CHAPTER 9

Corporate-Level Strategy: Horizontal Integration,

Vertical Integration, and Strategic Outsourcing
Objective

Horizontal Integration

Vertical Integration

Why, and under what conditions, cooperative relationships such as

strategic alliances may become a substitute for vertical integration

Strategic Outsourcing

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 Corporate-Level Strategy(1)

Corporate-level strategy involves choices strategic managers must make:

Deciding in which businesses and industries a company should compete

Selecting which value creation activities it should perform in those businesses

Determining how it should enter, consolidate, or exit businesses or industries to

maximize long-term profitability

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 Corporate-Level Strategy(2)
Their concern is with building and managing the corporate portfolio of business
to maximize corporate profitability

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 Corporate-Level Strategy(3)

Horizontal Vertical Strategic

Integration Integration Outsourcing

Horizontal integration, vertical integration, and strategic outsourcing are three

corporate level strategies that are primarily directed toward improving a company’s
competitive advantage and profitability in its current business or industry.

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Horizontal Integration : Single-Industry Corporate Strategy (1)

For many companies, profitable growth and expansion often entail finding
ways to successfully compete within a single market or industry over time.

It allows a company to focus all of its managerial, financial, technological, and functional resources
and capabilities on competing successfully in one area.

It allows a company to stay focused on what it knows and does best.

A company does not make the mistake of entering new industries in which its existing resources and
capabilities create little value and/or where a whole new set of competitive industry forces—present
unanticipated threats.
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Horizontal Integration : Single-Industry Corporate Strategy (2)

Expand into the movie business and acquired

Columbia Pictures; it also acquired a large
California winemaker

It soon found it lacked the competencies to

successfully compete in these new industries

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Horizontal Integration : Single-Industry Corporate Strategy (3)

Even when a company stays in one industry, sustaining a successful business

model over time can be difficult because of changing conditions in the
environment, such as advances in technology that allow new competitors into
the market, or because of changing customer needs.

One corporate-level strategy that has been widely used to help managers
strengthen their company’s business model is horizontal integration

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 Horizontal Integration
Horizontal Integration
• The process of acquiring or merging with industry competitors to achieve
the competitive advantages that arise from a large size and scope of
operations.
• e.g. Lenovo acquired PC department of IBM

Acquisition - Company uses Merger – is an agreement between

its capital resources to equals to pool their operations and
purchase another company create a new entity.

A Firm A Firm
A or B C Firm
Firm
B Firm B Firm

Warner Media vs Discovery=Warner Bros. Discovery9

 Benefits of Horizontal Integration (1)

Lowers the cost structure

• It creates increasing economies of scale. e.g. AT&T
• It reduces the duplication of resources between two companies.

Increases product differentiation

• By increasing the flow of innovative new products that a company’s sales force can sell to
customers at premium prices
• e.g. Eli Lilly paid $6.5 billion to ImClone Systems to acquire its new cancer preventing drugs in
order to increase its product categories and outbid rival Bristol-Myers Squibb

Leverages a competitive advantage more broadly

• Firms that have resources or capabilities that could be valuably deployed across multiple market
segments or geographies
• e.g.Thaitown (瓦城) vs the Diner (樂子). https://www.thaitown.com.tw/
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 Benefits of Horizontal Integration (2)

Reduces rivalry within the industry

• Acquiring or merging with a competitor helps to eliminate excess capacity in an industry, which
triggers price wars

Increases bargaining power over suppliers or buyers

• A company becomes a much larger buyer of suppliers’ products and uses this as leverage to
bargain down the price it pays for its inputs, thereby lowering its cost structure.
• When a company has greater ability to raise prices to buyers or bargain down the price paid for
inputs, it has obtained increased market power

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 Problems with Horizontal Integration

Problems associated with merging very different company cultures

• e.g BENQ vs SIEMENS

High management turnover in the acquired company when the acquisition is a

hostile one

The company comes into conflict with the Federal Trade Commission (FTC), the
government agency responsible for enforcing antitrust laws.

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 Vertical Integration

Entering new industries to strengthen the “core” business model

Backward vertical integration - backward into an industry that produces inputs

for the company’s products.
IBM integrated backward into the chip and memory disk industry to produce the components
that work inside its mainframes and servers

Forward vertical integration - forward into an industry that uses, distributes, or

sells the company’s products.
Apple entered the retail industry in 2001 when it decided to establish a chain of Apple stores to
sell its PCs and iPods

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Increasing Profitability through Vertical Integration
Vertical integration increases product differentiation, lowers costs, and reduces
industry competition when it:

Facilitates investments in efficiency-enhancing specialized assets

Protects product quality

Results in improved scheduling

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 Facilitating Investments in Specialized Assets
A specialized asset is one that is designed to perform a specific task and whose value is
significantly reduced in its next-best use.

Companies invest in specialized assets because these assets allow them to lower their
cost structure or to better differentiate their products to facilitate premium pricing.

Apple
• iOS

Toyota
• invest in specialized equipment to lower manufacturing costs

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 Enhancing Product Quality
By entering industries at other stages of the value-added chain, a company can
often enhance the quality of the products in its core business and strengthen its
differentiation advantage.

