets Market Development Diversification New 3

Types of Mergers and Acquisitions Horizontal Merger: Merging of two firms that produce or sell identical or similar products Vertical Merger: The merger in which one firm acquires either a customer or a supplier. Merging with customer means Forward integration. Merging with supplier mans Backward integration Conglomerate Mergers: Merging of two firms in completely different industries. For example, merging of departmental stores and information technology corporation.

Horizontal Integration Horizontal Integration means to acquire business activities at the same level of the value chain.  This can be done in the same geography or probably in other countries to increase your reach. Acquiring activities dealing with similar products, Acquiring activities that are substitutes for one’s products. Acquiring competitors. In this way reducing the threat from competition. Completing the product range which is ‘expected’ by the customer.

STRENGTHS OF HORIZONTAL INTEGRATION. BENEFITS Economies of scale. Synergy. Defence against substitutes. Reduction in competition. Fulfilling customer expectations. Increased negotiation power. Get more leverage over powerful suppliers or customers.

Vertical Integration A B C D Oil Exploration Oil Extraction Oil Refining Distribution Vertical Integration A B C D Oil Exploration Oil Extraction Oil Refining Distribution Oil Exploration Oil Extraction Oil Refining Distribution

What is Vertical Integration? Firm’s ownership of vertically related activities, i.e. successive stages of the value chain. Extent of vertical integration is indicated by the ratio of a firm’s value added to its sales revenues: If a company makes more, its value added is greater relative to revenue.

Types of Vertical Integration Types of Vertical Integrations: Backward integration –the company tries to own an input product company. Like a car company owning a company which makes tires. Forward integration –the business tries to control the post production areas, namely the distribution network. Like a mobile company opening its own Mobile retail chain. Balanced integration – a mix of the above two. A balanced strategy to take advantages of both the worlds. Decisions To integrate (more) Is this a good way to grow / defend existing position? To dis-integrate Types of Vertical Integration

Make or buy? Supermarket can: own farms and grow fruit & vegetable or go to market and buy from farmers Transaction costs – associated with organising across markets Administrative costs – associated with organizing within firms Ronald Coase suggests estimating the relative cost.

Transaction vs Administrative Costs in Vertical Exchanges Overheads Bureaucracy Loss of efficiency Transaction costs if going to market: Search Negotiate Contracts or other legal Monitoring Invoice and payment Supply management Forecasting Delivery Very Operational!

Value Chain for Steel Cans Iron ore mining Steel production Steel strip production Can-making Canning of food and drink Market Contracts Vertical Integration Market Contracts Both Steel Making: http://www.youtube.com/watch?v=cvXtUKYs3tw&feature=BFa&list=PL67012EB74BEE8506 Grant (2010, P.355)

Strategic Motives Operating System Internet Browser Search Engine Why Google needs its own browser http://www.pbs.org/cringely/pulpit/2008/pulpit_20080905_005415.html Why Google made the Chrome OS - Why is Chrome so important to Google? It's a 'locked-in user'- http://www.zdnet.com/blog/btl/why-is-chrome-so-important-to-google-its-a-locked-in-user/47295 Why Google created Android? http://www.electronista.com/articles/10/05/20/google.io.keynote.says.jobs.vision.is.draconian/

Mobile Software Map Development Strategic Moves Why Apple got its own maps? http://www.guardian.co.uk/technology/blog/2012/sep/24/apple-iphone-5-maps-google Also having its own stores

Does this remind you of any particular Model?

Porter’s Five Forces Analysis Threat of Potential Entrants Supplier Power Intensity of Competitor Rivalry Buyer Power (Customers) Threat of Substitutes

Porter’s Five Forces Analysis Threat of Potential Entrants Power Supplier Power Intensity of Competitor Rivalry Buyer Power (Customers) Threat of Substitutes

Administrative Costs of Internalisation Differences in optimal scale between different stages of production Developing distinctive capabilities Managing strategically different businesses The incentive problem Competitive effects of vertical integration Flexibility Compounding risk

Alternatives to VI Long-term contracts Vendor partnerships Franchising

Summary Consider VI if: In unstable environments More cost-effective Transaction costs avoided are higher than management costs There’s an advantage in synchronising production Blocking competitors Locking in expertise Grabbing scarce resource Stable environment Low / no penalty for locking in relationship In unstable environments Especially technological Remain flexible?