1. Corporate Strategy: Vertical Integration and Diversification

2. 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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3. What Is Corporate Strategy? (cont'd)
Economies of scale
Average per-unit cost decreases as its output increases
Ex: Anheuser-Busch Inbev largest global brewer
Economies of scope
Savings that come from producing 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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4. Firms vs. Markets: Make or Buy
Should a firm do things in-house (to make)? Or obtain externally (to buy)?
If Cin-house < Cmarket, then the firm should vertically integrate
Ex: Microsoft hires programmers to write code
in-house rather than contracting out
Firms and markets have distinct advantages and disadvantages (see Exhibit 8.2)
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5. 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.
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6. Firms vs. Markets: Make or Buy?
Disadvantage of “make” in-house
Principal – agent problem
owner = principal, manager = agent
Agent pursues his/her own interests
Disadvantage of “buy” from markets
Search cost
Opportunism
Incomplete contracting
Enforce legal contracts
Information asymmetries
One party is more informed than others
Akerlof – “Lemons problem” for used cars
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7. Repurchasing PepsiCo GM Boeing Bottle distributors
Gain merchandising control GM
Purchased a minority stake in Delphi Automotive LLC
Ensuring supply
Boeing
Aggressively outsources parts
Purchased a 50% stake in a joint venture that supplies parts for 787 Dreamliner jet
(Worthen, B., Tuna, C., & Scheck, J. 2009)
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8. Alternatives along the Make or Buy Continuum
EXHIBIT 8.3
Alternatives along the Make or Buy Continuum
INSTRUCTOR: An Interactive video activity is available online through McGraw-Hill Connect on this section of the text. It covers Learning Objective 8.2.
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9. 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
Internal, firm-level value chains (Chapter 4)
Vertical value chain
Industry-level integration from upstream to downstream
Examples: cell phone industry value chain
Many different industries and firms
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10. 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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11. Types of Vertical Integration
Full vertical integration
Ex: Weyerhaeuser
Owns forests, mills, and distribution to retailers
Backward vertical integration
Ex: HTC’s backward integration into design of phones
Forward vertical integration
Ex: HTC’s forward integration into sales & branding
Not all industry value chain stages are equally profitable
Zara – primarily designs in-house & partners for speedy new fashions delivered to stores
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12. 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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13. Benefits and Risks of Vertical Integration
Benefits of vertical integration
Securing critical supplies
Lowering costs
Improving quality
Facilitating scheduling and planning
Facilitating investments in specialized assets
Ex: HTC started as OEM & expanded to fully integrated
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14. Strategic health system development
Vertical integration in managed health care
Shared information – improved quality & facilitating scheduling and planning
Hospital and Physician alliance against insurance companies - lowering costs
Specialists - Facilitating investments in specialized assets
(Nauert, R. C., 2002)
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15. Risks of Vertical Integration
Increasing costs
Internal suppliers lose incentives to compete
Reducing quality
Single captured customer can slow experience effects
Reducing flexibility
Slow to respond to changes in technology or demand
Increasing the potential for legal repercussions
FTC carefully reviewed Pepsi plans to buy bottlers
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16. Alternatives to Vertical Integration
Taper integration
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 value chain activities outside the firm's boundaries
Ex: EDS and PeopleSoft provide HR services to many firms that choose to outsource it.
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17. 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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18. 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.
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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19. Types of Corporate Diversification
Single business
Google
Dominant business
Microsoft
Related diversification
Related constrained
ExxonMobil
Related linked
Disney
Unrelated diversification GE
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20. Different Types of Diversification
EXHIBIT 8.7
Different Types of Diversification
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21. Richard Rumelt - UCLA
Business world – diversification is done to sustain top-line growth.
Companies begin thinking about diversification when growth has leveled-out and opportunities for expansion within their own business has subsided.
(Lovallo & Mendonca, 2007)

22. Leveraging Core Competencies for Corporate Diversification
Core competence
Unique skills and strengths
Allows firms to increase the value of product/service
Lowers the cost
Examples:
Walmart – global supply chain
Infosys – low-cost global delivery system
The core competence – market matrix
Provides guidance to executives on how to diversify in order to achieve continued growth
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23. The Core Competence – Market Matrix
EXHIBIT 8.8
The Core Competence – Market Matrix
Pepsi - Gatorade
Salesforce.com
BoA - NCNB
BoA - Merrill Lynch
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24. Organizational Capabilities
Examples: marketing skill, distribution skills, human resources skill at top and middle management.
Heart of a companies value – firms seek businesses that are a good match for their capabilities.
Linked to diversification
When a business declines, should you liquidate your organizational capabilities or transfer them into a new business?
(Matsusaka, 2001)

25. The Diversification-Performance Relationship
EXHIBIT 8.9
The Diversification-Performance Relationship
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.
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26. Corporate Diversification
How does diversification enhance performance?
Economies of scale  lower the cost
Economies of scope  increase the value
Reduce cost and increase value simultaneously
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27. Corporate Diversification
Restructuring
Process of reorganizing and divesting business units
To refocus a company to leverage its core competencies
Boston Consulting Group growth-share matrix
Dogs
Cash cows
Stars
Question marks
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28. EXHIBIT 8.11
BCG Matrix
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29. Corporate Diversification
Internal capital markets
Source of value creation in a diversification strategy
Allows conglomerate to do a more efficient job of allocating 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
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30. Chapter Eight Conclusion
Corporate-level strategy
Options for firms to organize economic activity..
Two types of vertical integration – backward and forward
Benefits and risks of vertical integration
Alternatives to vertical integration
Different types of corporate diversification
Core competence-market matrix for different diversification strategies.
Diversification strategy – competitive advantage or not

31. References
Lovalla, D. P. & Mendonca, L.T. (2007) Strategies strategist: An Interview with Richard Remult. Strategy, The McKinsey Quaterly, August Retrieved from
Matsusaka, J.G. (2001). Corporate diversification, value maximization, and organizational capabilities. Journal of Business, 2001, 74 (3), Retrieved from =pdf
Nauert, R. C. (2002). Strategic health system development and managed care delivery. Journal of Health Care Finance, 29(2), Retrieved from
Worthen, B., Tuna, C., & Scheck, J. (2009, Nov 30). Companies more prone to go 'vertical'. Wall Street Journal. Retrieved from