Ch 8: Corporate Strategy- Vertical Integration and Diversification

The decisions and actions taken to gain and sustain competitive advantage in several industries and markets simultaneously

Corporate Strategy

Knowing where to compete

Corporate Strategy

What are the questions to determine corporate strategy? (3)

In what stages of the industry value chain should we participate? (vertical integration)
What range of products and services should we offer? (diversification)
Where should we compete? (geographical scope)

Underlying the three questions of corporate strategy, why do firms need to grow? (5)

Stock market implications
Lower costs
Increase market power
Reduce risk
Managerial motives

all internal and external costs associated with an economic exchange

transaction cost

Theme is firm vs markets; helps explain and predict boundaries of the firm and helps managers decide what to insource and outsource

Transaction Cost Economics (TCE)

Transaction Cost Economics (TCE) helps managers decide:

What to insource and outsource

What are the two main external costs?

Searching for a firm/individual to contract with
Negotiating, monitoring, and enforcing the contract

costs to organize an exchange within a firm

internal transaction costs

What are examples of internal costs?

Recruiting and retaining employees
Paying salaries and benefits
Setting up a shop floor
Providing office space and computers

explains the decision to vertically integrate

Transaction Cost Economics (TCE)

the firms ownership of its production of needed inputs or the channel by which it distributes its outputs

vertical integration

When a firm is fully integrated, all business activities are:

conducted within the boundaries of the firm

moving ownership of activities upstream to the originating inputs of the value chain

backward vertical integration

moving ownership of activities closer to the end customers

forward vertical integration

Downstream integration

forward vertical integration

TCE suggests that if the ___ , vertically integrate

Cost in house < Cost of the market

When firms are more efficient than the market:

vertically integrate

What are the potential benefits of vertical integration

Lower costs
Facilitates scheduling and planning
Facilitates investments in specialized assets
Secures critical supplies and distribution channels

What are the potential risks of vertical integration (4)

Increase in costs (bc in house suppliers not exposed to market competition)
Reduction in quality (know there is always a buyer)
Reduction in flexibility
Potential for legal repercussions (monopoly concerns)

If vertical integration doesn’t work, companies can:

disintegrate

What are the items on the make-or-buy continuum? from less to more integrated? (7)

Buy
ST Contracts
LT Contracts
Equity alliances
Joint Ventures
Parent-sub relationship
Make

Firm sends out request for proposal (RFP) using competitive bidding for contracts for less than a year in duration

Short term Contracts

What are the benefits of ST Contracts?

Longer planning period
Lower prices

What are the drawbacks of using ST contracts

Firms responding to RFP have no incentive to make transaction-specific investments

longer than a year in duration, help facilitate transaction specific investment

LT Contract (Licensing)

What example was used for LT contracts and liscencing

Humulin was developed by Genetech based on licensing agreement and commercialized by Eli Lily

What are the types of LT Contracts

Liscensing
Frainchising

franchisor grants the franchisee the right to:

Trademark
Busn process

Franchisee provides to franchisor:

Up front buy in
Percent of Revenue

partnership is which one firm takes partial ownership in the other (buy stocks or assets)

Equity alliance

What is the example of equity alliance

Coke bought Monster with stakes in the company so that it could keep reputation and glean profits

Why perform equity alliances instead of acquisition for Coke and Monster

Wrongful death suits
Benefit from growth
Protect wholesale image and brand

two or more partners create and jointly own new firm; LT commitment and facilitates transaction specific investment

joint ventures

corporate parent owns subsidiary and directs it via command and control

parent-subsidiary relationship

An alternative to vertical integration that involves backward integration and relying on others for supplies with forward integration and relying on others for distribution

taper integration

what was the example of taper integration

Tara (50% integrated)

Moving one or more internal value chain activities outside the firms boundaries to other firms in the industry value chain

strategic outsourcing

What is the example of strategic outsourcing

outsourcing offshore- move value chain activities outside firms boundaries to other firms in another country

an increase in the variety of products and services a firm offers or the markets and geographic regions in which it competes

diversification

What are the types of business diversification? (4)

Single business (more than 95% revenue from one busn)
Dominant business (between 75% and 95% from one busn)
Related Diversification ( less than 70% of rev from one business)
Unrelated diversification (conglomerate)

What are the two types of related diversification?

related constrained
related linked

All businesses that are related share competencies, like Exxon and Nike

Related Constrained

some businesses that are related share competencies, ex: amazon and disney

related linked

no businesses that are under the same roof share competencies

unrelated diversification

If a company has unrelated diversification, it is typically a :

conglomerate

What are the examples of unrelated diversification (conglomerates)

Berkshire Hathaway
Yamaha
Tata Group

High and low levels of diversification =

lower performance

moderate levels of diversification =

higher firm performance

How can diversification enhance firm performance

Provide economies of scale (reduce costs)
Exploit economies of scope (increase value)

may be the advantageous form of diversification in emerging economies

unrelated diversification

why would unrelated diversification be advantageous in emerging economies?

Overcome institutional weaknesses (lack of capital markets and well defined legal systems/property rights )

Reorganizing and divesting business units and activities to refocus a company on its core competencies

restructuring

What is the Boston Consulting Group (BCG) Growth Share Matrix

Shows market growth verses market share and helps companies determine where to go from there

According to the BCG Growth Share Matrix, if you are in the question mark, your market growth potential is ___ and your relative market share is ___ so you should ___

High
Low
Increase mkt share or harvest and divest

According to the BCG Growth Share Matrix, if you are in the star, your market growth potential is ___ and your relative market share is ___ so you should ___

High
High
Hold or invest for growth

According to the BCG Growth Share Matrix, if you are in the Cash Cow, your market growth potential is ___ and your relative market share is ___ so you should ___

Low
High
Hold

According to the BCG Growth Share Matrix, if you are in the dog, your market growth potential is ___ and your relative market share is ___ so you should ___

Low
Low
Harvest and divest