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Presentation transcript:

Chapter 6

The Strategic Management Process External Analysis Strategic Choice Strategy Implementation Competitive Advantage Mission Objectives Which Businesses to Enter? Internal Analysis • Vertical Integration Corporate Level Strategy

Logic of Corporate Level Strategy Corporate level strategy should create value: 1) such that the value of the corporate whole increases 2) such that businesses forming the corporate whole are worth more than they would be under independent ownership • vertical integration = value chain

What is Vertical Integration? Where your pizza comes from Dairy Farmers (milk) Seed Companies (Alfalfa & Corn) Pizza Chains Leprino Foods (Mozzarella Cheese) Crop Farmers (Alfalfa & Corn) End Consumer Food Distributors

What is Vertical Integration? Backward Vertical Integration Dairy Farmers (milk) Seed Companies (Alfalfa & Corn) Pizza Chains Leprino Foods (Mozzarella Cheese) Crop Farmers (Alfalfa & Corn) End Consumer Food Distributors Forward Vertical Integration

Value Chain Economies The Logic of Value Chain Economies Backward Vertical Integration Dairy Farmers (milk) • the focal firm is able to create synergy with the other firm(s) • cost reduction Leprino Foods (Mozzarella Cheese) • revenue enhancement • the focal firm is able to capture above normal economic returns (avoid perfect competition) Food Distributors Forward Vertical Integration

Competitive Advantage If a vertical integration strategy meets the VRIO criteria… Is it Valuable? Is it Rare? Is it costly to Imitate? Is the firm Organized to exploit it? …it may create competitive advantage.

Value of Vertical Integration Market vs. Integrated Economic Exchange The two extremes in economic exchange are the market and integrated economic exchange (also called the hierarchy). In the market, the focal firm buys the product or service from outside players or sells its product to outside intermediaries. In integrated economic exchange, the firm performs these activities internally. (Leprino) Integration makes sense when the focal firm can capture more value than a market exchange provides

Value of Vertical Integration Three Value Considerations Vertical integration can create value – decrease costs or increase revenues – in three situations: to reduce the threat of opportunism to leverage firm capabilities to remain flexible Opportunism-Based Explanation is when a firm is unfairly exploited in an exchange. In other words, one of the two firms in an exchange holds up the other to the financial benefit of the first firm. The hold up can occur with regard to price, delivery terms, quality, etc. For the firm that is being held up, the exchange creates an economic loss. To avoid this, the firm can vertically integrate. By bringing the activity in-house, the firm controls it and therefore removes the possibility of opportunistic behavior causing economic losses.

Value of Vertical Integration Three Value Considerations Vertical integration can create value – decrease costs or increase revenues – in three situations: Leveraging Capabilities-Based Explanation Leveraging the focal firm’s capabilities, on the other hand, is a proactive approach to vertical integration. The logic here is simple: a firm should vertically integrate into those business activities where they possess valuable, rare, and costly-to-imitate resources and capabilities. This also means that a firm should not vertically integrate into activities where they do not have the resources to get a competitive advantage.  

Value of Vertical Integration Three Value Considerations Vertical integration can create value – decrease costs or increase revenues – in three situations: Flexibility-Based Explanation Flexibility pertains to the cost (and time) of changing the strategic and operational decisions of an organization. A flexible organization can change its strategic/operational choices quickly. (Intel) the vertical integration decision may conflict with each other and confuse decision making. In other words, the opportunism argument may point to vertical integration, while the capabilities and the flexibility arguments may point to de-integration.  

Rarity of Vertical Integration Integration vs. Non-Integration • a firm’s integration strategy may be rare because the firm integrates or because the firm does not integrate • thus, the question of rareness does not depend on the number of forms observed • a firm’s integration strategy is rare or common with respect to the value created by the strategy Example: Toyota’s Choice Not to Integrate Suppliers

Imitability of Vertical Integration Form vs. Function • the form, per se, is usually not costly to imitate • the value-producing function of integration may be costly to imitate • small numbers prevent further integration • capital requirements are prohibitive

Imitability of Vertical Integration Modes of Entry • acquisition and internal development are alternative modes of entry into vertical integration • thus, one firm may acquire a supplier while a competitor could imitate that strategy through internal development • in both cases, the boundaries of the firm would encompass the new business • strategic alliances can be viewed as a substitute for vertical integration—without the costs of ownership

Organizing Vertical Integration Functional Structure (U-Form) CEO’s Role Cooperation Accounting Finance Marketing HR Engineering Original Business Original Business Original Business Original Business Original Business Conflict Cooperation New Business New Business New Business New Business New Business Conflict

Organizing Vertical Integration Management Controls What needs to be ‘controlled’ in a vertically integrated firm? • managers’ efforts to achieve the desired value chain economies • cooperation and competition among and between functions • the integration of new businesses into the existing business • time horizon of managers

Organizing Vertical Integration Management Controls Board Committees Budgets Budgets help in the control process by identifying the metrics by which performance is to be measured. • provide oversight and direction to managers • separating strategic and operational budgets • help ensure that strategic direction is maintained • strategic: inputs & outputs • operational: outputs These mechanisms focus management attention on achieving value chain

Summary Vertical Integration… • makes sense when value chain economies can be created and captured • may allow a firm to leverage capabilities • may be a response to the threat of opportunism and uncertainty • as a form of exchange per se, is not rare nor costly to imitate

Summary Vertical Integration… • is an important consideration in the decision to expand internationally (range of possibilities) • makes sense when done for the right reasons, under the right circumstances • can be a costly mistake if done wrong Ownership is costly—integrate only when the benefits outweigh the costs of integration!

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall