Corporate Strategy

Vertical & Horizontal Integration,

&
Strategic Outsourcing
Thompson et al. 19th Edition (Chapter 8)
Thompson et al. 21 st Edition (Chapter 6)
Lesson Plan
1. What does corporate strategy entails?
2. Distinction between corporate and business level strategies.
3. What is Vertical Integration;
i. Benefits & Costs of VI
ii. Alternatives of Vertical Integration
iii. Designing Vertical Relationship
4. What is Horizontal, Integration;
i. Benefits & Costs of Horizontal Integration;
5. Strategic Outsourcing
i. The big risks of outsourcing
WHAT IS CORPORATE LEVEL
STRATEGY?
Corporate Strategy
• Corporate strategy defines the scope of the firm in
terms of industries and markets in which it competes.
• This chapter is about the corporate strategies of
diversified companies.
• The business level strategy is equivalent to corporate
level strategy in one business company
• The top executives in div.co. thus need to move up to
one step up– by devising a companywide corporate
strategy
– But, in a diversified company strategy development requires
assessing multiple industry environments and developing a set
of business strategies , one for each industry.
Corporate Strategy cont…..

• Corporate strategy defines the scope of the firm in terms

of industries and markets in which it competes.
• Concern of C/L Strategy
– Identify the business in which co should participate.
– The value creation activities
• Best means for expanding & contracting in different
business
• Goal – maximize long-term profitability.
Corporate Strategy contd…..
• Corporate strategy is primarily concerned with the decisions
over the scope of firm the firm activities. Including:
– Product scope
• how specialized should the firm be in terms of the
range of products it supplies (single or diversified
industry?)
– Geographic scope
• What is the optimal geographical spread of activities
for the firm? (single/multiple country)
– Vertical scope
• What range of vertically linked activities should the
firm encompass
Corporate Strategy contd…..
• Thus,
• C/L Strategy decisions include choice over:
– Vertical Integration
– Horizontal Integration
– Strategic Outsourcing
DIFFERENCES BETWEEN
CORPORATE AND
BUSINESS LEVEL
STRATEGY
The sources of Superior Profitability (Corporate -
Level Strategy)
We are
here
now
Industry
Attractivenes Corporate
Rate of Profit s Strategy
Above the Which business
should we be in
Cost of
Capital

How do we make
money? Competitive
Advantage Business
How do we Strategy
make money?
Difference between Corporate Strategy & Business
Level Strategy

Corporate Level Strategy Business Level Strategy

•Defines the firm in terms of •Decision includes choices

industry and market. over how to build
Decision includes choice competitive advantage
over diversification, vertical •Concerned with how the
Int., acquisition and new firm competes within a
ventures. particular industry or market
•Concerned with where a
firm competes.
Diversification
means………….
• Diversification is a form of corporate strategy
for a company.
• It seeks to increase profitability through
greater sales volume obtained from new
products and new markets.
• Diversification can occur at :
– Business unit level - a new segment of an industry that the
business is already in.
– Corporate level - investing in a promising business outside
of the scope of the existing business unit.
 What Does Crafting
Diversification strategy Entails
 What Does crafting Diversification strategy Entails

• Crafting Diversification involves four distinct facets:

1. Picking new industries to enter and deciding on the means
of entry.
2. Pursuing Opportunities to leverage cross-business value
chain relationships and strategic fit into competitive adv.
3. Establishing investment priorities and steering corporate
resources into the most attractive business units
4. Initiating actions to boost the combined performance and
co’s collection of businesses
What Does crafting Diversification strategy Entails contd..

• Crafting Diversification involves four distinct facets contd…:

1. Picking new industries to enter and deciding on the means of entry.

 Mgt needs to decide which new industries to enter; and
 Decide mode of entry – new bus? Acquire? or JV?

