Corporate-Level Strategy & Vertical Integration

Strategic Management Overview

Strategic management is about how companies make big plans to succeed and stay ahead. It involves:

• Looking at the world outside your company (External Analysis)
• Looking at what your company is good at internally (Internal Analysis)
• Deciding your company's purpose and goals, then making a plan to achieve them (Mission → Goals → Strategy Formulation)
• Putting that plan into action (Strategy Implementation) to gain an edge over competitors (Competitive Advantage).

There are two main ways companies make these plans:

• Business-Level Strategy: This is about how a single business tries to win in its specific market. It usually means trying to be the lowest cost provider or offering something unique that customers value (Product Differentiation).
• Corporate-Level Strategy: This is for larger companies that own multiple different businesses. The main question here is: “What different types of businesses should our company be involved in?” It also means deciding:
  1. What markets and industries the company will compete in.
  2. How the company will enter these new businesses (e.g., buying them or starting fresh).
  3. How to manage and coordinate all these different businesses together.

Corporate-Level Strategy: Key Modes & Choices

When a big company decides which businesses to own, it makes choices about its 'portfolio' (which companies it has):

• Vertical Integration: This means owning different steps in the process of making or selling a product.
• Diversification: This means owning businesses in completely different industries.

Companies can get into new businesses in a few ways:

• Mergers & Acquisitions (M&A): Buying other companies or merging with them.
• Strategic Alliances / Joint Ventures: Partnering with other companies.

All these big corporate decisions must help the individual businesses within the company either reduce costs or offer something special to their customers.

Vertical Integration: Core Concept

Definition: Vertical integration is when a company owns and controls several consecutive steps in the process of creating and delivering a product or service, from getting raw materials to selling to the final customer.

There are two directions this can go:

1. Backward Integration: The company moves 'upstream' to own parts of the process closer to the raw materials or suppliers. Think of a bakery buying the farm that grows the wheat.
2. Forward Integration: The company moves 'downstream' to own parts of the process closer to the final customers or stores where products are sold. Think of a bakery opening its own chain of cafes.

Example Supply Chain (Beef → Butcher → Steakhouse → Consumer):

• A company that runs a steakhouse could integrate backward by buying cattle farms.
• That same steakhouse company could integrate forward by owning butcher shops or even directly selling to consumers.

Rationale & Benefits

When companies integrate vertically, they can create 'value-chain economies' (also known as synergy), which means things work together better than if they were separate. This leads to:

• ext{Cost Reduction}: They can save money by avoiding extra charges from middlemen, reducing costs of dealing with many different suppliers, and having more power when negotiating prices.
• ext{Revenue Enhancement}: They can make more money by having better control over product quality, innovating faster, and keeping their brand consistent.
• Higher Profits: They might be able to earn more money than their competitors by avoiding tough competition in certain parts of the market.
• Better Coordination: It helps reduce misunderstandings and delays because all parts are under one roof.
• Protection: It can protect against sudden price increases for materials or problems with distributors.

Potential Risks & Considerations

Vertical integration isn't always good; there are downsides:

• High upfront cost: It requires a lot of money to invest, which can make the company less flexible.
• Hard to manage: It can become very complex to run, leading to inefficiencies as the company grows too large.
• Loss of motivation: When a company owns all parts of the process, it might get lazy because it doesn't face competition from outside suppliers or distributors.
• Missed opportunities: The money and effort invested internally might have earned better returns if invested elsewhere.
• Companies must weigh whether it's cheaper to buy services from other companies (transaction costs) or to do them internally (administrative costs).

Illustrative Examples

Backward Integration

1. Ford – River Rouge Complex (1920s)
   • Ford owned everything: from iron ore mines and steel mills to glass factories and assembly lines for cars.
   • Why: To cut costs and ensure consistent quality for mass-produced cars.
2. Netflix – Original Content (post-2013)
   • The cost to license movies and shows from other companies went up by about 700 ext{%}.
   • Why: Netflix started making its own shows (like “House of Cards”).
   • Outcome: This gave Netflix more power when dealing with studios, allowed them to offer content globally, and use their customer data to create popular shows.

Forward Integration

1. Inditex / Zara
   • Started in the 1960s making clothes for other companies; opened its first store in 1975.
   • Now: Owns about 2,123 stores, with 90 ext{%} being wholly owned.
   • Why: Zara has a "fast-fashion" model where store sales data quickly informs design and production. This allows them to create new clothes in about 2 weeks, much faster than the industry norm of 6 months.
2. Apple Retail Stores
   • In 1997, Apple relied on big computer stores, which didn't represent their brand well.
   • Why: Steve Jobs wanted to sell directly and create a unique customer experience. He hired retail experts and built a global network of "flagship" stores (around 494 locations).
   • Benefits: This created an immersive brand experience, led to higher profits on accessories and services, and provided quick customer feedback.

Strategic Fit & Real-World Implications

Vertical integration decisions should always match a company's main way of competing:

• Cost leaders (like Ford) use integration to cut costs.
• Differentiators (like Apple, Zara) use it to protect their unique product or customer experience.

Other important points:

• Ethics/Responsibility: When a company owns different stages, it also becomes responsible for labor and environmental standards in those areas.
• Legal scrutiny: If a company integrates too much, it might face anti-trust investigations for potentially limiting competition.
• Learning and Improvement: Integrated companies often gather unique data (like Netflix's viewership data or Zara's sales data) that helps them constantly improve.

Connections to Other Corporate Moves

• Diversification vs. Integration:
  • Diversification is about entering new, different industries (e.g., a car company buying a food company).
  • Vertical integration is about going deeper within the company's existing industry by owning parts of its supply chain (e.g., a car company buying a tire factory).
• M&A vs. Greenfield:
  • Acquiring a supplier or retailer is a fast way to integrate, but it can lead to difficulties in combining different company cultures.
  • Greenfield (building a new facility from scratch) gives more control but takes longer to get established.
• Strategic Alliances:
  • These are partnerships that are less than full ownership but more than just a simple contract. They are useful when full ownership is too expensive but close collaboration is still needed.

Key Takeaways for Exam Preparation

• Remember the definitions and directions: backward integration = upstream = closer to suppliers, forward integration = downstream = closer to customers.
• Be able to draw simple diagrams of supply chains and show where a firm integrates.
• Use specific numbers or facts (like the 700 ext{%} Netflix cost spike) to support why companies integrated.
• Understand the pros and cons; explain why companies choose one option over another based on cost savings or better control.
• Connect all these big company decisions to how they achieve their business goals of being low-cost or highly differentiated.