Copyright © 2001 Houghton Mifflin Company. All rights reserved. Chapter 9 Corporate Strategy: Vertical Integration, Diversification, and Strategic Alliances Strategic Charles W. L. Hill Management Gareth R. Jones Fifth Edition PowerPoint Presentation by Charlie Cook An Integrated Approach

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-2 FIGURE 9.1 Stages in the Raw-Material-to-Consumer Value Chain UpstreamDownstream

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-3 Concentration on a Single Business Advantages  Operational focus on a single familiar industry or market.  Current resources and capabilities add value.  Growing with the market brings competitive advantage. Disadvantages  No diversification of market risks.  Vertical integration may be required to create value and establish competitive advantage.  Opportunities to create value and make a profit may be missed.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-4 Stages in the Raw-Material-to-Consumer Value Chain in the Personal Computer Industry FIGURE 9.2 End userDistributionAssembly Intermediate manufacturer Raw materials Examples: Dow Chemical Union Carbide Kyocera Examples: Intel Seagate Micron Examples: Apple Compaq Dell Examples: Computer World Office Max

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-5 Vertical Integration Integration backward into supplier functions  Assures constant supply of inputs.  Protects against price increases. Integration forward into distributor functions  Assures proper disposal of outputs.  Captures additional profits beyond activity costs. Integration choice is that of which value- adding activities to compete in and which are better suited for others to carry out.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-6 FIGURE 9.3 Full and Taper Integration Full Integration Taper Integration

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-7 FIGURE 9.4 Structure of a Company Sharing Marketing Between Two Business Units

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-8 Creating Value Through Vertical Integration Advantages of a vertical integration strategy:  Builds entry barriers to new competitors by denying them inputs and customers.  Facilitates investment in efficiency-enhancing assets that solve internal mutual dependence problems.  Protects product quality through control of input quality and distribution and service of outputs.  Improves internal scheduling (e.g., JIT inventory systems) responses to changes in demand.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-9 Creating Value Through Vertical Integration Disadvantages of vertical integration  Cost disadvantages of internal supply purchasing.  Remaining tied to obsolescent technology.  Aligning input and output capacities with uncertainty in market demand is difficult for integrated companies.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-10 Bureaucratic Costs and the Limits of Vertical Integration The costs of running an organization rise with integration due to:  The lack of an incentive for internal suppliers to reduce their operating costs.  The lack of strategic flexibility in times of changing technology or uncertain demand. Bureaucratic costs reduce the value of vertical integration.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-11 Alternatives to Vertical Integration: Cooperative Relationships and Strategic Outsourcing Short-term contracts and competitive bidding  Strong competitors attempt to control supplier costs with minimal-length contracts. Poor treatment of suppliers raises competitor input costs. Strategic alliances and long-term contracting  Long-term contracts foster cooperative relationships.  Alliances reduce the need for vertical integration.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-12 Building Long-Term Cooperative Relationships Hostage taking  Both parties arrange to become mutually dependent on each other, fostering a cooperative relationship. Credible commitments  A believable commitment to support the long-term relationship. Maintaining market discipline requires:  Periodic renegotiation of the contractual relationship.  Developing a parallel sourcing policy with two suppliers for critical inputs.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-13 Strategic Outsourcing and the Virtual Corporation Outsourcing  Allowing subcontractors to perform value creation activities. Outsourcing advantages  Efficient subcontractors reduce overall costs.  Better product differentiation.  Allows for the concentration of available resources.  Firm becomes more flexible and responsive. Outsourcing disadvantages  Failure to learn from outsourced activity.  Too much dependence on a single supplier.  Danger of outsourcing value creation activities leading to competitive advantage.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-14 Diversification Related diversification  Entry into new business activity based on shared commonalities in the components of the value chains of the firms. Unrelated diversification Unrelated diversification  Entry into a new business area that has no obvious relationship with any area of the existing business.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-15 Creating Value Through Diversification Superior internal governance  Place business units in self-contained divisions.  Manage divisions in a decentralized manner.  Link performance to incentive pay. Acquisition and restructuring strategy  Replace nonperforming top management team.  Dispose of unproductive assets.  Establish performance goals requiring significant improvements in operating efficiency.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-16 Creating Value Through Diversification Transferring competencies:  Lowers the cost of value creation activities in the diversified businesses.  Creates opportunities for differentiation and premium pricing value creation activities.  Adds value where commonalities important to competitive advantage exist.  Creates value by applying skills for one business opportunity and applying them to another.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-17 Creating Value Through Diversification Economies of scope  Sharing of resources and functions by business units creates value in high asset utilization and lower operating costs.  Economies of scope and scale are closely related. Greater operational capacity and larger markets can help a competitor attain low-cost position.  Resource sharing creates significant competitive advantage when it outweighs coordination costs.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-18 Bureaucratic Costs and the Limits of Diversification Number of businesses  Information overload can lead to poor resource allocation decisions and create inefficiencies. Coordination among businesses  As the scope of diversification widens, control and bureaucratic costs increase.  Resource sharing and pooling arrangements that create value also cause coordination problems. Limits of diversification Limits of diversification  The extent of diversification must be balanced with its bureaucratic costs.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-19 Diversification That Dissipates Value Diversification to pool risks  An ineffective attempt to offset the cyclical effects of businesses by merging their income streams.  Downturns in one business are intended to be offset by upturns in another business. Diversification to achieve greater growth  Concept focuses on growth (which is normally a by- product of diversification) and not value creation.  Usually the choice of “empire builders”.

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-20 Related Versus Unrelated Diversification Comparing Related and Unrelated Diversification Strategy Ways of Creating Value Source of Bureaucratic Costs Related diversification RestructuringRestructuring Transferring of skillsTransferring of skills Economies of scopeEconomies of scope Number of businessesNumber of businesses Coordination among businessesCoordination among businesses Unrelated diversification RestructuringRestructuring Number of businessesNumber of businesses TABLE 9.1

Copyright © 2001 Houghton Mifflin Company. All rights reserved.9-21 Strategic Alliance as An Alternative to Diversification Advantages  Avoids bureaucratic costs of diversification.  Shared costs and risks.  Uses complementary skills of each partner.  Creates value through economies of scope. Disadvantages  Profits must be shared.  Disclosure of critical know-how to potential competitor.