Transcription
Chapter 8: Corporate Strategy:Vertical Integration and Diversification
amazon.com Originally was an online book seller– Started in a garage in a Seattle suburb amazon now:– Sells 30 times the number of items sold by Wal-mart– A widely-diversified technology company– Holds 2/3 market share in e-books Sells more e-books than print books– Streams music, movies, TV shows– Largest cloud computing service provider globally– Is establishing country-specific sitesCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3amazon.com amazon is engaged in a competitive battle.– For control of the emerging digital ecosystem– Competes with Apple, Google, Facebook, Walmart,Microsoft, and IBM amazon is one of the five largest technologycompanies.– Annual sales 100 billion– Struggles to obtain profitability In 2014, it lost 250 millionCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
amazon.com amazon.com continues to diversify.– Is positioning to capture a piece of the 10B collegebookstore market Goals and outcomes of “amazon campus”–––––To offer textbooks, clothing, foodOffer prime membership at a discountGuarantees next-day deliveryEstimated to save students 200- 400 per yearBinds a new generation of users early.Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
5amazon.com Amazon.com continues to spend billions on seeminglyunrelated diversification efforts. Do you believe theseefforts contribute to Amazon gaining and sustaining acompetitive advantage. Why or why not? Amazon is now over 20 years old and makes over 100billion in annual revenues. As an investor, would it concernyou that Amazon.com has yet to deliver on economicprofits? Why or why not? How much longer do you think investors will be patientwith Jeff Bezos as he continues to pursuebillion dollar diversification decisions?Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
What is Corporate Strategy?Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
What Is Corporate Strategy? Corporate strategy Corporate strategy is the way a company creates value throughthe configuration and coordination of its multi-market activities Quest for competitive advantage when competing in multipleindustries Corporate strategy concerns the scope of the firm: What stages of the industry value chain (vertical integration)? What range of products and services (horizontal integration)? What geographic markets (regional, national,and/or global) to compete in?8–7
Three Dimensions of Corporate StrategyScope of the firm determines boundaries along these three dimensions.
The Boundaries of the FirmCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Transaction Cost Economies Helps explain and predict boundaries of the firm Helps managers decide– Which activities to perform in-house– Which services and products to obtainfrom the external marketCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.Exhibit 8.2
12Transaction Costs Costs associated with an economic exchange Can be within or external to a firm External transaction costs– Searching for a firm individual to contract with– Negotiating, monitoring, and enforcing the contract Internal transaction costs––––Recruiting and retaining employeesPaying salaries and benefitsSetting up a shop floorProviding office space and computers, etc.Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Firms vs. Markets: Make or Buy? Should a firm do things in-house (to make)? Or obtainexternally (to buy)? If Cin-house Cmarket, then the firm should vertically integrate Example: Google hires programmers to write codein-house rather than contracting out Firms and markets have distinct advantagesand disadvantages (see Exhibit 8.3)8–13
14Organizing Economic Activity:Firms vs. MarketsExhibit 8.3Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Alternatives on the Make-or-buy ContinuumExhibit 8.4Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Risks in undertaking cooperativeagreements or strategic alliances Adverse selection Moral Hazard Partners misrepresent skills, ability and otherresourcesPartners provide lower quality skills andabilities than they had promisedHoldup Partners exploit the transaction specificinvestment made by others in the alliance
17Coca-Cola and Monster Alliance Partnership The demand for Coke/Pepsi is falling.– Replaced by water and energy drinks Coca Cola formed an alliance partnership with Monster.– 2 billion for a 16.7% stake in the company Why not an acquisition?– Several wrongful death suits– They can benefit from explosive growth.– They can protect their wholesome image and brand.– What is the strategic logic for why Coca-Colatook a minority investment in Monster?Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Vertical Integration along the Industry Value ChainCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
19A Vertical Value ChainThe transformation of raw materials into finishedgoods and services along distinct vertical stagesExhibit 8.5Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Forward and Backward Integration:The Smartphone IndustryExhibit 8.6Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Back to the Future: PepsiCo’s Forward Integration PepsiCo acquired bottlers in 2009 Gain control over quality, pricing, distribution, andin-store display. Reverseda 1999 decision to sell off Pepsi bottlers Goal now is faster innovative products launched Forward integration Enhance flexibility and improve decision making Cost saving and interdependence Coca-Cola did the same:forward integration with bottlers
22Benefits of Vertical Integration Lowers costs Improves quality Facilitates scheduling and planning Secures critical supplies and distribution channels Facilitates investments in specialized assetsCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Benefits of Vertical Integration Specialized assets Assets that have significantly more value in theirintended use than in their next best use Types of specialized assets Site specificity Co-located such as coal plant andelectric utility Physical asset specificity Bottling machinery Human asset specificity Mastering procedures of a particular organization
Optimal Input tive tocontracting costs?YesNoContractManagerial Eco. - Rutgers UniversitySpot ExchangeComplex contractingenvironment relative tocosts of integration?YesVerticalIntegration6-13
Risks of Vertical Integration Increasing costs Internal suppliers lose incentives to compete Reducing quality Single captured customer can slow experience effects Reducing flexibility Slow to respond to changes in technology or demand Increasing the potential for legal repercussions FTC carefully reviewed Pepsi plans to buy bottlers8–25
26Taper Integration An alternative to vertical integration Involves either:– Backward integration and relying on others for supplies– Forward integration and relying on others for distributionExhibit 8.7Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Strategic Outsourcing Moving one or more internal value chain activitiesoutside the firm’s boundaries to other firms in theindustry value chain Example: Offshoring Most active sectors of offshoring:– Banking and financial services– Information Technology (IT)– Health CareCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
