Corporate-Level Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing9Chapter 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CHARLES W. L. HILL / GARETH R. JONESStrategic Management An Integrated Approach 10th ed.Student VersionPrepared by C. Douglas Cloud , Professor Emeritus of Accounting, Pepperdine University

Learning Objective: After reading this chapter you should be able to discuss how corporate-level strategy can be used to strengthen a companys business model and business-level strategies. 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CORPORATE-LEVEL STRATEGY AND THE MULTIBUSINESS MODELCorporate-level strategies drive a companys business model over time.It determines which types of business- and functional-level strategies managers will choose to maximize long-term profitability.

9-* 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CORPORATE-LEVEL STRATEGY AND THE MULTIBUSINESS MODELOnly when a company selects the corporate-level strategy can a company choose the pricing option that will allow it to maximize profitability.When a company decides to expand into new industries, it must construct a business model at two levels.It must develop a business model and strategy for each business unit or division in every industry in which it competes.It must develop a higher-level business-level model that justifies its entry into these businesses.

9-*Learning Objective: After reading this chapter you should be able to define horizontal integration and describe the primary advantages and disadvantages associated with this corporate-level strategy.HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. An advantage of staying within one industry is that it allows a company to focus all of its managerial, financial, technological, and functional resources and capabilities on competing successfully in one area.

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A second advantage is that a company sticks to the knitting, meaning that it stays focused on what it knows and does best.Even when a company stays within one industry, it is easy for strategic managers to fail to see the changing nature of the industry because they are focusing only on how to position current products.A focus on corporate-level strategy can help managers anticipate future trends.

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Horizontal integration is the process of acquiring or merging with industry competitors to achieve the competitive advantages that arise from a large size and scope of operation.An acquisition occurs when one company uses its capital resources, such as stock, debt, or cash, to purchase another company.A merger is an agreement between equals to pool their operations and create a new entity.

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Lower Cost StructureHorizontal integration can lower a companys cost structure because it creates increasing economies of scale.A company can lower its cost structure when horizontal integration allows it to reduce the duplication of resources between two companies.Benefits of Horizontal Integration

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Increased Production Differentiation:By increasing the flow of innovative new products that a company sales force can sell to customers at premium prices.Product bundling involves offering customers the opportunity to purchase a range of products at a single combined price.Benefits of Horizontal Integration(continued)

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cross-SellingCross-selling is when a company takes advantage of or leverages its established relationship with customers by way of acquiring additional product lines or categories that it can sell to customers.Cross-selling provides a total solution and satisfies all of a customers specific needs.Benefits of Horizontal Integration

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reduced Industry Rivalry:Acquiring or merging with a competitor helps to eliminate excess capacity in an industry, thus creating a more benign environment in which prices might stabilizeor increase.Horizontal integration often makes it easier to implement tacit price coordination between rivals.Benefits of Horizontal IntegrationIncreased Bargaining Power

9-*HORIZONTAL INTEGRATION: SINGLE-INDUSTRY CORPORATE STRATEGY 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Implementing a horizontal integration strategy is not an easy task for managers.There are problems associated with merging very different company cultures.When the acquisition is a hostile one, there is high management turnover.Using horizontal integration to grow, companies face conflict with the FTC due to antitrust laws.Problems with Horizontal Integration

Learning Objective: After reading this chapter you should be able to define vertical integration and describe the primary advantages and disadvantages associated with corporate-level strategy. 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A company pursuing a strategy of backward vertical integration expands it operations backwards into an industry that produces inputs for the companys products.If it pursues this strategy forward into an industry that uses, distributes, or sells the companys product, it is known as forward vertical integration.

9-*INCREASING PROFITABILITY THROUGH VERTICAL INTEGRATION 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. A specialized asset is one that is designed to perform a specific task and whose value significantly reduced in its next-best use.A company might invest in specialized assets to lower their cost structure or to better differentiate their product.It is often necessary that suppliers invest in specialized assets to produce the inputs that a specific company needs.

