Strategic Management

Mission Objectives
External
Analysis
Internal
Analysis
Strategic
Choice
Strategy
Implementation
Competitive
Advantage
The Strategic Management Process
Corporate Level
Strategy
Which Businesses
to Enter?
Vertical Integration
Logic of Corporate Level Strategy
Corporate level strategy should create value:
2) such that businesses forming the corporate whole
are worth more than they would be under
independent ownership
3) that equity holders cannot create through
portfolio investing
a corporate level strategy should create
synergies that are not available in equity
markets
vertical integration = value chain economies
1) such that the value of the corporate whole increases
What is Vertical Integration?
Leprino Foods
(Mozzarella Cheese)
Where your pizza comes from
Dairy Farmers
(milk)
Crop Farmers
(Alfalfa & Corn)
Seed Companies
(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
What is Vertical Integration?
Leprino Foods
(Mozzarella Cheese)
Dairy
Farmers
(milk)
Crop Farmers
(Alfalfa & Corn)
Seed Companies
(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
Backward
Vertical
Integration
Forward
Vertical
Integration
Primary
Secondary
Tertiary
Retail Stores
Manufacturer
Vertical Integration
Backwards
acquisition takes
place towards the
source
Vertical Integration
Primary
Secondary
Tertiary
Dairy Farming Co-
operative
Cheese Processing
Plant
Vertical Integration
Forwards
acquisition takes
place towards the
market
An example of vertical integration is Andrew
Carnegie's steel company, when he bought out all of the
businesses that were needed to produce steel, including
railroads and mines.


An example of horizontal integration is Cornelius
Vanderbilt's railroad business, in which Vanderbilt bought
out many major railroads in 19th century America.
Examples
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.

Can aim at either full or partial integration

Generates cost savings only if volume needed is big
enough to capture efficiencies of suppliers
Potential to reduce costs exists when
Suppliers have sizable profit margins
Item supplied is a major cost component
Resource requirements are easily met
Can produce a differentiation-based competitive
advantage when it results in a better quality part
Reduces risk of depending on suppliers of crucial
raw materials / parts / components
Advantageous for a firm to establish its own
distribution network if
Undependable distribution channels undermine
steady production operations
Integrating forward into distribution and retailing
May be cheaper than going through independent
distributors
May help achieve stronger product
differentiation, allowing escape from price
competition
May provide better access to users
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 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

Rarity of Vertical Integration
Integration vs. Non-Integration
a firms 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 firms integration strategy is rare or common with
respect to the value created by the strategy
Example: Toyotas Choice Not to Integrate Suppliers
Direct duplication
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
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, if:
the integrated firm possesses resource
combinations that are the result of:
historical uniqueness
causal ambiguity
social complexity
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
strategic alliances can be viewed as a substitute for
vertical integrationwithout the costs of ownership
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
Spot sales/
purchases
Long-term
contracts
Agency
agreements
Franchises
Vertical
integration
Joint
ventures
Informal
supplier/
customer
relationships
Supplier/
customer
partnerships
Low Degree of Commitment High
L
o
w

F
o
r
m
a
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i
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a
t
i
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H
i
g
h

How many firms are available The fewer the companies
to undertake the activities? the more attractive is VI
Is transaction-specific investment If yes, VI more attractive
needed?
Does limited information permit VI can limit opportunism
cheating?
Are taxes or regulation imposed VI can avoid them
on transactions?
Do the different stages have similar Greater the similarity, the
optimal scales of operation? more attractive is VI
Are the two stages strategically Greater the strategic
similar? similarity ---the more
attractive is VI
How great the need for entrepreneurship Greater the need, the greater
& continual upgrading of capabilities the disadvantages of VI
How uncertain is market demand? Greater the unpredictability
----the more costly is VI
Are risks compounded by VI increases risk.
linkages between vertical stages
Boosts resource requirements
Locks firm deeper into same industry Compounding
Risks
Results in fixed sources of supply and less flexibility in
accommodating buyer demands for product variety
Poses problems of balancing capacity at each stage of
value chain - Demand uncertainty
May require radically different skills / capabilities
Reduces manufacturing flexibility, lengthening design
time and ability to introduce new products
Loss of flexibility (technological change)
Bureaucratic costs/Inefficiency



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 costlyintegrate only when the
benefits outweigh the costs of integration!