28Corporate Diversification:Expanding Beyond a Single MarketCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Different Types of Corporate Diversification
30The Tata Group: Integration at the Corporate Level A multinational conglomerate in Mumbai, India– Activities: tea, hospitality, steel, IT,communications, power, and automobiles Tata Motors– Bought Jaguar and Range Rover from Ford (2008)– Created the Tata Nano a small, no-frills car 50% cheaper than their next-lowest cost car– Pursues differentiation and low coststrategies simultaneouslyCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
The Tata Group: Integration at the Corporate Level Tata Group’s corporate strategy aspires tointegrate different strategic business units, eachwith its own profit and loss responsibilities. Do you believe that Tata Group will be successfulin implementing this corporate strategy?Why or why not?Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Motivations For Diversification Value Enhancing Motives: Increase market power Multi-point competition R&D and new product development Developing New Competencies (Stretching) Transferring Core Competencies (Leveraging) Utilizingexcess capacity (e.g., in distribution) Economies of Scope Leveraging Brand-Name(e.g., Haagen-Dazs to chocolate candy)
Leveraging Core Competencies forCorporate Diversification Core competence Unique skills and strengths Allows firms to increase the value of product/service Lowers the cost Examples:– global supply chain Infosys – low-cost global delivery system Wal-mart The core competence – market matrix Provides guidance to executives on how to diversifyin order to achieve continued growth
34Leveraging Core Competencies For Corporate DiversificationExhibit 8.9SOURCE: Adapted from G. Hamel and C.K. Prahalad (1994), Competing for the Future (Boston, MA: Harvard BusinessSchool Press).Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Other Motivations For Diversification Motivations that are “Value neutral”: Diversification motivated by poor economic performancein current businesses. Motivations that “Devaluate”: Agency problem Managerial capitalism (“empire building”) Maximize management compensation Sales Growth maximization Professor William Baumol
Diversification Issue #1: When there is a reduction in managerial(employment) risk, then there is upside and downsideeffects for stockholders: On the upside, managers will be more willing to learnfirm-specific skills that will improve the productivity andlong-run success of the company (to the benefit ofstockholders). On the downside, top-level managers mayhave the economic incentive to diversify toa point that is detrimental to stockholders.
Diversification Issue #2: There may be no economic value to stockholdersin diversification moves since stockholders are free todiversify by holding a portfolio of stocks.No one has shownthat investors pay a premium for diversified firms --in fact,discounts are common. A classic example is Kaiser Industries that was dissolved asa holding company because its diversification apparentlysubtracted from its economic value. Kaiser Industries main assets: (1) Kaiser Steel; (2) Kaiser Aluminum;and (3) Kaiser Cement were independent companies and the stockof each were publicly traded. Kaiser Industries was selling at adiscount which vanished when Kaiser Industriesrevealed its plan to sell its holdings.
38Corporate Diversification and Firm Performance Does corporate diversification lead to superior performance?– High and low levels of diversification lower performance– Moderate levels of (related) diversification higher firm performanceExhibit 8.10SOURCE: Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2000), “Curvilinearity in the diversification-performancelinkage: An examination of over three decades of research,” Strategic Management Journal 21: 155–174.Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Vertical Integration and Diversification:Sources of Value Creation and CostsExhibit 8.11Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
40Boston Consulting Group (BCG)Growth-share MatrixCopyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.Exhibit 8.12
Oracle Corporate Strategy: CombiningVertical Integration and Diversification8–41
42Dynamic Corporate Strategy:Nike vs. AdidasExhibit 8.13Copyright 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distributionin any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Corporate Diversification Internal capital markets Source of value creation in a diversification strategy Allows conglomerate to do a more efficient job ofallocating capital Coordination costs A function of number, size, and types of businesseslinked to one another Influence costs Political maneuvering by managers to influencecapital and resource allocation Bandwagon effects Firms copying moves of industry rivals8–44
Problems inAchieving SuccessReasons forAcquisitionsIncreasedmarket powerIntegrationdifficultiesOvercomeentry barriersInadequateevaluation of targetCost of newproduct developmentLarge orextraordinary debtIncreased speedto marketAcquisitionsInability toachieve synergyLower riskcompared to developingnew productsToo s overlyfocused on acquisitionsAvoid excessivecompetitionToo largeCh7-3
Sustainable Competitive Advantage Trying to gain sustainable competitive advantage viamergers and acquisitions puts us right up against the“efficient market” wall: If an industry is generally known to be highly profitable, therewill be many firms bidding on the assets already in themarket. Generally the discounted value of future cash flowswill be impounded in the price that the acquirer pays.Thus, the acquirer is expected to make onlya competitive rate of return on investment.
Sustainable Competitive Advantage And the situation may actually beworse, given the phenomenon of thewinner’s curse. The most optimistic bidder usually over-estimates the true value of the firm: QuakerOats, in late 1994, purchasedSnapple Beverage Company for 1.7 billion.Many analysts calculated that Quaker Oatspaid about 1 billion too much for Snapple.In 1997, Quaker Oats sold Snapple for 300 million.
Sustainable Competitive Advantage Under what scenarios can the bidder do well? Luck Asymmetric Information– This eliminates the competitive biddingpremise implicit in the “efficient markethypothesis” Specific-synergies (co-specialized assets)between the bidder and the target.– Once again, this eliminates thecompetitive bidding premise of theefficient market hypothesis.
What Is Corporate Strategy? Corporate strategy Corporate strategy is the way a company creates value through the configuration and coordination of its multi-market activities Quest for competitive advantage when competing in multiple industries Corporate strategy concerns the scope of the firm: What s
