Chapter 6

Vertical Integration

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Vertical Vertical Integration Integration

The Strategic Management Process

External Analysis Strategic Choice

Mission

Objectives

Strategy Implementation

Competitive Advantage

Internal Analysis

Which Businesses to Enter? Corporate Level Strategy

Vertical Integration

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Vertical Vertical Integration Integration

Logic of Corporate Level Strategy

Corporate level strategy should create value:
1) such that the value of the corporate whole increases

2) such that businesses forming the corporate whole are worth more than they would be under independent ownership
3) that equity holders cannot create through portfolio investing

a corporate level strategy should create synergies that are not available in equity markets vertical integration = value chain economies
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Vertical Vertical Integration Integration

What is Vertical Integration?

Where your pizza comes from
Dairy Farmers
(milk)

Seed Companies
(Alfalfa & Corn)

Pizza Chains Leprino Foods

(Mozzarella Cheese)

Crop Farmers
(Alfalfa & Corn)

End Consumer

Food Distributors

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Vertical Vertical Integration Integration

What is Vertical Integration?

Backward Vertical Integration Pizza Chains Leprino Foods
(Mozzarella Cheese)

Dairy Farmers
(milk)

Seed Companies
(Alfalfa & Corn)

Crop Farmers
(Alfalfa & Corn)

End Consumer

Food Distributors

Forward Vertical Integration

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Vertical Vertical Integration Integration

Value Chain Economies

The Logic of Value Chain Economies
the focal firm is able to create synergy with the other firm(s)
Dairy Farmers
(milk)

Backward Vertical Integration

cost reduction revenue enhancement

the focal firm is able to capture above normal economic returns (avoid perfect competition)
Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall. Strategic Management & Competitive

Leprino Foods
(Mozzarella Cheese)

Food Distributors

Forward Vertical Integration

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Vertical Vertical Integration Integration

Competitive Advantage
If a vertical integration strategy meets the VRIO 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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Vertical Vertical Integration Integration

Value of Vertical Integration

Market vs. Integrated Economic Exchange
markets and integrated hierarchies are forms in which economic exchange can take place
economic exchange should be conducted in the form that maximizes value for the focal firm thus, firms assess which form is likely to generate more value

Integration makes sense when the focal firm can capture more value than a market exchange provides
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Vertical Vertical Integration Integration

Value of Vertical Integration

Three Value Considerations
Leverage Capabilities firm capabilities may be sources of competitive advantage in other businesses Manage Opportunism opportunism may be checked by internalizing (TSI) Exploit Flexibility internalizing is usually less flexible

flexibility is prized when internalizing must if not, then dont uncertainty is be less costly than integrate exchange high opportunism
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Vertical Vertical Integration Integration

Rarity of Vertical Integration

Integration vs. Non-Integration
a firms integration strategy may be rare because the firm integrates or because the firm does not integrate thus, the question of rareness does not depend on the number of forms observed a firms integration strategy is rare or common with respect to the value created by the strategy Example: Toyotas Choice Not to Integrate Suppliers
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Vertical Vertical Integration Integration

Imitability of Vertical Integration

Form vs. Function
the form, per se, is usually not costly to imitate the value-producing function of integration may be costly to imitate, if: the integrated firm possesses resource combinations that are the result of: historical uniqueness causal ambiguity social complexity small numbers prevent further integration capital requirements are prohibitive
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Vertical Vertical Integration Integration

Imitability of Vertical Integration

Modes of Entry
acquisition and internal development are alternative modes of entry into vertical integration
thus, one firm may acquire a supplier while a competitor could imitate that strategy through internal development in both cases, the boundaries of the firm would encompass the new business strategic alliances can be viewed as a substitute for vertical integrationwithout the costs of ownership
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Vertical Vertical Integration Integration

Organizing Vertical Integration

Functional Structure (U-Form)
CEOs Role Cooperation
Accounting Finance Marketing HR Engineering

Cooperation

Conflict

Original Business

Original Business

Original Business

Original Business

Original Business

New Business

New Business

New Business

New Business

New Business

Conflict
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Vertical Vertical Integration Integration

Organizing Vertical Integration

Management Controls
What needs to be controlled in a vertically integrated firm? managers efforts to achieve the desired value chain economies cooperation and competition among and between functions the integration of new businesses into the existing business time horizon of managers
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Vertical Vertical Integration Integration

Organizing Vertical Integration

Management Controls Budgets
separating strategic and operational budgets strategic: inputs & outputs operational: outputs

Board Committees
provide oversight and direction to managers

help ensure that strategic direction is maintained

These mechanisms focus management attention on achieving value chain economies

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Vertical Vertical Integration Integration

Organizing Vertical Integration

Compensation
Salary

Integration Opportunism
Cash Bonus: Individual Stock Grants: Individual

Leveraging Capabilities

Cash Bonus: Group Stock Grants: Group Stock Options: Individual Stock Options: Group

Cooperation

Exploiting Flexibility

Time Horizon

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Vertical Vertical Integration Integration

Summary
Vertical Integration makes sense when value chain economies can be created and captured

may allow a firm to leverage capabilities

may be a response to the threat of opportunism and uncertainty as a form of exchange per se, is not rare nor costly to imitate
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Vertical Vertical Integration Integration

Summary
Vertical Integration is an important consideration in the decision to 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 costlyintegrate only when the benefits outweigh the costs of integration!
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Vertical Vertical Integration Integration

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Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall. Strategic Management & Competitive

Advantage Barney & Hesterly

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