Chapter 8: Corporate Strategy: Vertical Integration and Diversification

Corporate strategy

goal directed actions leaders take in the quest for competitive advantage in several industries simultaneously

Value Chain

transforming inputs to outputs with primary activities and support activities

Transaction cost economics (TCE)

helps explain and predict boundaries of the firm based on incurred costs

Transaction costs

costs associated with economic exchange

internal transaction costs

firms internal business activates (ex. Recruiting and training employees)

external transaction costs

firms spending in open market (ex. Spend money researching for partner firm)

if external costs > internal costs

vertically integrate, own production, own distribution

if internal costs > external costs

purchase outside firm

Vertical integration

firm’s ownership of its production of needed inputs or of the channels by which it distributes its outputs

backward vertical integration

moving upstream towards raw materials

forward vertical integration

moving closer to customers

specialized assets

unique assets with high opportunity cost

Alternatives to vertical integration

Taper integration, strategic outsourcing

Taper integration

backward integration and relying on outside market firms

Strategic outsourcing

moving one or more internal value chain activities outside the firm

Product diversification

increase in variety of products

Geographic diversification

increase in variety of markets

Product-market diversification

product and geographic diversification

Diversification discount

stock price of highly diversified firms is valued at less than the sum of their individual business units

High and low levels of diversification

lower performance

Moderate levels of diversification

higher firm performance

Diversification premium

the stock price of related-diversification firms is valued at greater than the sum of their individual business units

Restructuring

reorganizing and divesting business activities