Corporate Strategy: Growth and Integration

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Questions and Answers

What is considered backward vertical integration?

Moving ownership of activities upstream to the originating inputs (correct)

Contracting a third party for the assembly of products

Purchasing completed products from other manufacturers

Owning a retail store to sell products directly to customers

Which is a benefit of vertical integration?

It guarantees immediate market entry

It eliminates the need for specialized assets

It enhances competition with external suppliers

It lowers costs and improves quality (correct)

What is an example of forward vertical integration?

A car manufacturer buying a tire company

A coffee shop establishing a direct online sales portal (correct)

A company investing in automated assembly lines

A tech firm acquiring a component supplier

Which of the following represents a risk associated with vertical integration?

Higher costs without guaranteed returns Signup and view all the answers

What is one reason a company might decide to vertically integrate?

A shortage of critical raw materials Signup and view all the answers

What does taper integration involve?

Combining backward integration with reliance on others for supplies or forward integration with reliance on others for distribution Signup and view all the answers

Which of the following is NOT a risk associated with diversification?

Increased market power Signup and view all the answers

What is a primary benefit of diversification?

Risk reduction and revenue growth from new streams Signup and view all the answers

Which type of diversification involves a single business leveraging its competencies?

Single business Signup and view all the answers

What is a common misconception about vertical integration?

It is always a successful strategy for companies Signup and view all the answers

Which company exemplifies related diversification by sharing competencies?

Apple with its software and hardware Signup and view all the answers

What element is crucial for evaluating the success of diversification?

Sales data and customer feedback Signup and view all the answers

What defines unrelated diversification (conglomerate)?

Multiple businesses that do not share core competencies Signup and view all the answers

What is one of the key reasons firms pursue growth strategies?

To achieve economies of scale Signup and view all the answers

Which strategy focuses on maintaining consistent performance and stability within a firm?

Stability Strategies Signup and view all the answers

What does diversification in corporate strategy primarily refer to?

Offering a range of products and services Signup and view all the answers

What is a potential advantage of outsourcing production?

Flexibility to scale quickly Signup and view all the answers

What does the Transaction Cost Economics (TCE) theory help firms understand?

The implications of economic transactions between firms and markets Signup and view all the answers

Which of the following represents a disadvantage of in-house production?

Higher operational costs Signup and view all the answers

In the context of corporate strategy, what should firms consider regarding geographic scope?

Expanding into multiple international markets Signup and view all the answers

What risk is associated with outsourcing production to third-party manufacturers?

Dependency on third-party suppliers Signup and view all the answers

Study Notes

Corporate Strategy: Vertical Integration and Diversification

Corporate strategy involves decisions and actions for competitive advantage across multiple industries and markets.
Corporate strategic choices include growth, stability, and retrenchment strategies.
Growth strategies involve expanding through market penetration, product development, market development, or diversification.
Stability strategies focus on maintaining current operations and consistent performance.
Retrenchment strategies involve downsizing or divesting parts of the business to focus on core areas and improve financial health.

Why Firms Need to Grow

Economies of scale lead to lower costs.
Increased market share can offer a competitive edge.
Risk diversification via expansion reduces risks from market volatility.
Attracting skilled talent is often easier for larger companies.
Access to capital is often easier for bigger companies.
Larger companies often have greater longevity.
Larger firms may have greater social and economic contributions.

Questions to Determine Corporate Strategy

Vertical integration asks about participation in different stages of the industry's value chain.
Diversification identifies the range of products and services to offer.
Geographic scope defines the geographical regions to compete in.

Transaction Cost Economics (TCE)

TCE is a theory explaining economic transactions within firms and markets.
It considers both internal transaction costs (within a firm) and external transaction costs (market transactions).

Make or Buy Decision

Jasmine's sportswear business needs to decide if production should be outsourced or done in-house.
Outsourcing to a third-party manufacturer has lower upfront costs and quick scaling options but involves a loss of operational control and the risk of opportunism from suppliers.
Producing in-house offers complete quality and timeline control but involves high upfront investment and operational costs.

Advantages and Disadvantages of Outsourcing and In-House Production

Outsourcing: Advantages include lower upfront costs, quicker scaling, avoidance of operational management, and no supplier dependencies. Disadvantages include risk of quality issues, potential for supplier opportunism, and limited control over production processes.
In-house: Advantages include complete control over quality and timelines, potential for long-term savings, and avoiding supplier dependencies. Disadvantages include high initial investments and operational costs which include labor and maintenance costs. Requires dedicated management of employee and production processes.

Firms vs. Markets: Make or Buy?

Vertically integrate if in-house costs are lower than market costs.
This involves owning production inputs or output distribution channels such as in-house programmers at companies like Google.

Alternatives on the Make-or-Buy Continuum

The continuum ranges from arm's-length market transactions (buy) to full integration (make).
Mid-point options include strategic alliances, short-term contracts, long-term contracts, licensing, franchising, joint ventures, and parent-subsidiary relationships.

A Vertical Value Chain

A vertical value chain illustrates the transformation from raw materials to finished goods and services.
It outlines distinct vertical stages from upstream (raw materials) to downstream (distribution and customer service).

The Vertical Value Chain of a Cell Phone

The vertical value chain defines the stages of a cell phone from raw materials to the end consumer. It includes chemical and metal suppliers, intermediate goods, original equipment manufacturers, assembly contracts, and service providers like AT&T.
Original equipment manufacturing firms assemble cell phones under contract.

Types of Vertical Integration

Backward Vertical Integration: Owning upstream activities, such as raw materials sourcing or component production, like what Tesla does.
Forward Vertical Integration: Owning activities closer to the end customer, like Apple's retail stores or Amazon's logistics.

Benefits of Vertical Integration

Vertical integration offers cost reductions, quality improvements, planning and scheduling benefits, and security of critical supplies and distribution channels. It also allows for investments in specialized assets.

Specialized Assets

Specialized assets have higher value in their intended use than their next-best use and include site specificity, co-location requirements, physical asset specificity (unique physical and engineering properties), and human asset specificity (training and experience of employees).

Risks of Vertical Integration

Vertical integration has risks such as high costs, reduced quality or complexity, and reduced flexibility. Legal repercussions like antitrust issues are another risk.

When Does Vertical Integration Make Sense?

Vertical integration might be necessary when raw materials are in short supply (as with Henry Ford and mining operations).
Vertical integration can also enhance the customer experience and eliminate annoyances and poor interfaces. However, integrating steps away from a company's core competence is often unsustainable and risky (over 2/3 of cases fail).

Alternatives to Vertical Integration

Taper Integration: Involves either backward integration relying on others for supplies or forward integration relying on others for distribution.
Strategic Outsourcing: Moving internal value-chain activities to other firms (offshoring is an example).

Lessons from the Duck Song

Businesses can explore opportunities based on customer feedback through market research by testing new markets and evaluating success through sales data analysis, feedback, profitability metrics, and financial analysis.

Diversification

Diversification increases the variety of products/services or markets/geographic regions a firm competes in.
This can target products, geography, or both.

Benefits of Diversification

Diversification can lead to efficiency gains (shared resources and capabilities), excess resource utilization, risk reduction or mitigation of market volatility, revenue growth from new streams, and increased market power. Diversification also fosters greater innovation and learning.

Risks of Diversification

Risks from diversification include potential lack of synergy, operational inefficiency, overextension, neglecting core business areas, market misunderstanding (lack of expertise or underestimation of competition), and dilution of brand identity. Financial risks, such as increased debt, are also important to consider.

Four Main Types of Business Diversification

Single Business: Company leverages its competencies in a single business.
Dominant Business: Dominant business with less than 70% of business within that market, along with a minority of other businesses.
Related Diversification: Businesses share competencies.
- Related Constrained: All businesses share competencies.
- Related Linked: Some businesses share competencies.
Unrelated Diversification (Conglomerate): No connection between businesses or competencies.

Examples of Diversification

Netflix and Crocs (Single Business)
Coca-Cola and Microsoft (Dominant Business)
Procter & Gamble, Amazon, and Disney (Related Diversification)
Berkshire Hathaway (Unrelated Diversification)

Corporate Diversification and Firm Performance

The relationship between diversification and firm performance is an inverted U-shape.
Single businesses and dominant businesses do well.
Related diversification can have diminishing returns.
Further diversification often has a negative impact on firm performance.

The BCG Matrix is a tool to evaluate a portfolio of products or businesses.
Businesses are categorized by market growth and relative market share (star, cash cow, question mark, and dog).

Amazon and Apple on the BCG Matrix

These positions are examples of companies at different stages and their strategies

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Description

Explore the concepts of vertical integration and diversification in corporate strategy. This quiz covers the reasons firms pursue growth strategies, the advantages of increased market share, and the importance of strategic choices for competitive advantage. Test your knowledge on how companies maintain stability and manage retrenchment.