Corporate Strategies: Vertical integration and Diversification Chapters 6 and 7

Corporate strategy Product scope Geographic scope Diversification Geographic scope Local market or global markets Vertical scope (value chain) Short value chain or long value chain (vertical integration or outsourcing) Source : Grant

Vertical integration Types Backward, forward Value and rarity of vertical integration – When should firms vertically integrate? Opportunism and transaction specific investments - quality Firm capabilities Flexibility and uncertainty – improved scheduling Strategic alliances Barriers to entry Opportunism – unfair advantages? Capabilities – Only if they can exploit resources/capabilities (VRIO) Flexibility – how costly is it for a firm to alter its strategic and organizational decisions? Research suggests that veritical integration makes a firm less flexible to change strategically.

Body Glove International                                    Source: www.bodyglove.com

Disadvantages of vertical integration Inefficiency Loss of flexibility (technological change) Demand uncertainty Compounding of risk Bureaucratic costs

Do vertical empires work? Been there, done that : General Motors, Ford, Lockheed Martin Building vertically integrated structures : Microsoft, AOL-Time Warner Problems – costs, loss of customers, ethical and moral questions Lean, mean approach, Outsourcing through contractual arrangements : Dell, Hewlett-Packard, Nortel Networks Source: Business Week, 2000

Imitability Direct duplication Alternatives to vertical integration Path dependencies, social complexity, and causal ambiguity make imitation differences Alternatives to vertical integration Short term contracts Long term contracts / strategic alliances and joint ventures Strategic outsourcing

JV-distributes to hotels, embassies Worldwide airport kiosks STARBUCKS Philippines Korea Shinsegne Japan Rustan “To a large degree our international expansion will be driven by JV offers we receive” … Founder Licensee Licensee Singapore China JV stores Bonvests BAIC Beijing Licensee stores JV-distributes to hotels, embassies Geographic partners Cobranding partners Customer alliances 70 million passengers per year, worldwide Retail formats Host In-store stores Canada bookstores Worldwide airport kiosks Note: Starbucks Coffee, Sazaby’s, ITT Sheraton, United Airlines, Chapters, Host Marriott Services, Barnes & Noble Inc., Dreyer’s Grand Ice Cream, and Pepsi are proprietary trademarks, other partners include Nordstrom, Costco

Organization Functional structure Controls Compensation Conflict resolution Controls Budgets, internal management committees Compensation Firm specific investments by individuals and groups, flexibility Individual and group linked compensation Salary, bonuses and stock options, grants

International Expansion The Cost – Control Tradeoff Cost (Capital at Risk) High Greenfield Investment Vertically Integrated Acquisition Strategic Alliance Somewhat Vertically Integrated Franchising Licensing Not Vertically Integrated Exporting Control Low High

Corporate strategy Product scope Geographic scope Diversification Geographic scope Local market or global markets “Virtually all of the 500 largest firms in the U.S. and the world are diversified along product lines or geographically – yet the verdict is still out on performance benefits”  must create economic value!

Types of Diversification Limited Single business - 95% or more of firm revenues in one industry/business (e.g. Delta Airlines) Dominant business – 70 – 95% of firm revenues in a single industry/business (e.g. Donato’s Pizza) Related Constrained - <70% of firm revenues in a single business; different businesses share numerous links and common attributes (e.g. Bic or PepsiCo) Linked - <70% of firm revenues in a single business; different businesses share only a few links and attributes (e.g. Newell-Rubbermaid or Disney) Unrelated Less than 70% of firm revenues in a single business and there are few, if any, links or common attributes (e.g. Tyco International) Conglomerates or “management as portfolio” Virtually all of the 500 largest firms in the U.S. and the world are diversified along product lines or geographically – verdict is still out on performance benefits Newell-Rubbermaid – cleaning and organization products, home and family products, home fashions, office products, tools and hardware – under various brand names Tyco – electronics, fire and security, medical devices, plastics and adhesives, sprinklers, valves

Proctor and Gamble

Diversification How attractive is the industry to be entered? Can the firm establish a competitive advantage within an industry? Motives for diversification Growth Risk reduction Profitability Source : Grant

Diversification Advantages Disadvantages Market power / size Transfer of competencies, Leveraging competencies Economies of scope – when the value of products or services increase as function of the number of businesses that firm operates in Managing rivalry through multipoint competition Exploiting organizational competencies Disadvantages Bureaucratic costs (information overload0 Co-ordination costs Accountability issues

Economies of scope Operational Financial Anticompetitive Shared activities and shared core competencies Financial Internal capital allocation, risk reduction, and tax advantages Anticompetitive Multipoint competition and exploiting market power Employee and stakeholder incentives Minimizing management compensation

Imitability Diversification is not rare Substitutes Underlying economies of scope are rare Tacit/intangible economies of scope Substitutes Internal growth Strategic alliances

International diversification Cultural risk Perception of country of origin Neutral branding Financial risk Currency rates, economic conditions Hedging, diversification Political risk Nationalization, regulations, tariffs, quotas Building local identity, alliance with local company/Government