Session #6 (F2F #1) - Vertical Integration and Diversification (2).pdf

Welcome to Part B Understanding Business Cycles for Strategic Decisions © McGraw Hill  Welcome! © McGraw Hill  Gain & Sustain Competitive...

Welcome to Part B Understanding Business Cycles for Strategic Decisions © McGraw Hill  Welcome! © McGraw Hill  Gain & Sustain Competitive Session #9 Advantage Organizational Design Superior Systems, Culture Performance Session #8 Corporate Governance Session #7 Strategic Alliances Global Strategy Session #6 Corporate TODAY Strategy © McGraw Hill  Learning Goals ○ Understand Corporate Strategy ○ Understand Vertical Integration and Diversification ○ Apply the Core Competence-Market Matrix ○ Design a Corporate Strategy © McGraw Hill  STRATEGY : DEFINITION © McGraw Hill 5  Strategy is a process, a set of consistent and reinforcing decisions and goal-directed actions a firm takes to gain and sustain superior performance relative to competitors © McGraw Hill  Strategy Strategy is about answering a few key questions – WHAT is the unique value proposition (vs that of rivals) – WHERE & HOW to compete to address strategic challenge-exploit business opportunity Strategy is NOT sameness...it is a about Innovation - Distinctiveness - Uniqueness © McGraw Hill  COMPETITIVE ADVANTAGE Competitive advantage refers to the ways that a company can produce goods or deliver services better than its competitors. It allows a company to achieve superior margins and generate value for the company and its shareholders. A competitive advantage cannot be easily replicated and is exclusive to a company or business. This value is created internally and is what sets the business apart from its competition. © McGraw Hill 8  CORPORATE STRATEGY © McGraw Hill 9  Corporate Strategy The decisions that leaders make. Goal-directed actions that they take in the quest for competitive advantage. Boundaries of the firm: Vertical integration: In what stages of the industry value chain should the company participate? The industry value chain describes the transformation of raw materials into finished goods and services along distinct vertical stages. Diversification: What range of products and services should the company offer? Geographic scope: Where should the company compete geographically in terms of regional, national, or international markets? © McGraw Hill  3 Levels of strategy : (1/1) Concerned with the overall Decisions on scope of an organization and Diversity of products, services, business how value is added by the 1- Corporate- units, Allocation of resources among constituent business units. level business units, geographical coverage strategy Concerned with the way a Decisions on markets and business seeks to product improvement compete successfully in 2- Business-level strategies with a clear linkage its particular market. with corporate strategy strategy Concerned with how different parts of the Functional strategies (also called organization deliver “operational" strategy), concerning the strategy 3- Functional strategies how the organization approaches effectively in terms particular functions, such as of managing marketing, production, and sales resources, processes and people. Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved © McGraw Hill  3 Levels of strategy: (1/2) Diversifying from the organisation’s original activities into other activities 1- Corporate- e.g., Tesla selling batteries for home level use. strategy Marketing and product improvement strategies 2- Business-level e.g., Developing a lower strategy cost, volume car for Tesla. functional strategies are geared to meeting its investment 3- Functional strategies needs and raising finance. e.g.Tesla showrooms in shopping malls © McGraw Hill  Levels of Strategy (1/3) 1. Corporate-level Strategy is concerned with the overall scope of an organisation and how value is added to the constituent Business Units. 2. Business-level Strategy is concerned with the way a business seeks to compete successfully in its particular market. 3. Functional Strategy is concerned with how different parts of the organisation deliver the strategy effectively in terms of managing resources, processes and people. © McGraw Hill  Business vs. Corporate Strategy Business Strategy Corporate Strategy How to compete? Where to compete? – Generic Strategies: – Build/Borrow/Buy/Divest Cost Leadership, Example: Differentiation, Blue Ocean – Disney Example: Parks and Resorts – Singapore Airline (Differentiation) Streaming Services – Ryanair (Cost Leadership) Consumer Products and Interactive Media © McGraw Hill  Business Strategy Corporate Strategy How to compete? Where to compete? – Generic Strategies: – Buy/Divest Cost Leadership, LVMH Differentiation, Blue Ocean – Fashion & Leather Goods – Wines & Spirits H&M: Cost Leadership …and