Corporate Strategy: Vertical Integration and Diversification PDF

Corporate Strategy: Vertical Integration and Diversification BUSN 481 Yemisi Awotoye  Corporate Strategy Decisions & actions taken for competitive advantage in several industries and markets simultaneously.  Corporate Strategic Choices Growth Strategie...

Corporate Strategy: Vertical Integration and Diversification BUSN 481 Yemisi Awotoye  Corporate Strategy Decisions & actions taken for competitive advantage in several industries and markets simultaneously.  Corporate Strategic Choices Growth Strategies: Expansion through market penetration, product development, market development, or diversification. Stability Strategies: Maintaining current operations and focusing on consistent performance. Retrenchment Strategies: Downsizing or divesting parts of the business to focus on core areas and improve financial health.  Why Firms Need to Grow Economies of Scale Market Share Risk Diversification: Attract Talent Access to Capital Survival & Longevity Social/Economic Contributions Questions to Determine Corporate Strategy In what stages of the industry value chain should we participate? Vertical integration What range of products and services should we offer? Diversification Where should we compete geographically? Geographic scope Transaction Cost Economics (TCE) Theory that seeks to explain the processes, structures, and outcomes of economic transactions within the context of firms and markets. Make or Buy Decision for Empower Jasmine’s small sportswear business is growing, and she needs to decide whether to: 1.Outsource production to a third-party manufacturer, or 2.Invest in equipment and produce the sportswear in-house. Identify considerations for each option  Advantages and Disadvantages Advantages Disadvantages Risk of quality issues and Lower upfront costs delays Potential supplier Flexibility to scale quickly opportunism (price increases) No need to manage Limited control over Outsourcing production operations production process Full control over quality and timelines High initial investment No dependency on third- Higher operational costs party suppliers (labor, maintenance, etc.) Requires management of In-house Potential for long-term employees and production Production savings once established workflow Firms Vs. Markets: Make Or Buy? If Cin-house < Cmarket, vertically integrate Own production of the inputs or Own output distribution channels Example: Google in-house programmers Alternatives on the Make-or-buy Continuum  A Vertical Value Chain The transformation of raw materials into finished goods and services along distinct vertical stages The Vertical Value Chain of Your Cell Phone Raw materials Chemicals, ceramics, metals, oil for plastic Intermediate goods and components Integrated circuits, displays, touchscreens, cameras, and batteries Original equipment manufacturing firms Assembly of cell phones under contract Service provider AT&T, Sprint, T-Mobile, Verizon, etc.  Types of Vertical Integration Backward Vertical Integration Moving ownership of activities upstream to the originating inputs of the value chain Tesla/Grohmann Engineering Forward Vertical Integration Moving ownership of activities closer to the end customer Apple stores Amazon logistics and distribution  Benefits of Vertical Integration Lowers costs Improves quality Facilitates scheduling and planning Facilitates investments in specialized assets Secures critical supplies and distribution channels  Specialized Assets Unique assets with high opportunity cost: They have significantly more value in their intended use than in their next-best use. 3 Types: Site specificity Co-location requirements Physical asset specificity Unique physical & engineering properties Human asset specificity Investments made in human capital  Risks of Vertical Integration High costs Reduced quality/complexity Reduced flexibility Increase in the potential for legal repercussions Antitrust When Does Vertical Integration Make Sense? Shortage of raw materials Ex. Henry Ford ran mining operations Enhance the customer’s experience Eliminate annoyances & poor interfaces “When a company vertically integrates 2 or more steps away from its core competency, it fails 2/3 of the tim e” - The Economist , 2009 Alternatives to Vertical Integration Taper Integration Involves either: Backward integration & relying on others for supplies Forward integration & relying on others for distribution Apple and Nike – retail outlets + other retailers Strategic Outsourcing Moving one or more internal value chain activities outside the firm’s boundaries to other firms in the industry value chain e.g. Off- shoring  Lessons from the Duck Song https://www.youtube.com/watch?v=MtN1Y noL46Q Explore new opportunities based on customer feedback Market research Testing a new market for diversification Evaluate success - monitor sales data, customer feedback, and profitability through performance metrics, market response, and financial analysis  Diversification Increase in: The variety of products/services a firm offers, or The markets/geographic regions in which it competes Can be targeted towards: Products Geography Product-Market  Benefits of Diversification Efficiency - shared resources/capabilities for efficiency, increased value Utilization of excess resources Risk reduction/mitigate market volatility Revenue growth – new streams and cross- selling Increased market power Innovation and Learning  Risks of Diversification Lack of synergy Operational inefficiency Overextension Potentially neglecting core business areas/management overload Market misunderstanding – Lack of expertise/underestimation of competition Dilution of brand identity Financial risk –increased debt load Four Main Types of Business Diversification 1. Single business – Single business leverages its competencies 2. Dominant business – Dominant & minor businesses share competencies 3. Related diversification A. Related Constrained: all businesses share competencies B. Related Linked: some businesses share competencies 4. Unrelated diversification (conglomerate)  Examples 1. Single business – Netflix, Crocs 2. Dominant business – – Coca-Cola, Microsoft 3. Related diversification A. Related Constrained: Procter & Gamble B. Related Linked: Amazon, Disney 4. Unrelated diversification: (conglomerate) – Berkshire Hathaway Corporate Diversification and Firm Performance SOURCE: Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2000), “Curvilinearity in the diversification-performance linkage: An examination of over three decades of research,” Strategic Management Journal 21: 155–174. Boston Consulting Group (BCG) Growth-share Matrix AMAZON  APPLE Question Mark Star Dog Cash Cow