2. Pursuing Opportunities to leverage cross-business value chain

relationships and strategic fit into competitive adv.
 To determine whether there are Os to strengthen a diversified co’s business by such
means as
o Transferring competitively valuable R&C from one business to another.
o Combining the related value chain activities of different businesses to achieve
lower costs.
o Sharing the use of powerful and well represented brand name across multiple
o Encouraging knowledge sharing and collaborative activities among the
businesses
What Does crafting Diversification strategy Entails contd..

3. Establishing investment priorities and

steering corporate resources into the most
attractive business units
It means:
 pursuing rapid-growth strategies in its most
promising businesses.
 Initiating profit improvements or turnaround
strategies in weak-performing businesses with
potential; and
 Divesting businesses that are no longer attractive
or that don’t fir into mgt’s long term plans
What Does crafting Diversification strategy Entails contd..

4. Initiating actions to boost the combined performance and co’s

collection of businesses
 for improving the corporations overall performance include:
a. Sticking closely with the existing business and pursuing ‘O’s
presented by the businesses
b. Broadening the scope of diversification by entering additional
industries.
c. Divesting some businesses and retrenching to a narrower
collection of diversified businesses with better overall
performance prospects; and
d. Restructuring the entire co by divesting some businesses and
acquiring others so as to put a whole new face on the co’s lineup
When to Diversify………….
When to Diversify………….

• As long as a co has plentiful ‘O’s for profitable growth in its present

industry there is no urgency to pursue diversification

• Because there are benefit of Single Business:

– Less ambiguity about product/market

– Utilize full potential/capacity
– Specialization >> Entry to barrier
• But the risks of being one unit industry are …

– Change in technology
– New product in the market
– Change in buyers’ preference
When to Diversify………….

–There are clear four instances when it becomes obvious to

diversify

• Expansion to new industry with similar tech & product

which complement its present business

• Leveraging existing competencies and capabilities

• When diversification reduces costs

• Diversifying for brand name

Some Fundamental Issues Before Diversification…….

• Diversify only when the following questions

are answered:
– Is it only for risk diversification?
– Must add value to shareholders
– Three test
1. The industry attractiveness test
– Competitiveness
– Market environment
2. The cost-of-entry test
3. The Better-Off test
 Building Shareholder Value:
The Ultimate Justification for Diversifying
Building Shareholder Value…………….

• Diversification must do more for a co than simply spread

its business risk across various industries
• D. cannot be considered as success unless it results in –
adding long term economic value for shareholders.
• Long term economic value – means :
– the value which shareholders cannot capture on their own by
purchasing stock in co in different industries or investing in
mutual funds.
 Building Shareholder Value…………….

• To create this additional long terms shareholder value, a

move to diversify into new business must pass three tests:
i. The industry attractiveness test
 The industry to be entered must have enough O for profit and return on investment
– that is equal to or better than that of the co’s present business(es)

ii. The cost-of-entry test

 The cost to enter must not exceed the potential for good profitability

iii. The better-off test

 Diversification must offer potential for co’s existing business(es) and the new
business to perform better together under a single corporate umbrella than they
would perform independently - i.e. Synergy
 Building Shareholder Value…………….

• To create this additional long terms shareholder value, a

move to diversify into new business must pass three tests:
i. The industry attractiveness test
 The industry to be entered must have enough O for profit and return on investment
– that is equal to or better than that of the co’s present business(es)
ALL THESE 3 Tests Needs
ii. The cost-of-entry test to be passed before
Diversification Decision is
 The cost to enter must not exceed the potential for good profitability
finalized

iii. The better-off test

 Diversification must offer potential for co’s existing business(es) and the new
business to perform better together under a single corporate umbrella than they
would perform independently - i.e. Synergy
Some Fundamental Issues Before
Diversification…….
Some Fundamental Issues Before Diversification…….

