1. Corporate Strategy: Vertical Integration and Diversification By Cecilia, Christine, and Savanna

2. Part 2 Strategy Formulation
8-2
Christine

3. ChapterCase 8 Refocusing GE: A Future of Clean-Tech and Health Care?
Jeffrey Immelt appointed CEO of GE Sept. 7th 2001
Environmental Change (e.g., 9/11 and Global Financial Crises)
GE’s stock price fell by 84% over 17 months
Loss of shareholder value of $378 billion
Lost AAA credit rating
Refocus on green economy and health care industries
Sold majority stake in NBC Universal to Comcast
Listed for sale its appliance unit
Two strategic initiatives put into play
ecomagination: solar energy, hybrid locomotives, fuel cells, efficient lighting…etc (this generates $25 billion annually in revenues)
healthymagination: increase quality and access to health care at a lower cost
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Christine

4. GE’s Changing Product Scope
Refocusing GE: A Future of Clean-Tech
and Health Care?
ChapterCase 8
GE’s Changing Product Scope
8-4
Source: Author’s depiction of data in GE annual reports.
Christine

5. GE’s Changing Geographic Scope
Refocusing GE: A Future of Clean-Tech
and Health Care?
ChapterCase 8
GE’s Changing Geographic Scope
8-5
Source: Author’s depiction of data in GE annual reports.
Christine

6. What Is Corporate Strategy?
Quest for competitive advantage when competing in multiple industries
Ex: Jeffrey Immelt’s initiative in clean-tech and health care industries
Corporate strategy concerns the scope of the firm
Industry value chain
Products and services
Geography
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Christine

7. What Is Corporate Strategy? (cont'd)
Three dimensions that determine the boundaries of the firm . . .
vertical integration - the stages of the industry value chain
horizontal integration and diversification – the range of products and services the firm should offer
global strategy - where in the world to compete
These are the fundamental corporate-level strategic decisions.
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Christine

8. Three Dimensions of Corporate Strategy
EXHIBIT 8.1
Three Dimensions of Corporate Strategy
Scope of the firm determines boundaries along these 3 dimensions.
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Christine

9. What Is Corporate Strategy? (cont'd)
Economies of scale
The average per-unit cost decreases as its output increases (the larger the market share, the lower the costs)
Ex: Anheuser-Busch Inbev largest global brewer
Economies of scope
Savings that come from producing two or more outputs or providing different services at less cost
Ex: Amazon range of products & services
Transaction cost
The cost associated with economic exchange
"Make or buy" decision
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Christine

10. Transaction Cost Economics and Scope of the Firm
Explains and predicts the scope of the firm
Scope
Gain & sustain competitive advantage
Formulating corporate strategy
In-house vs external market
Institutional arrangements
SAV
8-12

11. Transaction Cost Economics and Scope of the Firm
Transaction costs
Costs associated with economic exchanges
Firm OR markets
Ex: negotiating and enforcing contracts
Administrative costs
Organizing an exchange within a hierarchy
Recruiting & training
Paying salaries and benefits
Providing supplies
SAV

12. Firms vs. Markets: Make or Buy
In-house (make)? Or externally (to buy)?
If Cin-house < Cmarket, then the firm should vertically integrate
Own input production or distribution outputs
Ex: Microsoft hires programmers
Both distinct advantages and disadvantages
SAV
8-13

13. Organizing Economic Activity: Firm vs. Markets
EXHIBIT 8.2
Organizing Economic Activity: Firm vs. Markets
INSTRUCTOR: An Interactive video activity is available online through McGraw- Hill Connect on this section of the text. It covers Learning Objective 8.2.
SAV
8-14

14. Firms vs. Markets: Make or Buy?
Disadvantage of “make” in-house
Principal – agent problem
owner = principal, manager = agent
Personal interests
Disadvantage of “buy” from markets
Search cost
Opportunism
Incomplete contracting
Enforce legal contracts
SAV
8-15

15. Firms vs. Markets: Make or Buy?
Information asymmetries
Uneven level of knowledge
Akerlof – “Lemons problem” for used cars
SAV

