Vertical integration

1
Vertical integration

• Session 14

2
Corporate strategy

• Product scope
• Diversification
• Geographic scope
• Local market or global markets
• Vertical scope (value chain)
• Short value chain or long value chain (vertical
  integration or outsourcing)

Source Grant
3
Scope of the firm

• Markets v/s hierarchies
• Transaction costs v/s administrative costs
• Transaction costs
• Opportunism, Bounded Rationality, Uncertainty,
  Small numbers
• Administrative costs
• Differences in scale of operations between
  different production stages
• Managing strategically different businesses

4
Railroad Tycoon
Source New York Times
5
Vertical integration

• Types
• Backward, forward
• Value and rarity of vertical integration
• Opportunism and transaction specific investments
  - quality
• Firm capabilities
• Flexibility and uncertainty improved scheduling
• Barriers to entry

6
CBS Viacom, Paramount, Spelling
Source NY Times
7
Keeping it in the family

• Warner Bros sells television rights for Harry
  Potter and the Sorcerers Stone to Disneys ABC
• Instead of selling it to AOL-TWs TV outlets
  (TBS, TNT and WB)
• Selling outside the group for more money
• Overcoming inefficiencies of vertical integration
• Vertical integration doesnt necessarily increase
  profits for the firm

8
Disadvantages of vertical integration

• Inefficiency
• Loss of flexibility (technological change)
• Demand uncertainty
• Compounding of risk
• Bureaucratic costs

9
Do vertical empires work?

• Been there, done that General Motors, Ford,
  Lockheed Martin
• Building vertically integrated structures
  Microsoft, AOL-Time Warner
• Problems costs, loss of customers, ethical and
  moral questions
• Lean, mean approach, Outsourcing through
  contractual arrangements Dell, Hewlett-Packard,
  Nortel Networks

Source Business Week, 2000
10
Imitability

• Direct duplication
• Alternatives to vertical integration
• Short term contracts (Market)
• Long term contracts / strategic alliances and
  joint ventures
• Strategic outsourcing

11
STARBUCKS
Philippines
Korea
Rustan
Shinsegne
Japan
To a large degree our international expansion
will be driven by JV offers we receive Founder
Licensee
Licensee
Singapore
China
Bonvests
JV stores
BAIC Beijing
Licensee stores
Geographic partners
JV-distributes to hotels, embassies
Cobranding partners
Customer alliances
70 million passengers per year, worldwide
Retail formats
Host
In-store stores
Canada bookstores
Worldwide airport kiosks
Note Starbucks Coffee, Sazabys, ITT Sheraton,
United Airlines, Chapters, Host Marriott
Services, Barnes Noble Inc.,Dreyers Grand Ice
Cream, and Pepsi are proprietary trademarks,
other partners include Nordstrom, Costco
12
Outsourcing

• Topsy Tail founded in 1991
• Achieved sales of 80 million in two years
• How many employees?

13
Strategic outsourcing

• Virtual corporations
• Benefits flexibility, speed, cost reduction,
  differentiation, pools resources and capabilities
  of many firms and focus on core activities
• Risks holdup, loss of control over scheduling,
  loss of information and capabilities

14
Organization

• Functional structure
• Conflict resolution
• Controls
• Budgets, committees
• Compensation
• Firm specific investments by individuals and
  groups, flexibility
• Individual and group linked compensation
• Salary, bonuses and stock options, grants

15
International Expansion
The Cost Control Tradeoff
Cost (Capital at Risk)
High
Greenfield Investment
Vertically Integrated
Acquisition
Strategic Alliance
Somewhat Vertically Integrated
Franchising
Licensing
Not Vertically Integrated
Exporting
Control
Low
High