• What kind of diversification? S

– Product T
– Market R
• What sort of diversification? A
– Related T
– Unrelated E
• How? G
– Acquiring an existing co Y
– Creating new co
– Joint venture
Approaches to Diversifying
the Business Lineup
Approaches to Diversifying the Business Lineup

• Entering business can take any of the three forms:

i. Acquisition,

ii. Internal startup,

iii. Joint Venture

Approaches to Diversifying the Business Lineup

i. Diversifying by Acquisition
 Quicker than new start-up; effective way to handle entry barriers –
technical know-how establishing supplier relationship, achieving
scale economies, building brand awareness;
 Commonly employed for accesing R&C that complements existing
business
 But, it is quite expensive- cost of acquiring includes- cost of
buying the business & cost of performing the business with due
diligence to ascertain the worth of other co; negotiating and
completing purchase transaction; & cost of integrating new
business into existing business portfolio
 The big dilemma – whether to buy a successful business with
premium price or to buy a struggling company with less price
Approaches to Diversifying the Business Lineup

i. Diversifying by Acquisition Do it when you see a promising

way to transform a weak firm into
 Quicker than new start-up; effective way to handle entry one
a strong barriers – the
and has
technical know-how establishing supplier relationship,
resources,achieving
tech know-how and
scale economies, building brand awareness; patients to do so
 Commonly employed for accesing R&C that complements existing
Do it when you have little
business
knowledge about the business
 But,but
it is quite capital
enough expensive- cost of acquiring includes- cost of
buying the business & cost of performing the business with due
diligence to ascertain the worth of other co; negotiating and
completing purchase transaction; & cost of integrating new
business into existing business portfolio
 The big dilemma – whether to buy a successful business with
premium price or to buy a struggling company with less price
Approaches to Diversifying the Business Lineup

ii. Entering a New Line of Business through Internal Development

 It is also referred as corporate venturing or new venture development - involves building a
new business from scratch
 Helps to avoid the pitfalls of acquiring existing business
 Hurdles – time consuming, need to overcome industry entry barrier; need t invest in new
production capacity, develop sources of supply, hire and train employees, build channel of
distribution, grow a customer base
 But at the end profits are greater if it handles carefully
 Take this strategy when:
1. The parent co already has in-house most of the skills and resources it needs
2. There is ample time to launch the business
3. The internal cost of entry is lower than the cost of entry through acquisition
4. The targeted industry is populated with many relatively small firms – i.e. no head
to head powerful rival
5. Adding new production capacity will not adversely impact the supply-demand
balance in the industry
6. Incumbent firms are likely to be slow or ineffective in responding to a new
entrant’s efforts
Approaches to Diversifying the Business Lineup

iii. Joint Venture

– 3 situations make it worth
• it is economic to pursue an opportunity through JV/P
• new opportunity needs require broader range of competency
• When it is the only way
– Challenges
• Dividing roles, powers and rights between partners
• Conflict of interest
Approaches to Diversifying the Business Lineup

Now, How to decide which one to choose?

Choosing Mode of Entry

– The choice depends on the answers to 4 important Questions
1. Does the co have all the R& c it requires to enter the business through
internal development or it is lacking some critical resources
2. Are there any entry barriers to overcome?
3. Is speed an important factor in the firm’s chances for successful entry?
4. Which is the least costly mode of entry, given the company’s
objectives?
 What Sort of Diversification?
Choosing the Diversification path –
Related Vs Unrelated
Related or Unrelated?….

 Once a co decides to diversify – then it needs to decide –

 whether to diversify into related business? or
 unrelated businesses? or
 some mix of both
 Related Businesses
 Possess competitively valuable cross-business Value-Chain & Resource
matchups.
 Unrelated Businesses
 Have dissimilar value chains and resource requirements with NO
competitively important cross-business relationships at the value chain
level.
Related or Unrelated?….

