1. Chapter 6

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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.

8. 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

9. 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.

10. 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.

11. 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.

12. 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

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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!

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