Corporate Strategy: Horizontal Integration, Vertical Integration, and Strategic OutsourcingStrategicManagementAn Integrated Approach
Corporate-Level StrategyCorporate-Level Strategy:How do we sustain competitive advantages in our currentbusiness? What new businesses or industries do we wish to enter?Corporate strategy is used to identify: Businesses or industries that the company should compete inValue creation activities that the company should perform in those businesses Methods to enter or leave businesses or industries in order tomaximize its long-run profitabilityHorizontal & vertical integration, interfirmcooperation, diversification, and corporate restructuringCompanies must adopt a long-term perspectivein formulating a corporate-level strategy.
Corporate-Level Strategy and the Multi-business ModelA multi-business company must construct its business model at two levels: Business models and strategies for each business unit or division in every industry in which it competes Higher-level multi-business model that justifies its entry into different businesses and industries
Repositioning and Redefining A Company’s Business ModelCorporate-level strategiesare primarily directed toward improving a company’s competitive advantage and profitability in its present business or product line:Horizontal Integration The process of acquiring or merging with industry competitorsVertical Integration Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company’s productsStrategic Outsourcing Letting some value creation activities within a business be performed by an independent entity
Horizontal Integration: Single-Industry StrategyHorizontal Integration:the process of acquiring or merging with industry competitors in an effort to achieve the competitive advantages that come with large scale and inside a single industry allows a company to:Focus resourcesResources devoted to competing successfully in one area‘Stick to the knitting’Company stays focused on what it does best
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Benefits of Horizontal IntegrationProfits and profitability increase when horizontal integration:Lowers the cost structure Creates increasing economies of scale Reduces the duplication of resourcesbetween two companiesIncreases product differentiation Product bundling –broader range at single combined price Total solution –saving customers time and money Cross-selling –leveraging established customer relationshipsReplicates the business model In new market segments within same industryReduces industry rivalry Eliminate excess capacity in an industry Easier to implement tacit price coordination among rivalsIncreases bargaining power Increased market powerover suppliers and buyers Gain greater control
Problems with Horizontal IntegrationA wealth of data suggests that the majority of mergers and acquisitions DO NOT create value and that many may actually DESTROY a horizontal integration is not an easy task Problems associated with merging very different company cultures High management turnoverin the acquired company when the acquisition is a hostile one Tendency of managers to overestimate the benefitsto be had in the merger Tendency of managers to underestimate the problemsinvolved in merging their operationsThe merger may be blockedif merger is perceived to: Create a dominant competitor Create too much industry consolidation Have the potential for future abuse of market power
Expanding Beyond a Single IndustryBUT staying within a single industry:Can be dangerous if the industry matures and goes into declineMay cause firms to miss the opportunity to leverage their distinctive competencies in new industriesCan cause firms to develop a tendency to rest on their laurels and not engage in constant learningTo stay agile, companies must leverage –find new ways to take advantage of their distinctive competencies and core business model in new markets and industries.
Vertical Integration: Entering New IndustriesBackward Vertical Integration Company expands its operations into an industry that produces inputs to the company’s productsForward Vertical Integration Company expands into an industry that uses, distributes, or sells the company’s productsFull Integration Company produces allof a particular input from its own operations Disposes of allof its completed products through its own outletsTaper Integration In addition to company-owned suppliers, the company will also use other suppliers for inputs or independent outlets in addition tocompany-owned outlets
Stages in the Raw-Materials-to-Costumer Value-Added Chain
Full and Taper Integration
Increasing Profitability Through Vertical IntegrationA company pursues vertical integration to strengthen the business model of its core business or to improve its competitive investments in efficiency-enhancing specialized assets Lowered cost structure or better or protects product quality To strengthen its differentiation advantage through either forward or backward integrationResults in improved scheduling Makes it easier and more cost-effective to plan, coordinate, and schedule the transfer of product within the value-added chain Enables a company to respond better to changes in demandBuilds entry barriers to new competitors by denying them inputs and/or customers.
Problems with Vertical IntegrationIncreased Cost Structure Company-owned suppliers develop a higher cost structure than those of the independent suppliers Bureaucratic costs of solving transaction difficultiesFast-changing Technology Vertical integration may lock into old or inefficient technology Prevent company from changing to a new technology that could strengthen the business modelUnpredictable DemandCreates risk in vertical integration investmentsVertical integration can weaken a business model when: •Company-owned suppliers lack incentive to reduce costs•Changing demand or technology reduces ability to be competitive
Alternatives to Vertical Integration: Cooperative RelationshipsShort-term contracts and competitive bidding Strong firms attempt to control supplier costs with minimal-length contracts. Poor treatment makes suppliers hesitant to facilitate investments in specialized assets. May yield short-term benefits but there is a long-term loss of trust with the alliances and long-term contracting Enables creation of a stable long-term relationship Becomes a substitutefor vertical integration Avoids the problems of having to manage a company located in an adjacent industry
Building Long-Term Cooperative RelationshipsHostage taking Both parties arrange to become mutually dependent on each other, fostering a cooperative relationship. Credible commitments A believable commitment to support the long-term relationship. Maintaining market discipline Periodic renegotiation of the contractual relationship (generally every four to five years). Developing a parallel sourcing policy with two suppliers for critical inputs.
Strategic OutsourcingStrategic Outsourcing allows one or more of a company’s value-chain activities or functions to be performed by independent specialized companiesthat focus all their skills and knowledge on just one kind of is choosing to focus on a fewer number of value-creation activities In order to strengthen its business modelCompanies typically focus on noncore or nonstrategicactivities In order to determine if they can be performed more effectively and efficiently by independent specialized companiesVirtual Corporation Describes companies that have pursued extensive strategic outsourcing
Strategic Outsourcing of Primary Value Creation Functions
Benefits of OutsourcingLower cost structure The specialist company cost is less than what it would cost to perform the activity internallyEnhanced differentiation The quality of the activity performed by the specialist is greater than if the activity were performed by the companyFocus on the core business Distractions are removed The company can focus attention and resources on activities important for value creation and competitive advantageStrategic outsourcing may be detrimental when there is: •Holdup –company becomes too dependent on specialist provider•Loss of information –company loses important customer contact or competitive information
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