Diversifying Into Related Business

 It involves– building the co around businesses with

strategic fit with respect to
 key value chain activities; and
 competitive assets
 Strategic Fit exists –
 whenever one or more activities constituting the value chain of
different businesses are sufficiently similar as to present
opportunities for cross-business sharing or transferring of the R&
C that enables these activities.
………..Related or Unrelated?
• Examples of Strategic Fitness

2. Cost Sharing between

businesses by
combining related value
chain
1. Transferring competitively
3. Exploiting common use of a
valuable expertise, tech or other
well-known brand name
capabilities

5. Engaging in cross business

collaboration and knowledge Strategic 4. Combine resource to create
sharing to create new Fit new strength an capabilities
competitively valuable R&C

R&D and Supply Chain Manufacturing Distribution- Sales and

Technology Activities Related Related Marketing
Related or Unrelated?….

Strategic Fit – Economic Scope - Competitive Advantage:

• Combining resources/capabilities >> Lower cost than
competitor
•Cost saving >> Economic Scope (resources sharing)
Flags:
•Wrong acquisition
•Wrong estimation of feasibility
•Technology /Demand change
Related or Unrelated?….

Diversification Into Unrelated Business

 This strategies discounts the merits of cross-business strategic
fit
 Instead focuses squarely on entering and operating businesses in
industries that allow a co as a whole to increase its earnings
 Companies in unrelated business are labeled as
“Conglomerates”
 Co usually pursue unrelated through acquisition of established
rather than by forming a startup
 Strategic Concern for managers–
 Screening new acquisition candidates
 Deciding whether to keep and divest existing business
Related or Unrelated?….

The decision of investment and divestment depends on few

factors:
 Can the business meet corporate targets for profitability and
ROI?
 Is there enough capital
 What about the growth potential?
 Is there any trade union difficulty?
 What about industry vulnerability?
Related or Unrelated?….

•Three types of companies becomes acquisition

candidates:
–Companies with undervalued assets
–Companies that are financially distressed
–Companies that have better future
•Benefits:
–Risk is diversified (instead of being in the similar industry)
–Investing into co with higher growth potential
–Value to a distressed company>> value to shareholders
–Profitability is more stable during economic upswing-
downswing
Related or Unrelated?….

•Capabilities Needed -
–Managerial skill to manage multidimensional
industrial challenges
–Handing company wide financial performance
–Smart transferring of resources and capabilities
–Expert negotiation skill to win acquisition table
–Shrewdly deciding on which to invest and divest
Related or Unrelated?….

Building shareholder Value via Unrelated Diversification

 Building economic shareholder value via unrelated business depends on the
ability of the parent co to improve its businesses via other means
 Parent company plays the role of corporate parent to do so.
 Corporate parenting refers to the role that a diversified co plays in
nurturing its component businesses through the
 provision of top mgt expertise,
 disciplined control,
 financial resource and
 other types of generalized R&C – like – long term planning system,
business development skilss, mgt dev process and incentive system.
Related or Unrelated?….

•Drawbacks of Unrelated Diversification

 Demanding managerial Requirement
 Limited competitive advantage potential
 Misguided reason for pursuing unrelated
diversification
Related or Unrelated?….

Combine related and unrelated

– Most widely used
Horizontal Integration
Horizontal Integration

• Horizontal integration is the process of a company

increasing production of goods or services at the
same part of the supply chain.
• A company may do this via internal expansion,
acquisition or merger.
• The process can lead to monopoly if a company
captures the vast majority of the market for that
product or service.
Horizontal Integration Contd…

• An Acquisition is a combination in which one co (the

acquirer) purchases and absorbs the operations of another
(the acquired)
• It occurs when one co used its capital to purchase other.
– It is a popular way of diversifying into another industry.
– Quick to launch a brand new operation
– Offers an effective way to overcome entry barriers
Horizontal Integration Contd…