Differentiation – Perfumes and Cosmetics – Selective Retailing Hermès: Differentiation © McGraw Hill  Directional strategies Retrenchment: reducing Stability: keeping operational Growth: expand to new markets, costs, cutting back on existing changes to a minimum. maintain to develop new products and/or find products, or reducing the the status quo, avoid risk, build new company's workforce resources toward the next income sources. expansion. © McGraw Hill  Why Firms Need to Grow To increase profits, results in shareholder returns. To lower costs and achieve economies of scale, reach efficiency To increase market power, fewer competitors, more bargaining power, higher profitability To reduce risk through diversification. Low performance in 1SBU can be compensated by another. To motivate management. Job security © McGraw Hill  4 dimensions of corporate expansion 4. Vertical “Economies of scope” Acquiring suppliers or buyers 3. Horizontal “Economies of scale” 1. Unrelated Acquiring a company No relationship between in the same industry New and existing businesses 2. Geographic expands operations across regions or countries. © McGraw Hill  Three Dimensions of Corporate Strategy Unrelated Diversification: Geographic or product. Vertical integration. Underlying concepts that guide these: Core Competencies (Chapter 4). Economies of Scale (Chapter 6). Economies of Scope (Chapter 6). Transaction Costs: cost effectiveness of vertical integration vs. diversification. © McGraw Hill  MAKE OR BUY © McGraw Hill 20  Transaction costs economics Applying the logic of transaction cost economics enables strategic leaders to answer the question whether it is cost effective for their firm to expand its boundaries through vertical integration or diversification. It implies taking on greater ownership of the production or needed inputs or the channel by which it distributes its outputs, or adding business units that offer new products and services. Transaction costs economics help strategic leaders decide what activity to do in house versus what services or products to obtain from the external market. © McGraw Hill 21  TRANSACTION COST ECONOMICS Transaction costs are all internal and external costs associated with an economic exchange, whether it takes place within the boundaries of a firm or in markets © McGraw Hill 22  External Transaction Costs Costs of searching for a firm or an individual with whom to contract, and then negotiating, monitoring, and enforcing the contract. © McGraw Hill  Internal Transaction Costs Costs pertaining to organizing an economic exchange within a firm Recruiting and retaining employees. Renting , maintaining buildings Administrative costs associated with coordinating economic activity between different business units of the same corporation such as transfer pricing for input factors, and between business units and corporate headquarters including important decisions pertaining to resource allocation, among others. © McGraw Hill 24  Internal and External Transaction Costs Exhibit 8.2 Predictions derived from transaction economics guide strategic leaders in deciding which activities a firm should pursue in-house (“make”) versus which goods and services to obtain externally (“ buy”) Access the text alternate for slide image. © McGraw Hill  Make or Buy? If Costs in-house < Costs market, Vertically integrate: Own production of the inputs. Or own output distribution channels. If Costs market < Costs in-house, The firm should consider purchasing instead. © McGraw Hill  Alternatives on the Make-or-Buy Continuum Exhibit 8.4 Access the text alternate for slide image. © McGraw Hill  The Principal-Agent Problem A major disadvantage of organizing economic activity within firms. Principal – the owner of the firm. Goal: create shareholder value. Agent – manager or employee. Should act on behalf of the principal. Problem: Agents pursue their own interests (corporate jets, golf outings). One Solution: Stock options to make agents owners. © McGraw Hill  VERTICAL INTEGRATION © McGraw Hill 31  Backward and Forward Vertical Integration along an Industry Value Chain Exhibit 8.5 Access the text alternate for slide image. © McGraw Hill  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. Final Assembly and manufacturing Marketing, sales, after-sales service and support: Pick a service provider. Get wireless data and voice service. © McGraw Hill  Vertical Integration along the industry value chain The ownership of inputs or distribution channels. Backward Vertical Integration: Owning inputs of the value chain. Forward Vertical Integration: Owning activities closer to the customer. © McGraw Hill  HTC’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry Exhibit 8.6 Access the text alternate for slide image. © McGraw Hill  Backward or Forward Integration? Ion-lithium