Vertical Scope

1. CH-ZWA645-005jsmGB Vertical Scope James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

2. Stock Performance

3. Nike, Adidas, and Reebok New Balance Ads http://www.nike.com/yellow/ Reebok

4. MJ Jordan 60 million pairs 17 years. New Jordan’s $200

5. Which would you prefer? Athletic shoes built around the belief that the marketing prowess of an NBA superstar can sell anything? Or athletic shoes built around the belief that better fit and technology mean better performance? We prefer the latter; that's why we adhere to a unique "Endorsed By No One™" philosophy. Instead of paying celebrities to tell you how great our products are, we invest in research, design, and domestic manufacturing and let our products speak for themselves. By adhering to this philosophy, we are able to celebrate the true stars: every day athletes who choose New Balance footwear and apparel because they fit and because they perform. Over the past decade, New Balance has grown substantially.  Worldwide sales have increased from $210 million in 1991 to $1.16 billion in 2001.

6. Nike & Reebok: Class Summary • A firm’s supply chain management strategy, including what and where to outsource, is often key to competitive success. • Nike’s core competencies are marketing (e.g., creating a brand name, including managing relationships with athletes) and shoe design. • Nike/Reebok design their global value chain to take advantage of country comparative advantages and to maximize flexibility to adjust to changing market conditions/country advantages.

7. Labor Issues • NEW YORK, April 25 2002 /U.S. Newswire/ -- • In a new report issued today on Nike's Asian manufacturing practices, a coalition of labor, student, and human rights groups demonstrates that while Nike has stated that they have improved their labor practices, the truth is that sweatshop factories still produce Nike goods.The report makes it clear that Nike is making China the country of choice for its global sweatshop strategy, recently having moved 40 percent of its contracting work there. It has also become evident that exploitation of Chinese workers is clearly a profitable business proposition for the company. In fact, the average Nike worker appears to be worse off than typical Chinese apparel workers (based on Nike and DOL numbers).It is estimated that Nike workers in China receive at most $1.50 for every pair of Nike shoes, which retail typically for $80-$120. The cost of taking the “high ground” with regard to social issues is typically very low; collaborative efforts with competitors may be an appropriate way to address social issues (e.g., industry association).

8. Continued • When firms choose to outsource, they need to determine whether to treat outside firms as partners or as arms-length subcontractors. • The greater the inter-company interdependence and value of coordination (and the less environmental factors change the relative performance of suppliers), the more it makes sense to partner.

9. Theories of Vertical Integration Efficiency • Vertical Integration as a means for reducing transaction costsand improving coordination. • When investments in specialized assets are high (e.g., oil refinery and pipeline) • Vertical Integration as a means to gain control over important inputs/markets • Avoid foreclosure to inputs or markets (e.g., Alcoa integrates back into bauxite to secure scarce and critical raw material for aluminum) • Guarantee input quality (e.g., McDonalds growing potatoes in Russia) • Vertical Integration as a means to control/acquire information • Protect proprietary information/technology (Bose makes most critical inputs for its audio equipment) • Acquire information on markets or technologies (e.g., GM integrating into automotive components to gain knowledge regarding suppliers’ costs and technology that assists in bargaining).

10. Theories of Vertical Integration Non-Efficiency • Vertically Integrate to exercise monopoly power • Price discrimination (to allow firm to price discriminate in different markets and avoid arbitrage). • Create or increase the size of the barrier to entry in to a business (capital market imperfections make it more costly to raise larger sums of capital required for multi-stage entry; e.g., Coke & Pepsi) • Squeeze non-integrated competitors (subsidize one stage of the value chain with another to squeeze competitor margins; bundle/matrix price, e.g., Microsoft Office vs. WordPerfect). • Vertical Integration as a “loophole” for regulatory action • Tax avoidance (through transfer pricing and sales tax avoidance). • Price controls/rate of regulation avoidance (integrate backwards into non regulated industries and make higher profits in that industry).

11. MODEL FOR MAKE VS. BUY Partner (compare capabilities) Make High - Seats - Air conditioners - Tires - Engines - Transmissions Component Value Buy Partner (compare capabilities) - Bolts - Nuts - Belts - Filters - Engine components - Interior and exterior trim products Low Low High Asset Specificity

12. Partner (compare capabilities) Make High Component Value Buy Partner (compare capabilities) Low Low High Asset Specificity MODEL FOR MAKE VS. BUY Chrysler GE Nike

13. Lower TC Control Inputs Control / TC Monopoly Power Why Integrate? Chrysler Efficiency Non-Efficiency Efficiency GE Non-Efficiency Efficiency Non-Efficiency Nike Debeer’s Efficiency Non-Efficiency

14. STRATEGIC SUPPLIER SEGMENTATION • Creating partnerships takes considerable time and resources on the part of both parties • Not all purchased products offer the potential to lower systems costs, offer new technologies, or speed products to market • The optimal strategy may require different approaches with different types/ groups of suppliers/customers

15. Conditions Under Which Each Model Is More Likely to Be Effective Arms-Length Model Partnership Model • Low volumes of exchange (buy low • percentage of supplier’s output) • One time or infrequent purchases • Low degree of supplier buyer • interdependence (sequential); low • ability to affect each other’s costs • Stand alone inputs (no or few • interaction effects with other inputs) • During a recession (when suppliers • have excess capacity) or when supplier • advantages rapidly change • Short-term cost reduction is the goal • High volumes of exchange • High degree of supplier-buyer • interdependence (reciprocal); high • ability to affect each other’s costs • Multiple interaction effects with • other inputs • During an expansion (when inputs • are scarce); when supplier relative • capabilities/costs are stable. • Long-term value creation is the goal • (speed-to-market, quality, new • technology)

16. Differences in Supply Chain Management Practices Arms-Length Model Partnership Model • Multiple functional interfaces (i.e., sales • to sales, mfg. to mfg.) • Capabilities benchmarking • Substantial assistance • Investments in interfirm knowlege - • sharing routines • Supplier performance on non-contractible • issues is key (I.e., innovation, quality, • responsiveness) • Trust is critical for optimal • performance • Single functional interface (i.e., sales to • purchasing) • Frequent price benchmarking • Minimal assistance • Low investment in interfirm knowledge - • sharing routines • Supplier performance easily contracted • for ex ante • Contractual safeguards are sufficient

17. Vertical Integration Who Let “INTEL INSIDE”?