16. Alternatives of the Make or Buy Continuum
Short-term contacts
Competitive bidding process
< One-year term
Lower prices cost advantages
Strategic alliances
Facilitate investment without administrative costs
Long-term contacts
Licensing & franchising
Joint ventures
Hulu
Equity alliances
Toyota & Orocobre
SAV
8-16

17. Toyota Locks Up Lithium for Car Batteries
STRATEGY HIGHLIGHT 8.1
Toyota Locks Up Lithium for Car Batteries
World demand for lithium-ion batteries for cars
Grow from $278 million in ‘09 to $25 billion in 2014
Toyota wants to secure long-term supply of lithium to power its hybrid fleet
Orocobre holds exploration rights to a large salt-lake area
Upfront investment to extract of lithium is very high
Should Orocobre make the investment to supply Toyota?
To encourage investment, Toyota took an equity position
INSTRUCTOR: A 6-minute video on China’s vital role in the supply of global rare earth metals. In fall of 2010, China restricted exports of the materials. The video was produced by The New York Times in November 2010.
shipments-of-rare-earths.html?scp=1&sq=rare%20earth&st=cse
China Rare Earth Video
SAV
1–18
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18. Alternatives of the Make or Buy Continuum
Parent – subsidiary relationship
Most integrated alternative
Parent has command and control
Ex: GM owns Opel and Vauxhall in Europe
SAV

19. Vertical Integration along the Industry Value Chain
In what stages of the industry value chain should the firm participate?
Vertical integration
Ownership of its inputs, production, & outputs in the value chain
Horizontal value chain
Transform inputs into outputs, with activities ranging from basic R&D to customer service.
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CECILIA

20. Vertical Integration along the Industry Value Chain
Vertical value chain (Industry)
Industry-level integration run from upstream to downstream
Examples: cell phone industry value chain
Many different industries and firms
Horizontal value chain (Internal, firm level)
Run Horizontally
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CECILIA

21. Backward and Forward Vertical Integration along an Industry Value Chain
EXHIBIT 8.4
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. It covers Learning Objective 8.3 & 8.4 on types and advantages of vertical integration.
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CECILIA

22. Example: of Vertical Integration is “Cell phone”
Stage 1:
Raw Materials
Chemicals, ceramics, metals, oil, and so on.
-DuPont (U.S.), ExxonMobil (U.S.), others.
Stage 2:
Intermediate goods
Components
Integrated circuits, displays, touch screens, cameras, and batteries.
-Jabil Circuit (U.S.), Intel (U.S.), others.
Stage 3:
Manufacturing
Final Assembly
Flextronics (Singapore) or Foxconn (China), others.
Stage 4:
Marketing
Sales
Telecommunications companies like Ericsson (Sweden), Motorola (U.S.), Nokia (Finland), others.
Stage 5:
Service Provider
To get wireless data and voice service.
-AT&T, Verizon, others.
CECILIA

23. Types of Vertical Integration
Full vertical integration
Ex: Weyerhaeuser
Owns forests, mills, and distribution to retailers
The company's operations are divided into three major business segments:
1- Timberlands — Growing and harvesting trees in renewable cycles.
2- Wood Products — Manufacturing and distribution of building materials for homes and other structures.
3- Cellulose Fiber — Research and development, manufacturing and distribution of pulp products.
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CECILIA

24. Types of Vertical Integration
Backward vertical integration
-Moving ownership of activities upstream to the originating (inputs) point of the value chain.
Forward vertical integration
By moving downstream into sales and increasing its branding activities.
Moving ownership of activities closer to the end (customer) point of the value chain.
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CECILIA

25. Types of Vertical Integration
Not all industry value chain stages are equally profitable
Zara – Vertically Disintegrated—
*Primarily designs in-house & partners for speedy new fashions delivered to stores
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CECILIA

26. HTC’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry
EXHIBIT 8.5
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. It covers Learning Objective 8.3 & 8.4 on types and advantages of vertical integration.
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CECILIA

27. Benefits of Vertical Integration
Specialized assets
Assets that have significantly more value in their intended use than in their next best use
Types of specialized assets
Site specificity
Co-located such as mining equipment
Physical asset specificity
Bottling machinery – different shapes, unique molds
Human asset specificity
Mastering procedures of a particular organization – not meant to be transferred elsewhere
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Christine

