1. 1 Corporate Strategy Lecture 9

2. 2 Overview  Horizontal integration The process of acquiring or merging with industry competitors  Acquisition and merger  Vertical integration Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company’s products  Strategic outsourcing Letting some value creation activities within a business be performed by an independent entity

3. 3 Benefits of Horizontal Integration  Reducing costs HP claims $2.5bn saving per annum in overhead  Increasing value Product bundling (e.g. Worldcom, MS Office) Cross selling (common in travel/finance industries)  Managing industry rivalry  Increasing bargaining power Horizontal integration in health care  first HMOs then hospital groups Market power (monopoly power)  Why did HP acquire Compaq?

4. 4 Drawbacks and Limits of Horizontal Integration  Majority of mergers and acquisitions do not create value only ~30% create value for the acquiring company, although total value is usually positive  Implementing a horizontal integration strategy is not easy  Mergers and acquisitions often fail to produce the anticipated gains (HP/Compaq)  Can bring the company into conflict with antitrust law e.g. Worldcom with Sprint acquisition

5. 5 HP stock performance Merger=May 2002.

6. 6 Vertical Integration: Stages in the Raw Material to Consumer Value Chain

7. 7 The Raw Material to Consumer Value Chain in the Personal Computer Industry

8. 8 Full and Taper Integration

9. 9 Increasing Profitability Through Vertical Integration  Builds entry barriers to new competitors by denying them inputs and distributors eg. Alcoa/Alcan bought all known bauxite sources  Facilitates investment in specialized assets subject to holdup.  Protects product quality through control of input quality and distribution and service of outputs. McDonalds sometimes takes over a franchise General Foods bought banana plantations McDonalds owns farms and trucks in Russia  Improves internal scheduling (e.g., JIT inventory systems) providing fast response to changes in demand

10. 10 Arguments Against Vertical Integration  Cost disadvantages Company-owned suppliers that have higher costs than external suppliers Telecom Australia, DOD  Rapid technological change Tying a company to an obsolescent technology  Demand unpredictability Difficulty of achieving close coordination among vertically integrated activities  Bureaucratic costs

11. 11 Alternatives to Vertical Integration: Cooperative Relationships  Short-term contracts and competitive bidding Poor treatment of suppliers makes them reluctant to invest in specific assets that may create value for the buyer (e.g. quality, technology).  Strategic alliances and long-term contracting Building long-term cooperative relationships Hostage taking & credible commitments Maintaining market discipline  Periodic renegotiation of the contractual relationship.  Parallel sourcing policy

12. 12 Strategic Outsourcing of Primary Value Creation Functions

13. 13 Benefits of Outsourcing  Reducing costs The specialist company is less than what it would cost to perform the activity internally  Differentiation The quality of the activity performed by the specialist is greater than if the activity were performed by the company  Focus Distractions are removed; the company can focus attention and resources on activities important for value creation and competitive advantage

14. 14 Identifying and Managing the Risks of Outsourcing  Holdup The company can become too dependent on the provider of the outsourced activity so that the provider can raise prices  Scheduling of activities Loss of control can result in distorted signals in the supply chain (e.g. Cisco’s $2bn blunder and eHub)  Loss of information Contact with the customer may be lost

15. 15 Exercises  Comparing vertical integration strategies Seagate vs. Quantum  Closing case: AOL Time Warner