Chapter 8: Corporate Strategy - Vertical Integration and Diversification
transaction costs
all internal and external costs associated with an economic exchange, whether within a firm or in markets
diversification
an increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes
site specificity
assets required to be co-located, such as the equipment necessary certain places
geographic diversification strategy
corporate strategy in which a firm is active in several different countries
product diversification strategy
corporate strategy in which a firm is active in several different product markets
product - market diversification strategy
corporate strategy in which a firm is active in several different product markets and several different countries
external transaction costs
costs of searching for a firm or an individual with whom to contract, and then negotiating, monitoring, and enforcing the contract
principal - agent problem
situation in which an agent performing activities on behalf of a principal pursues his or her own interests
information asymmetries
situation in which one party is more informed than another because of the possession of private information
diversification discount
situation in which the stock price of highly diversified firms is valued at less than the sum of their individual business units
vertical integration
the firm's ownership of its production of needed inputs or of the channels by which it distributes its outputs
specialized assets
unique assets with high opportunity cost: they have significatnly more value in their intended use than in their next best use. they come in 3 types
strategic alliances
voluntary arrangements between firms that involve sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services
vertical market failure
when the markets along the industry value chain are too risky, and alternatives too costly in time or money
strategy formulation centers around the key questions of ____ and _____ to compete in a single product market
where and how
diversification premium
situation in which the stock price of related diversification firms is valued at greater than the sum of their individual business units
corporate strategy
the decisions that senior management makes and the goal-directed actions it takes to gain and sustain competitive advantage in several industries and markets simultaneously
industry value chain
the depection of the transformation of raw materials into finished goods and services along distinct vertical stages, each of which typically represents a distinct industry in which a number of different firms are competing
taper integration
a way of orchestrating value activities in which a firm is backwardly integrated but also relies on outside-market firms for some of its supplies and/or is forwardly integrated but also relies on outside market firms for some of its distribution
forward vertical integration
changes in an value chain that involve moving ownership of activities closer to the end (customer) point of the value chain
conglomerate
a company that combines two or more strategic business units under one overarching corporation; follows an unrelated diversification
credible commitment
a long term strategic decision that is both difficult and costly to reverse
human asset specificity
investments made in human capital to acquire unique knowledge and skills
forward vertical integration examples in stages
marketing & sales , after sales service & support
strategic outsourcing
moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain
disadvantages of a firm
-administrative costs -low powered incentives -principal - agent problem
advantages of a firm
-command and control (flat and hierarchical lines of authority) -coordination -transaction-specific investments -community of knowledge
what are the underlying strategic management concepts that will guide our discussion of vertical integration, diversification, and geographic competition
-core competencies -economies of scale -economies of scope -transaction costs
benefits of taper integration
-exposes in house suppliers and distributors to market competition so that performance comparisons are possible -enhances firms flexibility -firms can combine internal and external knowledge, possibly paving the path for innovation
advantages of markets
-high powered incentives -flexibility
risks of vertical integration
-increasing costs -reducing quality -reducing flexibility -increasing the potential for legal repercussions
strategic alliances examples
-long term contracts -licensing -franchising -equity alliances -joint ventures
benefits of vertical integration
-lowering costs -improving quality -facilitating scheduling and planning -facilitating investments in specialized assets -securing critical supplies and distribution channels
for diversification to enhance firm performance, it must do at least one of the following:
-provide economies of scale, which reduces costs -exploit economies of scope, which increases value -reduce costs and increase value
disadvantages of markets
-search costs -opportunism (hold up) -incomplete contracting (specifying and measuring performance, information asymmetries) -enforcement of contracts
alternatives on the make or buy continuum
-short term contracts -strategic alliances -parent - subsidiary relationships
3 types of specialized assets
-site specificity -physical asset specificity -human asset specificity
alternatives to vertical integration
-taper integration -strategic outsourcing
by formulating corporate strategy, executives make important choices along three dimensions that determine the boundaries of the firm:
-the degree of vertical integration -the type of diversification -the geographic scope
executives must determine their corporate strategy by answering three questions:
1. in what stages of the industry value chain should the company participate (vertical integration)? 2. what ranges of products and services should the company offer (diversification)? 3. where should the company compete geographically in terms of regional, national, or international markets (geographic scope)?
why do firms need to grow?
1. increase profits 2. lower costs 3. increase market power 4. reduce risk 5. motivate management
four options to formulate corporate strategy via core competencies
1. leverage existing core competencies to improve current market position 2. build new core competencies to protect and extend current market position 3. redeploy and recombine existing core competencies to compete in markets of the future 4. build new core competencies to create and compete in markets of the future
four types of business diversification
1. single business 2. dominant business 3. related diversification 4. unrelated diversification: the conglomerate
what are the two variables to look at to identify different types of diversification
1. the percentage of revenue from the dominant or primary business 2. the relationship of the core competencies across the business units
core competence matrix market
a framework to guide corporate diversification strategy by analyzing possible combinations of existing/new core competencies and existing/new markets
boston consulting group growth share martric
a corporate planning tool in which the corporation is viewed as a portfolio of business units, which are represented graphically along relative market share (horizontal axis) and speed of market growth (vertical axis)
licensing
a form of long term contracting in the manufacturing sector that enables firms to commercialize intellectual property
related constrained diversification strategy
a kind of related diversification strategy in which executives pursue only businesses where they can apply the resources and core competencies already available in the primary business
related linked diversification strategy
a kind of related diversification strategy in which executives pursue various businesses opportunities that share only a limited number of linkages
franchising
a long term contract in which a franchiser grants a franchisee the right to use the franchiser's trademark and business processes to offer goods and services that carry the franchiser's brand name
equity alliance
a partnership in which at least one partner takes partial ownership in the other partner
joint venture
a stand alone organization created and jointly owned by two or more parent companies
transaction cost economies
a theoretical framework in strategic management to explain and predict the boundaries of the firm, which is central to formulating a corporate strategy that is more likely to lead to competitive advantage
caveat emptor
buyer beware
backward vertical integration
changes in an industry value chain that involve moving ownership of activities upstream to the originating (inputs) point of the value chain
related diversification strategy
corporate strategy in which a firm derives less than 70 percent of its revenues from a single business activity and obtains revenues from other lines of business that are linked to the primary business activity
unrelated diversification strategy
corporate strategy in which a firm derives less than 70 percent of its revenues from a single business and there are few, if any, linkages among its business
internal transaction costs
costs pertaining to organizing an economic exchange within a hierarchy: also called administrative costs
dominant business
derives between 70 and 95 percent of its revenues from a single business, but it pursues at least one other business activity that accounts for the remainder of revenue
single business
derives more than 95% of its revenues from one business
parent subsidairy relationship
descries the most integrated alternative to performing an activity within one's own corporate family
backward vertical integration examples in stages
design and manufacturing
cash cow
earnings: high, stable cash flow: high, stable strategy: hold
star
earnings: high, stable, or growing cash flow: neutral strategy: hold or invest for growth
dog
earnings: low, unstable cash flow: neutral or negative strategy: harvest/divest
question mark
earnings: low, unstable, or growing cash flow: negative strategy: increase market share or harvest/divest
community of knowledge
employees within firms have ongoing relationships, exchanging ideas and working closely together to solve problems
short term contracts
firm sends out requests for proposals to several companies, which initiates competitive bidding for contracts to be awarded with a short duration
stages of the industry value chain
stage 1 - raw materials stage 2 - components and intermediate goods stage 3 - final assembly and manufacturing stage 4 - marketing and sales stage 5 - after sales service & support
physical asset specificity
assets whose physical and engineering properties are designed to satisfy a particular customer