Chapter Nine

Corporate
Strategy:
Horizontal
Integration,
Vertical
Integration,
and Strategic
Outsourcing

Corporate-Level Strategy
Corporate-Level Strategy should allow a company, or its

business units, to perform the value-creation functions at lower

or in a way that allows for differentiation and premium price.

cost

Corporate strategy is used to identify:

1. Businesses or industries that the company should
compete in
2. Value creation activities that the company should
perform in those businesses
3. Method to enter or leave businesses or industries
in order to maximize its long-run profitability

Companies must adopt a long-term perspective

Consider how changes in the industry and its products,
technology, customers, and competitors will affect its
current business model and future strategies.

Corporate-Level Strategy:
The Multi-Business Model
A companys corporate-level strategies
should be chosen to promote the success of
a companys business model and to allow
it to achieve a sustainable competitive
advantage at the business level.

A multi-business company must construct its

business model at two levels:

1. Business models and strategies

for each business unit or division in every industry in

which it competes

2. Higher-level multi-business model

that justifies its entry into different businesses and

industries

Repositioning and Redefining

A Companys Business Model
Corporate-level strategies are primarily directed

toward improving a companys competitive advantage

and profitability in its present business or product line:

Horizontal Integration
The process of acquiring or merging with industry
competitors

Vertical Integration
Expanding operations backward into an industry that
produces inputs for the company or forward into an
industry that distributes the companys products

Strategic Outsourcing
Letting some value creation activities within a business
be performed by an independent entity

Horizontal Integration
Single-Industry Strategy
Horizontal Integration is the process of acquiring or merging
with industry competitors in an effort to achieve the
competitive advantages that come with large scale and scope.

Staying inside a single industry

allows a company to:
Focus resources
Its total managerial, technological,
financial and functional resources
and capabilities are devoted to
competing successfully in one area.

Stick to its knitting

Company stays focused on what it does best, rather than
entering new industries where its existing resources and
capabilities add little value.

Benefits of
Horizontal Integration
Profits and profitability increase when horizontal
integration:
1. Lowers the cost structure
Creates increasing economies of scale
Reduces the duplication of resources between two companies

2. Increases product differentiation

Product bundling broader range at single combined price

Total solution saving customers time and money
Cross-selling leveraging established customer relationships

3. Replicates the business model

In new market segments within same industry

4. Reduces industry rivalry

Eliminate excess capacity in an industry

Easier to implement tacit price coordination among rivals

5. Increases bargaining power

Increased market power over suppliers and buyers

Gain greater control

Problems with
Horizontal Integration
A wealth of data suggests that the majority of mergers
and acquisitions DO NOT create value and that many
may actually DESTROY value.
Implementing a horizontal integration is not an easy
task.

Problems associated with merging very different company

cultures
High management turnover in the acquired company when
the acquisition is a hostile one
Tendency of managers to overestimate the benefits to be had
in the merger
Tendency of managers to underestimate the problems
involved in merging their operations

The merger may be blocked if merger is perceived to:

Create a dominant competitor
Create too much industry consolidation
Have the potential for future abuse of market power

Vertical Integration
Entering New Industries
A company may expands its operations backward into
industries that produces inputs to its products or forward
into industries that utilize, distribute or sell it products.
Backward Vertical Integration

Company expands its operations into an industry

that produces inputs to the companys products.

Forward Vertical Integration

Company expands into an industry that uses,

distributes, or sells the companys products.

Full Integration

Company produces all of a particular input

from its own operations.
Disposes of all of its completed products through its own outlets.

Taper Integration

In addition to company-owned suppliers, the company will also use

other suppliers for inputs or independent outlets in addition to
company-owned outlets.

Stages in the Raw Material

to Consumer Value Chain
Figure 9.1

Raw Material to Consumer Value Chain

in the Personal Computer Industry
Figure 9.2

Full and Taper Integration

Figure 9.3

Increasing Profitability Through

Vertical Integration
A company pursues vertical integration to strengthen
the business model of its original or core business
or to improve its competitive position:

1. Facilitates investments in efficiency-enhancing

specialized assets
Allows company to lower the cost structure or
Better differentiate its products

2. Enhances or protects product quality

To strengthen its differentiation advantage through either
forward or backward integration

3. Results in improved scheduling

Makes it easier and more cost-effective to plan, coordinate,
and schedule the transfer of product within the value-added
chain
Enables a company to respond better to changes in demand

Problems with
Vertical Integration
Companies may disintegrate or exit industries adjacent
to the industry value chain when encountering
disadvantages from the vertical integration:
Cost structure is increasing.
Company-owned suppliers develop a higher cost structure
than those of the independent suppliers
Bureaucratic costs of solving transaction difficulties

The technology is changing fast.

Vertical integration may lock into old or inefficient technology

Prevent company from changing to a new technology that
could strengthen the business model

Demand is unpredictable.
Creates risk in vertical integration investments.
Vertical integration can weaken business model when:

Company-owned suppliers lack incentive to reduce costs

Changing demand or technology reduces ability to be competitive

Alternatives to Vertical Integration:

Cooperative Relationships

Strategic Alliances are long-term agreement between two or

more companies to jointly develop new products or processes
that benefit all companies concerned.

Short-term contracts and competitive bidding

May signal a companys lack of commitment to its supplier

Strategic alliances and long-term contracting

Enables creation of a stable long-term relationship
Becomes a substitute for vertical integration
Avoids the problems of having to manage a company located in an
adjacent industry

Building long-term cooperative relationships

Hostage taking creating a mutual dependency
Credible commitments a believable promise or pledge
Maintaining market discipline power to discipline supplier
Periodic contract renegotiation

Parallel sourcing policy

Strategic Outsourcing
Strategic Outsourcing allows one or more of a companys
value-chain activities or functions to be performed by
independent specialized companies that focus all their
skills and knowledge on just one kind of activity.

Company is choosing to focus on a fewer

number of value-creation activities

In order to strengthen its business model

Companys typically focus on noncore or

nonstrategic activities

In order to determine if they can be performed more

effectively and efficiently by independent specialized
companies

Virtual Corporation

Describes companies that have pursued extensive

strategic outsourcing

Strategic Outsourcing of Primary

Value Creation Functions
Figure 9.4

Benefits of Outsourcing
1. Reducing the cost structure

The specialist company cost is less than what it would cost

to perform the activity internally.

2. Enhanced differentiation

The quality of the activity performed by the specialist is

greater than if the activity were performed by the company.

3. Focus on the core business

Distractions are removed.

The company can focus attention and resources on
activities important for value creation and competitive
advantage.

Strategic outsourcing may be detrimental when:

Holdup company becomes too dependent on specialist provider

Loss of information company loses important customer contact or
competitive information