Part III Corporate Strategies Chapter #6 Vertical Integration

Opening Case Outsourcing

Definitions Corporate Strategy –A firm’s theory of how to gain competitive advantage by operating several businesses simultaneously. Vertical Integration –The number of steps in a value chain that a firm accomplishes within its boundaries

Backward and forward Backward to secure raw materials or resources Forward to secure markets

What is the value of integration? Do we ignore the invisible hand of the market Centralized planning

Transaction cost theory Transaction specific investments

Transaction specific investments make parties to an exchange vulnerable Vertical integration solves this vulnerability problem

Capabilities theories of vertical integration Emphasizes vertical integration to exploit the valuable, rare and costly to imitate resources and capabilities a firm may control

Vertically integrate? Should –Integrate into those business activities where they possess valuable, rare and costly to imitate resources and capabilities Should not –Integrate into business activities where they do not possess the resources necessary to gain competitive advantages

Real Options Theories of Vertical Integration In conditions of “high uncertainty”, when the future value of an exchange cannot be known when investments in that exchange are being made, less vertical integration is better than more vertical integration. Pharmaceuticals Blue Tooth

Alliance instead of Integration Down side costs are known Still maintain access to the upside potential

Research on the three theories Transaction costs –Oldest (most research) –Transaction specific costs lead to vertical integration (empirical evidence) Add uncertainty –Less vertical integration than predicted by transaction specific costs All three work together

Transaction costs and call centers What were the costs early on Now –Call center employees follow scripts –Only a few problems cannot be diagnosed from the script

Capabilities and managing call centers Early, call centers were a source of competitive advantage Now easy to duplicate

Real options and managing call centers Will outsourcing call centers really work? Try it with different call centers No incentive to internalize nor invest in a particular technology

Ethics Who is outsourcing?

The rarity of vertical integration Technology Rare capabilities Resolve uncertainty

Substitutes for vertical integration Alliances (chapter 7)

Organizing for vertical integration Organizational structure –Functional Management controls Compensation policies

Entrepreneurship and Small business Oprah, Inc

Resolving functional conflics Conflict not necessarily bad Manufacturing versus Sales

The budgeting process Making it work for functional managers –The process used in developing budgets is open and participative –The process reflects the economic reality facing functional managers and the firm –Quantitative evaluations augmented by qualitative

Committee Oversight Executive committee Operations committee

Compensation Firm specific costs –US versus Japanese Capabilities –Socially complex Real options –High risks, known downside –Upside potential