28. Risks of Vertical Integration
Increasing costs
Internal suppliers lose incentives to compete – always a buyer for their products
Reducing quality
Single captured customer can slow experience effects – external suppliers gain higher learning to develop quality products
Reducing flexibility
Slow to respond to changes in technology or demand – steel industry went bankrupt
Increasing the potential for legal repercussions
FTC carefully reviewed Pepsi plans to buy bottlers – vertical integration needs to be carefully considered
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Christine

29. Alternatives to Vertical Integration
Taper integration orchestrates value activities
Backward integrated but also relies on outside market firms for supplies OR
Forward integrated but also relies on outside market firms for some of its distribution
Strategic outsourcing
Moving one or more internal value chain activities outside the firm's boundaries
Ex: EDS and PeopleSoft provide HR services to many firms that choose to outsource it
Another example – support staff in schools
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Christine

30. EXHIBIT 8.6 Taper Integration along the Industry Value Chain
Outside suppliers could
also be off-shored when
they are not located in the
home country
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Christine

31. Corporate Diversification: Expanding Beyond a Single Market
Degrees of diversification
Range of products and services a firm should offer
Ex: PepsiCo also owns Lay's & Quaker Oats; Coca Cola only specializes in beverages
Diversification strategies:
Product diversification
Active in several different product categories
Geographic diversification
Active in several different countries
Product – market diversification
Active in a range of both product and countries
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Christine

32. Types of Corporate Diversification
Single business
Google – 95% or more from one business
Dominant business
Microsoft – 70 – 95% from single business, also XBox
Related diversification
Related constrained
ExxonMobil – trying to move into another area
Related linked
Disney – active in a wide array of business activities
Unrelated diversification
GE – less than 70% comes from a single business; they are all over the place with jet engines, household appliances, TV shows, etc
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Christine

33. Different Types of Diversification
EXHIBIT 8.7
Different Types of Diversification
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Christine

34. Leveraging Core Competencies for Corporate Diversification
Unique skills and strengths
Increase perceived value/lower production costs
Examples:
Walmart – global supply chain
Apple - Integration and user experience
Infosys – low-cost global delivery system
The core competence – market matrix
Guidance to diversification strategies
Leading to growth
SAV
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35. The Core Competence – Market Matrix
EXHIBIT 8.8
The Core Competence – Market Matrix
Pepsi - Gatorade
Salesforce.com
BoA - NCNB
BoA - Merrill Lynch
SAV
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36. Corporate Diversification
Diversification discount
Stock price lowers
Diversification premium
Stock price is greater
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. It covers Learning Objective 8.8 on the appropriate context of diversification for competitive advantage.
SAV
8-39

37. Corporate Diversification (cont'd)
How does diversification enhance performance?
Economies of scale lower the cost
Economies of scope increase the value
Reduce cost and increase value simultaneously
SAV
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38. Vertical Integration and Diversification: Sources of Value Creation and Costs
EXHIBIT 8.10
INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. It covers Learning Objective 8.8 on the appropriate context of diversification for competitive advantage.
SAV
8-42

39. Corporate Diversification (cont'd)
Restructuring
Reorganizing and divesting business units
Refocus and leverage core competencies
Boston Consulting Group growth-share matrix
Dogs
Low-performing
Cash cows
Low growth/considerable market share
Stars
High market share/fast growing market
Question marks
Unclear transformation
SAV
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40. EXHIBIT 8.11
BCG Matrix
SAV
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41. Corporate Diversification (cont'd)
Internal capital markets
Value creation in diversification strategy
Efficient allocating of capital
Coordination cost
A function of number, size, and types of businesses linked to one another
Influence cost
Political maneuvering by managers to influence capital and resource allocation
Bandwagon effects
Firms copying moves of industry rivals
SAV
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42. Corporate Strategy: Combining Vertical Integration and Diversification
Firms’ corporate strategy
Level of integration on value chain
AND
Level of diversification
Ex: Oracle earned $23B in 2009
Enterprise software is core competency
Backward integration – Sun Microsystems
Forward integration – PeopleSoft
Diversification at Oracle:
Related – IP management bought Sophoi
Unrelated – ID theft bought Bharosa
SAV
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43. Oracle Corporate Strategy: Combining
Vertical Integration and Diversification
EXHIBIT 8.12
SAV
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44. Take-Away Concepts - Review
LO 8-1 Define corporate-level strategy, and describe the three dimensions along which it is assessed.
While business strategy addresses “how to compete,” corporate strategy addresses “where to compete”.
Corporate strategy concerns the scope of the firm along three dimensions:
vertical integration (along the industry value chain);
horizontal integration (diversification); and
geographic scope (global strategy).
CECILIA