• Merger is an agreement between equals to pool their

operations & create new entity.
• The difference between a M & A related more to the
details of ownership, management control and financial
arrangements, than to strategy and CA
 Horizontal Integration Contd…
 Horizontal merger and Acquisition- (which involves
combining the operations of firms within the same product
or service market), provide an effective means for firms to
rapidly increases the scale and horizontal scope of their core
business.
 Companies integrate horizontally for a number of
reasons.
o To expand internationally. If “Bengal Meat”, a
Bangladesh based butcher, shop merge with a foreign
butcher shop chain as an easy way to enter overseas
markets.

o To increase capacity. For an oil company that is

experiencing rapid growth, it’s easier to buy another refinery
Horizontal Integration Contd…

o To expand their brand equity to new product lines.-

Hatil is a household furniture manufacturer with high brand
recognition. Hatil purchased purchases XYZ, which is a
lesser-known outdoor furniture manufacturer, in order to
enter that market. ABC will then sell the outdoor furniture
under their more recognizable brand.

o To gain quick access to new technology or other

Resources and Capabilities. – Making acquisition to
bolster a co’s tech know-how or to expand its skill and
capabilities allows a co to bypass a time-consuming and
expensive internal effort to build a desirable new R or C.
Horizontal Integration Contd…

o Leading the convergence of industries whose boundaries

are being blurred by changing technologies and new
market opportunities.- News co has prepared for the
convergence of media services with the purchase of satellite
TV co to complement its media holdings in TV Broadcasting
Ex: (Fox networks and TV Stations in many countries(, cable
TV (Fox news, Fox Sports(, filmed entertainment (Twentieth
Century Fox and Fox Studio) news paper and book
publishing.
 Horizontal Integration Contd…

 Horizontal M & A can Strengthen a co’s Competitiveness

in five ways:
1. By improving the efficiency of its operations
2. By Heightening its product differentiation
3. By reducing market rivalry
4. By increasing the co’s bargaining power over
suppliers and buyers &
5. By enhancing its flexibility and dynamic capabilities
 Horizontal Integration Contd…

• Reduce Cost
– Economies of Scale
– Reducing duplicates – Like: instead of having 2 head office
they have 1.
• Increasing Value
– Product bundling – offering bundle product with single price.
– Total Solution
– Cross selling – purchasing from same org.
• Managing Rivalry within the industry
– First by – eliminating excess capacity of competitor
– 2ndly reducing the number of player.
• Increasing Bargaining Power over supplier
& Buyer
 Horizontal Integration Contd…

Drawbacks of Horizontal Integration

i. Acquisition is expensive
o The cost of acquisition include not only the acquisition price but also
the cost of negotiating and completing the purchase transaction and
the cost of integrating the business into the diversified company’s
portfolio.

ii. Cultural Problem

iii. High Mgt Turnover
iv. Tendency on the part of mgrs to underestimate the expenses
v. Tendency to Overestimate.
vi. Gains in competitive capabilities might take substantially
longer to realize , or worse, may never materialize at all.
Horizontal Integration Contd…

Dilemma of Horizontal Integration

• The big dilemma of an acquisition-minded firm is
whether to pay a premium price for a successful
company or to buy a struggling company at a bargain
price.
• If the buying co has ample capital and little tech know-
how of the industry --- it is better to go for paying
premium for successful co..otherwise….
 Vertical
Integratio
n
 Vertical Integration

• Vertical integration refers to a firm’s

ownership of vertically related
activities .
• It provides another way of
strengthening co’s position in its core
market
• A vertically integrated firm is one that
participate in multiple stages of an
industry’s value chain system
 Vertical Integration contd…

• By this co expands its operations either backward or

forward.
– Backward into an industry that produces input for the co’s
product.
– Forward into an industry that uses or distributes the co’s
product.
• Vertical Integration strategies may aim at
– Full Integration – when co produces all of a particular input
needed to produce or disposes of all of its output through its
own operation.
– Taper Integration – when co buys from independent
supplier in addition to co-owned supplier or dispose though
independent outlets in addition to co-owned outlets.
Vertical Integration

