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Chapter 9

CORPORATE-LEVEL STRATEGY: HORIZONTAL INTEGRATION, VERTICAL

INTEGRATION, AND STRATEGIC OUTSOURCING

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Learning Objectives

• Discuss how corporate-level strategy can be used

• Define horizontal integration- advantages & disadvantages

• Explain difference between company and industry value chain

• Discuss why and under what conditions cooperative relationships may become a substitute for vertical integration

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“The great commander knows when to attack and when to stand down. Never fight a battle when nothing is gained by winning.”

- General George S. Patton

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How do we sustain competitive advantages in our current business? What new businesses or industries

do we wish to enter?

Corporate-Level Strategy

Corporate strategy is used to identify: 1. Businesses/industries firm should be in2. Value creation activities firm should perform3. Methods to enter/exit businesses/industries

to maximize long-run profitability

Companies must adopt a long-term perspective in formulating a corporate-level strategy.

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Corporate-Level Strategyand Multi-Business Model

Multi-BusinessCompany Must Construct:

1) Business model & strategies for each business unit/division in every industry it competes

2) Higher-level model- justifies entry into different businesses & industries

Division

Business Unit

Dept. Dept.

Business Unit

Dept.

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o Horizontal Integration- acquiring/merging with industry competitors

o Vertical Integration- expanding operations backward into industry that produces inputs for company or forward into industry that distributes company’s products

o Strategic Outsourcing- letting some value creation activities within business be performed by independent entity

Repositioning &Redefining A Business Model

Corporate-level strategies primarily directed toward improving company’s competitive advantage and profitability in present business or product line.

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Horizontal Integration:Single-Industry Strategy

o Focus resources- resources devoted to competing successfully in one area

o ‘Stick to the knitting’- company stays focused on what it does best

Process of acquiring/merging with industry competitors in effort to achieve competitive advantages that come

with large scale & scope.

Staying in single industry allows firm to:

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Benefits of Horizontal IntegrationProfits/profitability increase if horizontal integration:

1.Lowers cost structure2. Increases product differentiation

• Product bundling • Cross-selling

3.Replicates business model4.Reduces industry rivalry5. Increases bargaining power

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Problems with Horizontal Integration

Data suggests the majority of mergers/acquisitions DO NOT create value and many may DESTROY value.

o Implementing horizontal integration not easy task• Problems with merging different company cultures• High management turnover in acquired when

acquisition is hostile• Managers tend to overestimate benefits of merger• Managers tend to underestimate problems in merging

o Merger may be blocked if perceived to:• Create dominant competitor• Create too much industry consolidation• Have potential for future abuse of market power

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Vertical Integration:Entering New Industries

o Backward Vertical- expands into industry that produces inputs to company

o Forward Vertical- company expands into industry that uses, distributes, sells company’s products

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Stages in Raw-Materials-to-Customer Value-Added Chain

Figure 9.1

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Raw-Materials-to-CustomerValue-Added Chain in PC Industry

Figure 9.2

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“...strengthens the business model of the core business or... improves its competitive position.

Increasing ProfitabilityThrough Vertical Integration

1. Facilitates investments in specialized assets- lowers cost structure or better differentiation.

2. Enhances product quality- strengthens its differentiation advantage through either forward or backward integration

3. Improved scheduling• Easier & more cost-effective to plan, transfer of

product in value-added chain• Enables company to respond better to changes

in demand

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Problems with Vertical Integration

o Increased Cost Structure• Company-owned suppliers develop higher

cost structure than independent suppliers• Bureaucratic costs of solving transaction

difficultieso Technological Change

• May lock into old/inefficient technology• Prevent company from changing to new

technology that could strengthen business model

o Unpredictable Demando Creates risk in vertical

integration investments

Vertical Integration Limits

Company-owned suppliers lack incentive to reduce costs

Changing demand/technology reduces ability to be competitive

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Alternatives to Vertical Integration: Cooperative Relationships

o Short-term contracts/competitive bidding- lack of commitment to supplier

o Strategic alliances/long-term contracting• Enables creation of stable long-term relationship• Becomes substitute for vertical integration• Avoids problems of managing additional company

o Building long-term cooperative relationships• Hostage taking – creating mutual dependency• Credible commitments – believable promise/pledge• Maintaining market discipline

• Periodic contract renegotiation • Parallel sourcing policy

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Strategic Outsourcing

o Focus on fewer value-creation activities o Goal to outsource noncore/nonstrategic

activitieso Virtual Corporation- companies that

pursue extensive strategic outsourcing

Allows one or more of company’s value-chain activities/functions to be performed by independent

specialized companies to focus all skills/knowledge on one activity.

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Strategic Outsourcing ofPrimary Value Creation Functions

Figure 9.3

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Benefits of Outsourcing1. Lower cost structure- specialist cost is less

than performing activity internally

2. Enhanced differentiation- quality of activity performed by specialist is greater than if activity were performed by the company

3. Focus on the core business• Distractions are removed• Company can focus attention/resources

on activities important for value creation/competitive advantage

Risks of Outsourcing

Holdup – company becomes too dependent on specialist provider

Loss of information – company loses important customer contact or competitive information

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- Douglas Daft, Chairman, Coca-Cola

“Coke can grow faster by forming alliances that give it access to research and other expertise.”