Corporate Strategies: Vertical integration and Diversification

1. Corporate Strategies:Vertical integration and Diversification Chapters 6 and 7

2. Corporate strategy • Product 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

3. 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

4. Body Glove International Source: www.bodyglove.com

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

6. 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

7. Imitability • 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

8. STARBUCKS Philippines Korea Rustan Shinsegne Japan “To a large degree our international expansion will be driven by JV offers we receive” … Founder Licensee Licensee Singapore China Bonvests JV stores BAIC Beijing Licensee stores Geographic partners JV-distributes to hotels, embassies 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

9. Organization • Functional structure • 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

10. 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

11. Corporate strategy • Product 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!

12. 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”

13. Proctor and Gamble

14. 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

15. Diversification • Advantages • 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

16. Economies of scope • Operational • 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

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

18. 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