9-* 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. By entering industries at other stages of the value-added chain, a company can often enhance the quality of the products in its core business and strengthen its differentiation advantage.Sometimes important strategic advantages can be obtained when vertical integration makes it quicker, easier, and more cost-effective to plan, coordinate, and improve scheduling of transferring the product between adjacent stages of the value-added chain.INCREASING PROFITABILITY THROUGH VERTICAL INTEGRATION

9-* 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. When the disadvantages of vertical integration are so great that vertical integration reduces profitability, a company is engaged in vertical disintegration.What are the disadvantages of vertical integration?Vertical integration can raise costs if, over time, a company makes mistakes.Company-owned suppliers do not have to compete with independent, outside suppliers for orders, thus they have less incentive to look for ways to reduce operating costs or improve component quality.(continued)THE LIMITS OF VERTICAL INTEGRATION

9-* 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. When technology is changing fast, vertical integration locks a company into an old, inefficient technology and prevents it from changing to a new one that would strengthen its business model.If the demand for a companys product wildly fluctuates and is unpredictable, the firm may find itself burdened with warehouses full of component parts it no longer needs, which is a major drain on profitability.When demand is unpredictable, vertical integration makes it hard to manage volume flow.THE LIMITS OF VERTICAL INTEGRATION

9-* 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Vertical integration may weaken when:Bureaucratic costs increase company-owned suppliers lack the incentive to reduce operating costs, andChanging technology or uncertain demand reduces a companys ability to change its business model to protect its competitive advantage.Companies should be as willing to vertically disintegrate as they are to vertically integrate, to strengthen their core business model.THE LIMITS OF VERTICAL INTEGRATION

9-*Learning Objective: After reading this chapter you should be able to describe why, and under what conditions, cooperative relationships such as strategic alliances and outsourcing may become a substitute for vertical integration.ALTERNATIVES TO VERTICAL INTEGRATION: COOPERATIVE RELATIONSHIPS 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Companies have found that they can realize many of the benefits associated with vertical integration by entering into long-term cooperative relationships with companies in industries along the value-added chain.

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COOPERATIVE RELATIONSHIPSStrategic alliances are long-term agreements between two or more companies to jointly develop new products or processes that benefit all companies concerned. 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Many companies use short-term contacts that last for a year or less to establish the price and conditions under which they will purchase raw materials or sell their final products to distributors or retailers.Short-Term Contracts and Competitive Bidding

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Short-Term Contracts and Competitive BiddingShort-term contracting does not result in the specialized investments that are required to realize differentiation and cost advantages because it signals a companys lack of long-term commitment to its suppliers.When there is a need for cooperation, the use of short-term contracts and comprehensive bidding can be a serious drawback.

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Strategic Alliances and Long-Term ContractingA strategic alliance becomes a substitute for vertical integration because it creates a relatively stable long-term partnership that allows both companies to obtain the same kinds of benefits that result from vertical integration.Component suppliers benefit from strategic alliances because their business and profitability grow as companies they supply grow.

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Building Long-Term Cooperative RelationshipsThere are several strategies companies can adopt to promote the success of a long-term cooperative relationship and lessen the chance that one company will renege on its agreement and cheat the other.Hostage taking is essentially a means of guaranteeing that each partner will keep its side of the bargain.(continued)

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPS 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Building Long-Term Cooperative RelationshipsA credible commitment is a believable commitment or pledge to support the development of a long-term relationship between companies.A company that forms a strategic alliance with an independent component supplier runs the risk that its alliance might become inefficient over time.(continued)

9-*ALTERNATIVES TO VERTICAL INTEGRATION: COPPERATIVE RELATIONSHIPSBuilding Long-Term Cooperative Relationships 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Because long-term contracts are renegotiated every 3-5 years, the supplier knows that if it fails to live up to its commitments, its partner may refuse to renew the contract.Many companies use parallel source policiesthey enter into long-term contracts with two suppliers for the same component.

9-*STRATEGIC OUTSOURCING 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Strategic outsourcing is the decision to allow one or more of a companys value-chain activities or functions to be performed by independent specialist companies that focus all of their skills and knowledge on just one kind of activity.It may encompass an entire function or it may be just one kind of activity that a function performs.There has been a clear move to outsource activities that managers regard as noncore.

9-*STRATEGIC OUTSOURCING 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Outsourcing has several advantages:It can help the company lower its cost structure.It can increase product differentiation.It can help a company focus on the distinctive competencies that are vital to its profitability.Benefits of OutsourcingOutsourcers holdup refers to specialist raising prices if a firm becomes too dependent.A company could suffer loss of important information.Risks of Outsourcing