Lecture Outline

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Lecture Outline
Strategic Management and Competitive
Advantage Jay B. BarneyWilliam S. Hesterly
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Chapter 6
Vertical Integration
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The Strategic Management Process
External Analysis
Strategic Choice
Strategy Implementation
Competitive Advantage
Mission
Objectives
Which Businesses to Enter?
Internal Analysis
Vertical Integration
Corporate Level Strategy
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Logic of Corporate Level Strategies

• Corporate Level Strategy Should Create Value
• Such that the value of the corporate whole
  increases
• Such that businesses forming the corporate whole
  are worth more than they would be under
  independent ownership
• That equity holders cannot create though
  portfolio investing
• A corporate level strategy should create
  synergies that are not available in equity markets

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What is Vertical Integration?

• Vertical Integration
• Describes a style of ownership and control
• Degree of Vertical Integration
• The degree to which a firm owns its upstream
  suppliers and its downstream buyers determines
  how vertically integrated it is.
• Vertically integrated companies are united
  through a hierarchy and share a common owner.
• Usually each member of the hierarchy produces a
  different product or service, and the products
  combine to satisfy a common need.

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Famous Example of Vertical Integration
Carnegie Steel
Coal Mines That Supplied the Coal
Mines Where the Iron Ore Was Extracted
Ships That Transported the Iron Ore
Mills Where the Steel Was Manufactured
University to Teach the Steel Processes
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Modern Example of Vertical Integration
Apple Inc.
Apple Store
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What Is Vertical Integration?(1 of 2)
Where your pizza comes from
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What is Vertical Integration(2 of 2)
Backward Vertical Integration
Forward Vertical Integration
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Value Chain Economics
The Logic of Value Chain Economies
Backward Vertical Integration
the focal firm is able to create synergy with
the other firm(s)
cost reduction
revenue enhancement
the focal firm is able to capture above normal
economic returns (avoid perfect competition)
Forward Vertical Integration
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Competitive Advantage

• If the Vertical Integration Strategy Meets the
  VRIO criteria
• Is it valuable?
• Is it rare?
• Is it costly to imitate?
• ..it may create competitive advantage

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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
• 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
internalizing is usually less flexible
firm capabilities may be sources of
competitive advantage in other businesses
opportunism may be checked by internalizing
(TSI)
flexibility is prized when uncertainty
is high
internalizing must be less costly
than opportunism
if not, then dont integrate exchange
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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 crated by the strategy

Example Apple Opening Retail Stores
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Imitability of Vertical Integration(1 of 2)

• 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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Imitability of Vertical Integration(2 of 2)

• 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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Organizing Vertical Integration(1 of 4)
Functional Structure (U-Form)
CEOs Role
Cooperation
Accounting
Finance
Marketing
HR
Engineering
Original Business
Original Business
Original Business
Original Business
Original Business
Conflict
Cooperation
New Business
New Business
New Business
New Business
New Business
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Organizing Vertical Integration(2 of 4)

• Management Controls
• What needs to be controlled in a vertically
  integrated firm?
• Managers efforts to achieve the desired value
  chain economics
• Cooperation and competition among and between
  functions
• The integration of new businesses into the
  existing businesses
• Time horizon of managers

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Organizing Vertical Integration(3 of 4)
Management Controls
separating strategic and operational budgets
provide oversight and direction to managers
help ensure that strategic direction is
maintained
strategic inputs outputs
operational outputs
These mechanisms focus management attention on
achieving value chain economies
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Organizing Vertical Integration(4 of 4)
Compensation
Salary
Cash Bonus Individual
Stock Grants Individual
Cash Bonus Group
Stock Grants Group
Stock Options Individual
Stock Options Group
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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
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Summary(1 of 2)
Vertical Integration
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Summary(2 of 2)
Vertical Integration
Ownership is costlyintegrate only when
the benefits outweigh the costs of integration!