GSM chpt 8 - vertical integration and diversification

firms need to grow

to increase profits, lower costs and get economies of scale, increase market power, reduce risk thru diversification, motivate mngrs and employees

three dimensions of corporate strategy

industry value chain (vertical integration), products/services(diversification), georgraphy (scope)

transaction cost economies

helps explain and predict boundaries of the firm based on incurred costs; help managers decide which activities to perform in house and which services/products to obtain from external market

external transaction costs

activites transacted in open market (searching for a firm to contract with, negotiation and enforcing contract)

internal transaction costs

firms perform business activties (recruiting employees, admin costs)

vertical integrate decision

cost of in house < cost of buying in market; when firms are more efficent than the market they should vertically integrate

backward integration

owning production of the inputs

forward integration

owning output dist channels

principal-agent problem

major disadv of organzing economic activity as opposed to within markets

principal: owner of firm and creates shareholder value

agent: manager/employee acting on behalf of principal

problem: agents pursue their own interests

solution: stock options to make agents owners

strategic alliances

voluntary arrangement between firms that involve sharing of knowledge, resources, capabilities with the intent of developing processes, products, or services

vertical integration

firms ownership of its production of needed inputs or channels by which it distributes its outputst

vertical integration benefits

secures critical supplies and dist channels (obtain more control over value chain activites), increases op efficencies thru improved coordination between different value chain activites (lowering costs), facilitates investments in specialized assets

specialized assets

investments in specialized assets tend to incur high opp costs so vertical integration is undertaken to overcome the threat of opportunism

vertical integration risks

reduces strategic flexibility like in case of external environment changes (emergence of EV), increases in internal transaction costs (admin costs), increasing potential for legal repercussions

taper integration

backward/forward integrated, reliance on outside firms such as suppliers or dist for some of its supplies and dist

strategic outsourcing

moving one or more internal value chain activities to other frims (HR mgmt system)

diversification

product diversification: variety of products/serices a firm offes

geographic diversification: markets/geo regions in which it competes

four types of business diversification

single business, dominant business, related diversification, unrelated diversification

classification scheme

percentage of revenue from dominant business, relationship of the core competencies across the business unit

single business

leverages its competencies, derives more than 95% of its revenue from one businessdo

dominant business

dominnat and minor businesses share competencies, derives 70-95% of its revenues from a single business

related diversification

derives less than 70% of its revenue from a single business and obtains revenues from other business lines related to the primary business activity; benefit from economies of scale and scope (ex. amazon)

unrelated diversification (conglomerate)

less than 70% of revenues come from a single business, few linkages among business lines

high and low levels of diversification

single business and unrelated diversifiaction = lower performance

diversification discount: stock price valued less than sum of indivdual business units

moderate level of diversifcation

dominant business and related diversification = high firm performance

diversification premium: stock price valued greater than sum of individual business units

BCG Growth Share Matrix

question mark: high growth, low market share

star: high growth, high market share

dog: low growth, low market share

cash cow: low growth, high market share