Chapter 8 Corporate Strategy: Vertical Integration and Diversification

1. Chapter 8 Corporate Strategy: Vertical Integration and Diversification

3. Chapter Outline 8.1 What Is Corporate Strategy? 8.2 The Boundaries of the Firm • Firms vs. Markets: Make or Buy? • Alternatives on the Make-or-Buy Continuum 8.3 Vertical Integration along the Industry Value Chain • Types of Vertical Integration 8.4 Corporate Diversification: Expanding Beyond a Single Market • Types of Corporate Diversification • Leveraging Core Competencies for Corporate Diversification • Corporate Diversification and Firm Performance 8.5 Implications for the Strategist

4. ChapterCase 8 Courtesy of GE Healthcare Refocusing GE: A Future of Clean-Tech and Health Care? • In 2008, more than half of GE’s profits came from GE Capital. • Global financial crisis hit the company hard. • Stock price fell from $42.12 to $6.66 in 17 months! • GE launched two strategic initiatives: • Ecomagination−clean-tech focus • Healthymagination – increase access and reduce costs of health care services • Also sold 51% of NBC to Comcast in 2011 and the rest in 2013.

5. 8.1 What Is Corporate Strategy? • Corporate strategy determines the firm’s boundaries along three dimensions: • Industry value chain • Range of products and services • Where to compete: geography • Key strategic management concepts used here: • Core competencies – unique strengths • Economies of scale – average cost per unit decreases • Economies of scope – savings producing two (or more) outputs • Transaction costs – all internal and external costs associated with an economic exchange • CORPORATE-LEVEL STRATEGY

6. 8.2 The Boundaries of the Firm • Explains and predicts the scope of the firm • "Market vs. firms" have differential costs • External transaction costs • Costs associated with economic exchanges • Ex: negotiating and enforcing contracts • Internal transaction costs • Costs pertaining to organizing an exchange within a firm • Ex: recruiting & training employees • TRANSACTION COST ECONOMIES

7. Exhibit 8.2 Organizing Economic Activity: Firms vs. Markets

8. Principal – owner of the firm, i.e., shareholders • Agent – manager performing activities on behalf of the principal • Separation of ownership and control – one of the hallmarks of a publicly traded company • Principal−agent problem is almost inevitable. • Amanager may pursue his or her own interests such as job security and managerial perks (e.g., corporate jets and golf outings that conflict with the principal’s goals – in particular, creating shareholder value) • One potential way to overcome the principal−agent problem is to give stock options to managers, thus making them owners. • PRINCIPLE-AGENT RELATIONSHIP

9. Alternatives on the Make-or-Buy Continuum • Short-term contacts • Competitive bidding process • Less than one-year term • Lower prices  cost advantages • Strategic alliances • Facilitate investment without administrative costs • Ex: Long-term contacts, equity alliances, joint ventures • Parent–subsidiary relationship • Most integrated alternative • Parent companies have command and control • Ex: GM owns Opel and Vauxhall in Europe

10. Strategy Highlight 8.1 Toyota Locks Up Lithium for Car Batteries • World demand for lithium-ion batteries for cars • Grew from $278 million in ‘09 to $25 billion in 2014 • Toyota wants to secure long-term supply to power its hybrid fleet of over 5 million hybrids sold. • Orocobre holds rights to a large lithium deposit. • Upfront investment to extract of lithium is very high. • To encourage investment, Toyota invested $120 million in an equity position.

11. 8.3 Vertical Integration along the Industry Value Chain • In what stages of the industry value chain should the firm participate? • Vertical integration • Ownership of its inputs, production, & outputs in the value chain • Vertical value chain • Industry-level integration from upstream to downstream • Examples: cell phone industry value chain • Many different industries and firms

12. Exhibit 8.5 HTC’s Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry

13. Benefits and Risks of Vertical Integration • Securing critical supplies • Lowering costs & improving quality • Facilitating investments in specialized assets • Increasing costs & reducing quality • Reducing flexibility • Increasing the potential for legal repercussions • SOME BENEFITS OF VERTICAL INTEGRATION SOME RISKS OF VERTICAL INTEGRATION

14. Exhibit 8.6 Taper Integration along the Industry Value Chain

15. 8.4 Corporate Diversification: Expanding Beyond a Single Market • Degrees of diversification • Range of products and services a firm should offer • Ex: PepsiCo also owns Lay's & Quaker Oats, but sold off KFC • Differences in corporate strategy between KFC & Chick-fil-A • Diversification strategies • Product diversification • Active in several different product categories • Geographic diversification • Active in several different countries • Product–market diversification • Active in a range of bothproducts and countries • SECOND CORPORATE STRATEGY QUESTION

16. Types of Corporate Diversification • Single-business firmderives >95% from one business • Google revenues from online search • Dominant-business firm 70% to 95% from one business • Harley-Davidson yields 10% revenues from clothing • Related diversification strategy <70% from one business • Related-constrained – leverage current competencies • ExxonMobil strategic move into natural gas • Related-linked – share only limited links to current business • Amazon move into cloud computing, Kindle tablets, & video streaming • Unrelated diversification <70% and few if any links among businesses (a conglomerate) • GE, LG, Tata

17. Strategy Highlight 8.2 The Tata Group: Integration at the Corporate Level • Tata Group of India founded in 1868 – uses unrelated diversification • Tea, hospitality, steel, IT, power, and automobiles • 500,000 employees and $100 billion in annual revenues • Tata Motors • The luxury division with the Jaguar and Land Rover brands • focused differentiation strategy for developedmarkets • The Nano car division with the Tata Nano brand • Focused cost-leadership strategy for emergingmarkets • Targets non-consumers moving up from mopeds and bicycles

18. Exhibit 8.8 The Core Competence-Market Matrix

19. Corporate Diversification and Firm Performance • Does corporate diversification lead to superiorperformance? • The critical question to ask: • Are the individual businesses worth more under the company’s management than if each were managed in separate firms? • Research finds an inverted U-shaped relationship • Type of diversification • Overall firm performance

20. Exhibit 8.11 Restructuring the Corporate Portfolio: The Boston Consulting Group Growth-Share Matrix

21. 8.5 Implications for the Strategist • Effective corporate strategy helps to gain and sustain a competitive advantage. • Corporate strategy needs to be dynamic over time. • GE CEO Jeffrey Immelt formulated a new corporate strategy in clean-tech and health care. (ChapterCase 8) • Strategic positions of Nike and adidas another example • adidas founded in 1924 focused on athletic shoes • Integrated manufacturing model • Globalization led adidas to less integration and wider sports apparel • 2013 − 40% shoes, 50% apparel, 10% equipment • Nike started in 1978 as a vertically disintegrated firm.

22. ChapterCase 8 Courtesy of GE Healthcare Consider This… • 2012 – GE split the energy business into three SBUs: Power and Water; Oil and Gas; and Energy Management. • This move has both internal and external benefits. • GE increasing its global footprint • International sales were 19% in 1980; to over 52% in 2012. • Tackling big problems isastrength for a conglomerate. • India is seeking to replicate a “leap frog” approach in energy similar to that used in telecommunications. • Challenges for firms based in developed economies • Need robust solutions yet very economical