Chapter 8: Vertical Integration and Diversification

Diversification

an increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes

Economies of Scope

are the savings that come from producing two (or more) outputs or providing different services at less cost than producing each individually, though using the same resources and technology

Core Competencies

are unique strengths embedded deep within the firm

Site Specificity

assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting

Physical-Asset Specificity

assets whose physical and engineering properties are designed to satisfy a particular customer

Internal Capital Markets

can be a source of value creation in a diversification strategy if the conglomerate's headquarters does a more efficient job of allocating capital through its budgeting process than what could be achieved in external capital markets

Forward Vertical Integration

changes in an industry value chain that involve moving ownership of activities closer to the end (customer) point of the value chain

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

Software as a Service (SaaS)

clients do not need to install software or manage any servers, but can easily assess the CRM through a web browser

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 businesses

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

Internal Transaction Costs

costs pertaining to organizing an economic exchange within a hierarchy; also called administrative costs

Single-Business Firm

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 its revenue

Parent-Subsidiary Relationship

describes the most-integrated alternative to performing an activity within one's own corporate family

Restructuring

describes the process or reorganizing and divesting business units and activities to refocus a company in order to leverage its core competencies more fully

Platform as a Service (PaaS)

enables clients to build their own software solutions that are accessed the same way as the Salesforce CRM

C(in house) < C(market)

firm should vertically integrate by owning production of the needed inputs or the channels for the distribution of outputs

Opportunism

self-interest seeking with guile

Principal-Agent Provlem

situation in which an agent performing activities on behalf of a principal pursues his or her own interests

Information Asymmetry

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

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

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 significantly more value in their intended use than in their next-best use. they come in three types: site specificity, physical-asset specificity, and human-asset specificity

Strategic Alliances

voluntary arrangements between firms that involve sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services is an umbrella term that denotes different hybrid organizational forms - among them, long-term contracts, equity alliances, and joint ventures

Offshoring (Offshore Outsourcing)

when outsourced activities take place outside of the home country

Vertical Market Failure

when the markets along the industry value chain are too risk, and alternatives too costly in time or money

Joint Venture

a stand-alone organization created and jointly owned by two or more parent companies

Industry Value Chain

(also called vertical value chains) depiction 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

Disadvantages of Firm (3)

1. administrative costs 2. low-powered incentives 3. principal-agent problem

Advantages of Firm (4)

1. command and control a. flat b. hierarchical lines of authority 2. coordination 3. transaction-specific investments 4. community of knowledge

4 Underlying Strategic Management Concepts

1. core competencies 2. economies of scale 3. economies of scope 4. transaction costs

Advantages of Markets (2)

1. high-powered incentives 2. flexibility

3 Questions to Determine Corporate Strategy

1. in what stages of the industry value chain should the company participate (vertical integration)? 2. what range 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)?

5 Reasons Why Firms Need to Grow

1. increase profits 2. lower costs 3. increase market power 4. reduce risk 5. motivate management

4 Risks of Vertical Integration

1. increasing costs 2. reducing quality 3. reducing flexibility 4. increasing the potential for legal repercussions

3 Benefits of Taper Integration

1. it exposes in-house suppliers and distributors to market competition so that performance comparisons are possible. rather than hollowing out its competencies by relying too much on outsourcing, taper integration allows a firm to retain and fine-tune its competencies in upstream and downstream value chain activities 2. taper integration also enhances a firm's flexibility 3. using taper integration, firms can combine internal and external knowledge, possibly paving the path for innovation

4 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

5 Benefits of Vertical Integration

1. lowering costs 2. improving quality 3. facilitating scheduling and planning 4. facilitating investments in specialized assets 5. securing critical supplies and distribution channels

3 Things Diversification May Do to Enhance Firm Performance

1. provide economies of scale, which reduces costs 2. exploit economies of scope, which increases value 3. reduces costs and increase value

Disadvantages of Markets (4)

1. search costs 2. opportunism a. hold-up 3. incomplete contracting a. specifying & measuring performance b. information asymmetries 4. enforcement of contracts

4 Main Types of Business Diversification

1. single business 2. dominant business 3. related diversification 4. unrelated diversification: the conglomerate

3 Dimensions that Determine Boundaries of the Firm

1. the degree of vertical integration - in what stages of the industry value chain to participate 2. the type of diversification - what range of products and services to offer 3. the geographic scope - where to compete

2 Variables to Help Classify Diversification

1. the percentage of revenue from the dominant or primary business 2. the relationship of the core competencies across the business units

2 Fundamental Corporate Strategy Topics

1. vertical integration 2. diversification

3 Dimensions of Corporate Strategy

1. vertical integration 2. diversification 3. geographic scope

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 key insight is that different institutions - markets versus firms - have different costs attached

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 suppliers and/or is forwardly integrated but also relies on outside-market firms for some of its distribution

Transaction Costs

all internal and external costs associated with an economic exchange, whether within a firm or in markets

Conglomerate

a company that combines two or more strategic business units under one overarching corporation; follows an unrelated diversification strategy

Boston Consulting Group (BCG) Growth-Share Matrix

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). SBUs are plotted into four categories (dog, cash cow, star, and question mark), each of which warrants a different investment strategy

Resource-Based View of the Firm

a firm's boundaries are delineated by its knowledge bases and core competencies

Licensing

a form of long-term contracting in the manufacturing sector that enables firms to commercialize intellectual property

Core Competence-Market Matrix

a framework to guide corporate diversification strategy by analyzing possible combinations of existing/new core competencies and existing/new markets

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 franchisor grants a franchisee the right to use the franchisor's trademark and business processes to offer goods and services that carry the franchisor's brand name

Credible Commitment

a long-term strategic decision that is both difficult and costly to reverse

Equity Alliance

a partnership in which at least one partner takes partial ownership in the other partner

Human-Asset Specificity

investments made in human capital to acquire unique knowledge and skills

Star

market growth: high relative market share: high earnings: high, stable, or growing cash flow: neutral strategy: hold or invest for growth

Question Mark

market growth: high relative market share: low earnings: low, unstable, or growing cash flow: negative strategy: increase market share or harvest/divest

Cash Cow

market growth: low relative market share: high earnings: high, stable cash flow: high, stable strategy: hold

Dog

market growth: low relative market share: low earnings: low, unstable cash flow: neutral or negative strategy: harvest/divest

Strategic Outsourcing

moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain

Economies of Scale

occur when a firm's average costs per unit decreases as its output increases