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Chapter 8Corporate Strategy: Vertical Integration and Diversification

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Chapter Outline8.1 What Is Corporate Strategy?

8.2 The Boundaries of the Firm • Firms vs. Markets: Make or Buy?

• Alternatives on the Make-or-Buy Continuum

8.3 Vertical Integration along the Industry Value Chain• Types of Vertical Integration

8.4 Corporate Diversification: Expanding Beyond a Single Market• Types of Corporate Diversification

• Leveraging Core Competencies for Corporate Diversification

• Corporate Diversification and Firm Performance

8.5 Implications for the Strategist

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ChapterCase 8

Refocusing GE: A Future of Clean-Tech and Health Care?

In 2008, more than half of GE’s profits came from GE Capital.

Global financial crisis hit the company hard. • Stock price fell from $42.12 to $6.66 in 17 months!

GE launched two strategic initiatives: 1. Ecomagination − clean-tech focus

2. Healthymagination – increase access and reduce costs of health care services

Also sold 51% of NBC to Comcast in 2011 and the rest in 2013.

Courtesy of GE Healthcare

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Corporate strategy determines the firm’s boundaries along three dimensions: 1. Industry value chain

2. Range of products and services

3. Where to compete: geography

Key strategic management concepts used here:• Core competencies – unique strengths

• Economies of scale – average cost per unit decreases

• Economies of scope – savings producing two (or more) outputs

• Transaction costs – all internal and external costs associated with an economic exchange

8.1 What Is Corporate Strategy?

CORPORATE-LEVEL STRATEGY

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Explains and predicts the scope of the firm• "Market vs. firms" have differential costs

External transaction costs• Costs associated with economic exchanges

Ex: negotiating and enforcing contracts

Internal transaction costs• Costs pertaining to organizing an exchange within a firm

Ex: recruiting & training employees

8.2 The Boundaries of the Firm

TRANSACTION COST ECONOMIES

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Exhibit 8.2 Organizing Economic Activity: Firms vs. Markets

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Principal – owner of the firm, i.e., shareholders Agent – manager performing activities on behalf of the

principal Separation of ownership and control – one of the hallmarks

of a publicly traded company Principal−agent problem is almost inevitable.

• A manager may pursue his or her own interests such as job security and managerial perks (e.g., corporate jets and golf outings that conflict with the principal’s goals – in particular, creating shareholder value)

• One potential way to overcome the principal−agent problem is to give stock options to managers, thus making them owners.

PRINCIPLE-AGENT RELATIONSHIP

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Short-term contacts• Competitive bidding process• Less than one-year term• Lower prices cost advantages

Strategic alliances• Facilitate investment without administrative costs

Ex: Long-term contacts, equity alliances, joint ventures

Parent–subsidiary relationship• Most integrated alternative • Parent companies have command and control

Ex: GM owns Opel and Vauxhall in Europe

Alternatives on the Make-or-Buy Continuum

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Strategy Highlight 8.1

Toyota Locks Up Lithium for Car Batteries World demand for lithium-ion batteries for cars• Grew from $278 million in ‘09 to $25 billion in 2014

Toyota wants to secure long-term supply to power its hybrid fleet of over 5 million hybrids sold.

Orocobre holds rights to a large lithium deposit.• Upfront investment to extract of lithium is very high.

To encourage investment, Toyota invested $120 million in an equity position.

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In what stages of the industry value chain should the firm participate?

Vertical integration• Ownership of its inputs, production, & outputs in the

value chain• Vertical value chain• Industry-level integration from upstream to downstream

Examples: cell phone industry value chain• Many different industries and firms

8.3 Vertical Integration along the Industry Value Chain

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Exhibit 8.5 HTC’s Backward and Forward Integration along the Industry Value Chain in

the Smartphone Industry

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Securing critical supplies Lowering costs & improving quality Facilitating investments in specialized assets

Increasing costs & reducing quality

Reducing flexibility

Increasing the potential for legal repercussions

Benefits and Risks of Vertical Integration

SOME BENEFITS OF VERTICAL INTEGRATION

SOME RISKS OF VERTICAL INTEGRATION

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Exhibit 8.6 Taper Integration along the Industry Value Chain

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Degrees of diversification• Range of products and services a firm should offer

Ex: PepsiCo also owns Lay's & Quaker Oats, but sold off KFCDifferences in corporate strategy between KFC & Chick-fil-A

Diversification strategies• Product diversification

Active in several different product categories

• Geographic diversificationActive in several different countries

• Product–market diversificationActive in a range of both products and countries

8.4 Corporate Diversification: Expanding Beyond a Single Market

SECOND CORPORATE STRATEGY QUESTION

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Single-business firm derives >95% from one business Google revenues from online search

Dominant-business firm 70% to 95% from one businessHarley-Davidson yields 10% revenues from clothing

Related diversification strategy <70% from one business• Related-constrained – leverage current competencies

ExxonMobil strategic move into natural gas

• Related-linked – share only limited links to current businessAmazon move into cloud computing, Kindle tablets, & video

streaming

Unrelated diversification <70% and few if any links among businesses (a conglomerate)

GE, LG, Tata

Types of Corporate Diversification

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Strategy Highlight 8.2

The Tata Group: Integration at the Corporate Level

Tata Group of India founded in 1868 – uses unrelated diversification • Tea, hospitality, steel, IT, power, and automobiles • 500,000 employees and $100 billion in annual revenues

Tata Motors• The luxury division with the Jaguar and Land Rover brands

focused differentiation strategy for developed markets

• The Nano car division with the Tata Nano brand Focused cost-leadership strategy for emerging markets Targets non-consumers moving up from mopeds and bicycles

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Exhibit 8.8 The Core Competence-Market Matrix

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Does corporate diversification lead to superior performance?

The critical question to ask:• Are the individual businesses worth more under the

company’s management than if each were managed in separate firms?

Research finds an inverted U-shaped relationship• Type of diversification

• Overall firm performance

Corporate Diversification and Firm Performance

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Exhibit 8.11 Restructuring the Corporate Portfolio: The Boston Consulting

Group Growth-Share Matrix

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8.5 Implications for the Strategist

Effective corporate strategy helps to gain and sustain a competitive advantage.

Corporate strategy needs to be dynamic over time. • GE CEO Jeffrey Immelt formulated a new corporate

strategy in clean-tech and health care. (ChapterCase 8)

• Strategic positions of Nike and adidas another exampleadidas founded in 1924 focused on athletic shoes

Integrated manufacturing model

Globalization led adidas to less integration and wider sports apparel 2013 − 40% shoes, 50% apparel, 10% equipment

Nike started in 1978 as a vertically disintegrated firm.

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ChapterCase 8

Consider This…• 2012 – GE split the energy business into three SBUs: Power

and Water; Oil and Gas; and Energy Management.This move has both internal and external benefits.

• GE increasing its global footprintInternational sales were 19% in 1980; to over 52% in 2012.Tackling big problems isa strength for a conglomerate.

• India is seeking to replicate a “leap frog” approach in energy similar to that used in telecommunications.Challenges for firms based in developed economiesNeed robust solutions yet very economical

Courtesy of GE Healthcare

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