battery plant © McGraw Hill  Backward or Forward Integration? Buying Leather Good Makers and Clothing Manufacturer Source: https://www.themds.com/companies/chanel-keeps-integrating-suppliers-buys-stake-in-three-manufacturers.html#:%7E:text=Chanel%20ex pands%20its%20portfolio.,as%20French%20clothing%20manufacturer%20Grandis. © McGraw Hill  Backward or Forward Integration? Owns its supply chain (for rapid product turnover) Source: https://www.themds.com/companies/chanel-keeps-integrating-suppliers-buys-stake-in-three-manufacturers.html#:%7E:text=Chanel%20ex pands%20its%20portfolio.,as%20French%20clothing%20manufacturer%20Grandis. © McGraw Hill © McGraw Hill  Backward or Forward Integration? RESTAURANTS https://robbreport.com/food-drink/dining/worlds-most-expensive-steak-231397/ © McGraw Hill  Benefits of Vertical Integration Lowering costs. Improving quality. Facilitating scheduling and planning. Facilitating investments in specialized assets: Co-located assets, unique equipment, human capital. Securing critical supplies and distribution channels. © McGraw Hill  Risks of Vertical Integration Increasing costs. Reducing quality. Reducing flexibility. Increasing the potential for legal repercussions. © McGraw Hill  When Does Vertical Integration Make Sense? When there are issues with raw materials. Example: Henry Ford ran mining operations. To enhance the customer experience. Eliminate annoyances and poor interfaces. Vertical market failure: when transactions are too risky or costly. © McGraw Hill  DIVERSIFICATION © McGraw Hill 47  The degrees of diversification Product Diversification: Increase in variety of products / services. Coca Cola versus Pepsi Co: single drink versus several drinks +Lays & Dorito chips, Quaker oats. Active in several product markets. Geographic Diversification: Increase in variety of markets / geographic regions. Regional, national, or international markets. Product-Market Diversification: Product and geographic diversification. © McGraw Hill  Examples Product Diversification Coca-Cola, for example, focuses on soft drinks and thus, on a single product market. PepsiCo competes directly with Coca-Cola by selling a wide variety of soft drinks and other beverages, and also offering different types of chips such as Lay’s, Doritos, and Cheetos, as well as Quaker Oats products such as oatmeal and granola bars. Although PepsiCo is more diversified than Coca- Cola, it has reduced its level of diversification in recent years. © McGraw Hill 49  Example geographic diversification © McGraw Hill 50  Example of Product Market Diversification © McGraw Hill 51  Example of unrelated diversification © McGraw Hill 54  Competitive advantage based on core competencies Leaders need to identify their existing core competencies and understand the Firm’s current market situation. The core competency matrix guide managerial decisions in regard to diversification strategies. © McGraw Hill 55  The Core Competence–Market Matrix Exhibit 8.9 Source:. Adapted from G. Hamel and C.K. Prahalad (1994), Competing for the Future (Boston: Harvard Business School Press). How to Access the text alternate for slide image. © McGraw Hill  Corporate diversification leading to superior performance ? © McGraw Hill 57  The Diversification-Performance Relationship High and low levels of diversification are generally associated with lower overall performance, while moderate levels of diversification are associated with higher firm performance. This implies that companies that focus on a single business, as well as companies that pursue unrelated diversification, often fail to achieve additional value creation. Exhibit 8.11 Source:. Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2001), “Curvilinearity in the diversification-performance linkage:Access An examination of over three the text alternate fordecades slide image. of research,” Strategic Management Journal 21: 155–174.. © McGraw Hill  How Diversification Can Enhance Firm Performance Provides economies of scale (reduces costs). Occurs when a firm’ average cost per unit decreases as its output increases Exploits economies of scope (increases value). They are the savings that come from producing two or more outputs or providing different services at less cost than producing each individually through using the sale resources and technology Reduces costs and increase value. © McGraw Hill  Restructuring Reorganizing and divesting business units and activities. Helps refocus a company. Helps leverage core competencies more fully. Helpful restructuring tool: BCG growth-share matrix, Guides portfolio planning. Each category warrants a different strategy. © McGraw Hill  Restructuring the Corporate Portfolio: The Boston Consulting Group Growth–Share Matrix Exhibit 8.13 Access the text alternate for slide image. © McGraw Hill