45. Take-Away Concepts - Review
LO 8-2 Describe and evaluate different options firms have to organize economic activity.
Transaction cost economics help managers decide what activities to do in-house (“make”) versus what services and products to obtain from the external market (“buy”).
When the costs to pursue an activity in-house are less than the costs of transacting in the market (Cin-house< Cmarket), then the firm should vertically integrate.
Moving from less integrated to more fully integrated forms of transacting, alternatives include:
*short-term contracts,
*strategic alliances (including long-term contracts, equity alliances, and joint ventures), and
*parent–subsidiary relationships .
CECILIA

46. Take-Away Concepts - Review
LO 8-3 Describe two types of vertical integration along the industry value chain: backward and forward vertical integration.
Industry value chains (vertical value chains) depict the transformation of raw materials into finished goods and services. Each stage typically represents a distinct industry in which a number of different firms are competing .
Backward vertical integration involves moving ownership of activities upstream nearer to the originating (inputs) point of the industry value chain .
Forward vertical integration involves moving ownership of activities closer to the end (customer) point of the value chain.
CECILIA

47. Take-Away Concepts - Review
LO Identify and evaluate benefits and risks of vertical integration.
Benefits of vertical integration include:
*securing critical supplies,
*lowering costs,
*improving quality,
*facilitating scheduling and planning, and
*facilitating investments in specialized assets.
Risks of vertical integration include:
*increasing costs,
*reducing quality,
*reducing flexibility, and
*increasing the potential for legal repercussions.
CECILIA

48. Take-Away Concepts - Review
LO Identify and evaluate benefits and risks of vertical integration.
Vertical integration contributes to competitive advantage if the incremental value created is greater than the incremental costs of the specific corporate-level strategy.
CECILIA

49. Take-Away Concepts - Review
LO 8-6 Diversification
An increase in the variety of products or markets in which to compete.
There are various general diversification strategies:
*Product Diversification Strategy.
*Geographic Diversification Strategy.
*Product-Market Diversification Strategy.
CECILIA

50. To gain & sustain competitive advantage,
any corporate strategy must support and
strengthen a firm’s strategic position
regardless of whether it is a differentiation,
cost leadership, or integration strategy.

51. MINI CASE 8-Core Competencies: From Circuit City to CarMax
Early 1990s, executives look for new ways to utilize core competencies in other markets
Leverage retail competency and improve customer buying experience
Launch CarMax in 1993
Buy Trade-Ins at Blue Book value, even if you don’t buy
Buying used car=root canal experience
First store right by Circuit City Headquarters
125 point inspection and detailing
No haggle pricing, 5 day returns
Thousands of cars for sale at any time
100 Best companies to work for
100 locations, employ 13,500 people, sell 350,000 cars, revenue $8 billion

52. MINI CASE 8-Core Competencies: From Circuit City to CarMax
Do you judge CarMax to be successful? Why or why not?
What type of diversification strategy is Circuit City’s CarMax business venture?
Looking at core competence-market matrix in Exhibit 8.8, does circuit City’s CarMax diversification fall neatly into one of the four quadrants? Why or why not?

53. MINI CASE 8-Core Competencies: From Circuit City to CarMax
4. Was CarMax a good strategic move for Circuit City? Why or why not? 5. In 2002, Circuit City sold off CarMax, which trades on the NYSE under KMX. Was this a good decision by Circuit City’s top management team? Why or why not?

54. Questions?