The value chain for steel cans

CANNING
Iron ore Steel Steel strip Can OF FOOD
mining Production production making DRINK,OIL
etc

Market Market
Contracts Contracts Vertical
Integration
Vertical
& Market
Integration
Contracts
Benefits of Vertical Integration

 1. Integration Backward to Achieve Greater

Competitiveness
 It is difficult. For the backward integration to be a cost-
saving and profitable strategy, a co must be able to
i. Achieve the same scale economies as outside
suppliers
ii. Match or beat suppliers’ production efficiency with
no drop-off in quality
 Benefits of Vertical Integration contd…

 2. Integration Forward to Enhance Competitiveness

 It can lower cost by increasing efficiency and
bargaining power.
 In addition, it can allow manufacturers
i. To gain better access to end users
ii.To improve market visibility
iii.
Enhance brand name awareness
iv.By-passing regular wholesale and retail channels in favor
of direct sales and
v. Internet retailing can have appeal if it reinforces the brand
and enhances customers satisfaction, or
Benefits of Vertical Integration contd….

• Some other typical advantages:

– Technical economies
• Cost saving that arise from the physical integration
process (transportation and energy cost).
• Results in Improved Scheduling.
– Builds Barriers to Entry
– Facilitate investments in Efficiency-enhancing
specialized assets.
• Reduce risk of hold up.
– Protects Product Quality
Costs of Vertical Integration
• Differences in optimal scale between different
scale of production
• Developing distinctive capabilities
• Managing strategically different businesses
• Compounding risk
• Disadvantage when technology changes.
• When demand is unpredictable.
• Incentive problem
• Flexibility
Assessing Vertical Integration
• In reality VI is neither good nor bad
• It all depends upon the specific context.
• Managers need to identify the factors that determine
the relative advantage of the market transactions Vs
internalization
• Factors to consider are:
– How many firms are there in the vertically adjacent
activity?
– How evenly distributive is info between the vertical stages
– How uncertain is market demand?
– How uncertain are the circumstances of the transaction over
the period of the relationship…and so on
Designing Vertical Relationship
• In practice, buyers and sellers can interact and coordinate their
interests through a variety of relationships.
• There can be number of different types of relationship between
buyers and sellers: Long term, vendor partnership, franchaising
• These relationship can be categorized in relation to two categories.
– First, the extent to which the buyer and seller commit resources
to the relationship (arm’s-length, spot contracts involve no
resource commitment beyond single deal; VI typically involves
a substantial investment
– Second, the formality of the relationship: long term contracts
and franchises are formalized by the complex written
agreement; VI allows mgt discretion to replace legal formality
Different types of Vertical Relationship

Informal
Lo
Supplier/
w Customer Supplier/ Vertical
relationshi Customer Integratio
p partnership
Formalization

n
Spot
sales/pur Joint
chase venture

Agency
Agreemen
Long- t
Franchises
Term
High contracts

Low Degree of High

Commitment
 Strategic
Outsourcin
g
Strategic Outsourcing

• Involves
– separating out some of a co’s value creation activities & letting them
perform by an independent entity.

• In other words
– it is concerned with reducing the boundaries of the co & focusing on
fewer value creation functions.

• Outsourcing makes sense whenever:

– An activity can be performed better it more cheaply by outside specialists
– When the activity is not crucial to the firm’s ability to achieve sustainable
competitive adv.
– It improves organizational flexibility and speeds time to market
– It reduces co’s risk exposure to changing technology or buyers’ preference
– It allows a co to assemble diverse kinds of expertise speedily and efficiently
– It allows a co to concentrate on its core business
Benefits of Strategic Outsourcing
• Reducing Cost
• Differentiation through Outsourcing
• Focus through Outsourcing

Drawbacks of Strategic Outsourcing

• Hold Up
• Scheduling Activities
• Loss of Information
END