Chapter 8 Corporate Strategy Vertical Integration Diversification PDF

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Corporate Strategy Vertical Integration Diversification...

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Chapter 8: Corporate Strategy → Vertical Integration & Diversification What is Corporate Strategy ? ● Corporate strategy → decisions that senior management makes and the goal-directed actions it takes to gain & sustain competitive advantage in several industries and markets simultaneously ● Must determine corporate strategy along 3 dimensions ⇒ 1. Vertical Integration : In what stages of the industry value chain should the company participate? ○ Industry value chain = transformation of raw materials into finished goods and services along distinct vertical stages 2. Diversification: What range of products and services should company offer? 3. Geographic Scope : Where should company compete geographically in terms of regional, national, or international markets? 3 Dimensions of Corporate Strategy ● Underlying concepts that will guide the 3 dimensions of corporate strategy: ○ Core competencies -- unique strengths embedded deep w/in a firm that allows firm to differentiate its products and service from competitors ■ Creating higher value ○ Economies of scale -- occur when firms’ average cost per unit decreases as output increases ○ Economies of scope -- savings that come from producing 2 or more outputs or providing different services at less costs than producing individually ○ Transaction costs The Boundaries of the Firm ● Transaction costs economics → theoretical framework to explain & predict the boundaries of the firm, which is central to formulating a corporate strategy that is more likely to lead to competitive advantage ● Transaction costs → all internal and external costs associated w an economic exchange, whether it takes place within the boundaries of a firm or in markets ○ External transaction costs → cost of searching for a firm or an individual w whom to contract, and then negotiating, monitoring, and enforcing the contract ○ Internal transaction costs → cost pertaining to organizing an economic exchange within a firm ■ Ex: cost of recruiting and retaining employees ■ Paying salaries and benefits ■ Setting up shop floor Firm vs. Markets : Make or Buy ● If Costs (in house) < Costs (market) ○ Firm should vertically integrate ○ Own production of the inputs

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○ Own output distribution channels If Costs(market) < Costs (in house) ○ Firm should considering purchasing

Organizing Economic Activity : Firms vs Markets Firm Advantages

Disadvantages

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Markets

Command & Control Fiat - Hierarchical lines of authority - Coordination - Transaction specific investments - Community of knowledge -

Administrative costs Low powered incentives Principal agent problem

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Search costs Opportunism Holdup Incomplete contracting - Specifying & measuring performance - Information asymmetries - Enforcement of contracts ❖ Principal-agent problem → major disadvantage of organizing economic activity within firms, opposed to within markets ➢ Can arise when an agent (managers) performing activities on behalf of principal (owner), pursues their own interest ➢ One solution : Stock options to make agents owners ❖ Information asymmetry → situation in which 1 party is more informed than another because of possession of private info ➢ When firms transact in the market, such unequal info can lead to ⇒ lemons problems

Alternatives on the Make-or-Buy Continuum

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High powered incentives Flexibility

❖ Strategic Alliances → voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services ➢ Long term contracts: ■ Licensing → contracting in manufacturing sector that enables firms to commercialize to intellectual property ■ Franchising → franchisor grants the rights to use the franchisor’s trademark and business processes to offer goods and services that carry the franchisor’s brand name ➢ Equity alliances → partnership in which at least 1 partner takes partial ownership in the other partner ■ Credible commitment → long term strategic decisions that is both difficult and costly to reverse ➢ Joint ventures → 2 or more partners contributes equity to a joint venture, and jointly own a new organization ❖ Parent Subsidiary Relationship → describes the most integrated alternative to performing an activity within one’s own corporate family Vertical Integration Along the Industry Value Chain ● Vertical integration → firms’ ownership of its production of needed inputs or of the channels by which it distributes its outputs ○ “What percentage of a firm‘s sales is generated within the firm’s boundaries?” ○ Backward vertical integration → owning inputs of the value chain ○ Forward vertical integration → owning activities closer to the customer ● Industry value chain → depiction of transformation of raw materials into finished goods and services along with distinct vertical stages, each typically represents a distinct industry in which a number of different firms are competing ○ 5 stages in value chain ⇒ 1) Raw materials 2) Intermediate Goods & Components 3) Final Assembly and Manufacturing 4) Marketing & Sales 5) After Sales Service & Support ● EX: VERTICAL VALUE CHAIN OF YOUR CELL PHONE 1) Raw materials → chemicals, ceramics, metal, oil for plastic 2) Intermediate goods & components → integrated circuits, displays, touchscreen, camera, batteries 3) Manufacturing / Equipment → assembly of cell phones under contract 4) Service provider → At&T, t-mobile, etc Benefits & RIsk of Vertical Integration Benefits

Risks

Lowering costs Increasing costs Improving quality Reducing quality Facilitating scheduling & planning Reducing flexibility Facilitating investments in specialized assets Increasing potential for legal repercussions Securing critical supplies and distribution channels ❖ Specialized assets → unique assets w high opportunity costs ➢ Have significantly more value in their intended use than in their next best uses ➢ Come in 3 types ■ Site specificity → assets required to be co-located ● (ex: equipment needed for mining minerals ■ Physical asset specificity → assets who physical and engineering properties are designed to satisfy a particular customer ● Ex: bottling machinery for Coke (special molds etc) ■ Human asset specificity → investments made in human capital to acquire unique knowledge and skills ● Ex: mastering routines and procedures of a specific organization (not transferable) When does Vertical Integration make senses? ● When there are issues with raw materials ○ Ex: Henry Ford ran mining operations ● To enhance customer experience ○ Eliminate annoyances & poor interfaces ● Vertical market failure → when transaction are too risky or costly Alternatives to Vertical Integration ● Taper integration → way of orchestrating value activities in which a firm is backwardly integrating but also relies on outside market firms for some of its forwardly integrated but also relies on outsider market for some of its distribution ○ Benefits ⇒ 1) Exposes in house suppliers and distributors to market competition so that performance comparisons are possible 2) Enhances firm’s flexibility 3) Firms can combine internal and external knowledge (paving way for innovation) ● Strategic Outsourcing → moving 1 or more internal value chain activities outside the firm’s boundaries to other firms in the industry value chain Corporate Diversification: Expanding Beyond a Single Market ● Diversification → an increase in variety of products & services a firm offers or markets and the geographic regions in which it competes ● Generic Diversification Strategies ⇒

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Product diversification → corporate strategy in which a firm is active in several different product markets

o Geographic diversification → corporates strategy in which a firm is active in several different countries o Product market diversification strategy → corporate strategy in which a firm is active in several different product markets and several different countries Types of Corporate Diversification 1) Single - Business Firms derive > 95% from 1 business ○ Ex: Google revenues from online search 2) Dominant-Business Firms derive 70% to 95% from 1 business ○ Ex: Harley-Davidson yields 10% revenues from clothing 3) Related Diversification strategy derives...