vertical integration copyright © 2008 pearson prentice hall. all rights reserved. 6-1 chapter 6
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Vertical Vertical IntegrationIntegration
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Chapter 6Chapter 6
Vertical Integration
Strategic Management & Competitive Advantage – Barney & Hesterly 2
Vertical IntegrationVertical Integration
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Mission Objectives
ExternalAnalysis
InternalAnalysis
StrategicChoice
StrategyImplementation
CompetitiveAdvantage
The Strategic Management Process
Corporate LevelStrategy
Which Businessesto Enter?
• Vertical Integration
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Logic of Corporate Level Strategy
Corporate level strategy should create value:
2) such that businesses forming the corporate wholeare worth more than they would be under independent ownership
3) that equity holders cannot create throughportfolio investing
• a corporate level strategy should createsynergies that are not available in equitymarkets
• vertical integration = value chain economies
1) such that the value of the corporate whole increases
Vertical Integration
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What is Vertical Integration?
Leprino Foods(Mozzarella Cheese)
Where your pizza comes from
Dairy Farmers(milk)
Crop Farmers(Alfalfa & Corn)
Seed Companies(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
Vertical Integration
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What is Vertical Integration?
Leprino Foods(Mozzarella Cheese)
Dairy Farmers(milk)
Crop Farmers(Alfalfa & Corn)
Seed Companies(Alfalfa & Corn)
Food Distributors
Pizza Chains
End Consumer
BackwardVertical
Integration
ForwardVerticalIntegration
Vertical Integration
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Value Chain Economies
Dairy Farmers(milk)
Food Distributors
BackwardVertical
Integration
ForwardVerticalIntegration
Leprino Foods(Mozzarella Cheese)
The Logic of Value Chain Economies
• the focal firm is able tocreate synergy with theother firm(s)
• the focal firm is able tocapture above normal economic returns(avoid perfect competition)
• cost reduction
• revenue enhancement
Vertical Integration
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Competitive Advantage
If a vertical integration strategy meets theVRIO criteria…
Is it Valuable?
Is it Rare?
Is it costly to Imitate?
Is the firm Organized to exploit it?
…it may create competitive advantage.
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Value of Vertical Integration
Market vs. Integrated Economic Exchange
• economic exchange should be conducted in the formthat maximizes value for the focal firm
• markets and integrated hierarchies are ‘forms’ in whicheconomic exchange can take place
• thus, firms assess which form is likely to generatemore value
Integration makes sense when the focal firm can capture more value than a market exchange provides
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Value of Vertical Integration
Three Value Considerations
LeverageCapabilities
ExploitFlexibility
ManageOpportunism
• firm capabilitiesmay be sourcesof competitiveadvantage inother businesses
• if not, then don’tintegrate exchange
• opportunismmay be checkedby internalizing (TSI)
• internalizing mustbe less costly thanopportunism
• internalizing isusually lessflexible
• flexibility is prized whenuncertainty ishigh
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Rarity of Vertical Integration
Integration vs. Non-Integration
• a firm’s integration strategy may be rare becausethe firm integrates or because the firm does notintegrate
• thus, the question of rareness does notdepend on the number of forms observed
• a firm’s integration strategy is rare or common withrespect to the value created by the strategy
Example: Toyota’s Choice Not to Integrate Suppliers
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Imitability of Vertical Integration
Form vs. Function
• the form, per se, is usually not costly to imitate
• the value-producing function of integration maybe costly to imitate, if:
• the integrated firm possesses resourcecombinations that are the result of:
• historical uniqueness
• causal ambiguity
• social complexity
• small numbers prevent further integration
• capital requirements are prohibitive
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Imitability of Vertical Integration
Modes of Entry
• acquisition and internal development are alternativemodes of entry into vertical integration
• strategic alliances can be viewed as a substitute forvertical integration—without the costs of ownership
• thus, one firm may acquire a supplier while acompetitor could imitate that strategy throughinternal development
• in both cases, the boundaries of the firm wouldencompass the new business
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Organizing Vertical Integration
Functional Structure (U-Form)
Accounting Finance Marketing HR Engineering
Conflict
Con
flict
OriginalBusiness
NewBusiness
OriginalBusiness
NewBusiness
NewBusiness
NewBusiness
NewBusiness
OriginalBusiness
OriginalBusiness
OriginalBusiness
Cooperation
Cooperation
CEO’s Role
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Organizing Vertical Integration
Management Controls
What needs to be ‘controlled’ in a vertically integratedfirm?
• cooperation and competition among and betweenfunctions
• the integration of new businesses into the existing business
• managers’ efforts to achieve the desired valuechain economies
• time horizon of managers
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Organizing Vertical Integration
Management Controls
BudgetsBoard
Committees
• separating strategic andoperational budgets
• strategic: inputs& outputs
• operational: outputs
• provide oversight and direction to managers
• help ensure that strategicdirection is maintained
These mechanisms focus management attentionon achieving value chain economies
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Organizing Vertical Integration
CompensationSalary
Cash Bonus: Individual
Stock Grants: Individual
Cash Bonus: Group
Stock Grants: Group
Stock Options: Individual
Stock Options: Group
Opportunism
LeveragingCapabilities
ExploitingFlexibility
Cooperation
Time Horizon
Integration
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International Expansion
Cost(Capital at Risk)
ControlExporting
Licensing
Franchising
Strategic Alliance
Greenfield Investment
Low High
High
Acquisition
The Cost – Control Tradeoff
VerticallyIntegrated
Not Vertically Integrated
SomewhatVerticallyIntegrated
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Summary
Vertical Integration…
• makes sense when value chain economiescan be created and captured
• may allow a firm to leverage capabilities
• may be a response to the threat of opportunismand uncertainty
• as a form of exchange per se, is not rare norcostly to imitate
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Summary
Vertical Integration…
• is an important consideration in the decisionto expand internationally (range of possibilities)
• makes sense when done for the right reasons,under the right circumstances
• can be a costly mistake if done wrong
Ownership is costly—integrate only when thebenefits outweigh the costs of integration!