Ownership of retail outlets may be necessary if the required standards of after-sales service
for complex products are to be maintained.
• Apple stores

Firms found that local suppliers lacked the capability to produce ingredients of the quality
it demanded

• McDonald in Russia: It was then forced to vertically integrate through the local food
industry on a heroic scale and construct the world’s largest food-processing plant

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 Improved Scheduling

Vertical integration makes a firm quicker, easier, and more cost-effective to plan,
coordinate, and schedule the transfer of a product

• Ford integrated backward into steel foundries, iron ore shipping, and iron ore
production.

• Deliveries at Ford were coordinated to such an extent that iron ore unloaded at
Ford’s steel foundries on the Great Lakes was turned into engine blocks within
24 hours, which lowered Ford’s cost structure.

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Problems with Vertical Integration

Increasing cost structure

Disadvantages that arise when technology is changing fast

Disadvantages that arise when demand is unpredictable

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 Increasing Cost Structure
Firm can raise costs if, over time, it continues to purchase inputs from company-owned
suppliers when low cost independent suppliers that can supply the same inputs exist.
Because in-house suppliers do not have to compete with independent,
outside suppliers for orders, they have much less incentive to look for
new ways to reduce operating costs or increase component quality
• In-house suppliers simply pass on cost increases to the other divisions
Why would a company-
owned supplier develop • Transfer pricing: the price that one division of a company charges
such a high cost structure? another division for its products

Bureaucratic costs refers to the costs of solving the transaction

difficulties that arise from managerial inefficiencies

• e.g. when company-owned suppliers lose their incentive to increase

efficiency or innovation, firms have to spend considerable managerial
time and effort to reduce managerial inefficiencies 19
 Technological Change
When technology is changing fast, vertical integration may lock a company into an
old, inefficient technology and prevent it from changing to a new one that would
strengthen its business model

Sony TVs Alliance with

CRT Samsung Supply the LCD screens
(cathode ray tubes) that are used in its
BRAVIA TVs

Because Sony was locked into the outdated CRT technology, it was slow to
recognize that the future was flatscreen LCD screens and did not exit the CRT
business.
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 Demand Unpredictability

If demand for cars suddenly plummets, the carmaker may find itself
burdened with warehouses full of component parts it no longer needs

Vertical integration can be risky when demand is unpredictable because it is

hard to manage the volume or flow of products along the value-added chain.

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Alternatives to Vertical Integration: Cooperative Relationships
Is it possible to obtain the differentiation and cost-savings advantages associated
with vertical integration without having to bear the problems and costs associated
with this strategy?

Advantages Disadvantages

If they enter into long-term cooperative relationships with companies in industries

along the value-added chain, also known as quasi integration.
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 Quasi Integration

The use of long-term relationships, or investment into some of the

activities normally performed by suppliers or buyers, in place of full
ownership of operations that are backward or forward in the supply chain

Sharing the expenses of investment in Making long-term supply or purchase

production assets or inventory guarantees

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 Strategic Alliances and Long-term Contracting
Strategic alliances: Long-term agreements between two or more companies to jointly
develop new products or processes

Both companies agree to make specialized investments and work jointly to find ways to
lower costs or increase product quality

A strategic alliance becomes a substitute for vertical integration

A strategic alliance helps firms to avoid the problems (bureaucratic costs) that arise from
managerial inefficiencies

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Strategies to Build Long-Term Cooperative Relationships

Credible Maintaining
Hostage taking
Commitments Market Discipline

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 Hostage Taking
Means of exchanging valuable resources to guarantee that each partner to an
agreement will keep its side of the bargain

➢ They are mutually dependent

Northrop is a major Boeing is a major supplier

subcontractor for Boeing’s to Northrop’s defense
commercial airline division division
➢ Each company holds a hostage—
the specialized investment the
other has made.
➢ Boeing is unlikely to renege on
any pricing agreements with
Northrop
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 Credible Commitments
A credible commitment is a believable promise or pledge to support the development
of a long-term relationship between companies.

make substantial investments in

specialized assets
➢ IBM publicly committed itself
GE is one of the major
to purchase chips from GE for a
suppliers of advanced
10-year period
semiconductor chips to
➢ puts some money into the chip
IBM
IBM made a credible commitment development process
that it would continue to purchase
chips from GE

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 Maintaining Market Discipline

All contracts are periodically renegotiated, usually every three to five years, so the
supplier knows that if it fails to live up to its commitments, its partner may refuse
to renew the contract

Many companies use a parallel sourcing policy and enter into a long-term contract
with at least two suppliers for the same component

• This arrangement protects a company against a supplier that adopts an

uncooperative attitude
• The company can switch all its business to its other supplier partner

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 Strategic Outsourcing (1)

The decision to allow one or more of a company’s value-chain activities or

functions to be performed by independent specialist companies

The activity to be outsourced may encompass an entire function, such as the

manufacturing function, customer services (call center), pension systems

When a company chooses to outsource a value-chain activity, it is choosing

to focus on fewer value creation activities to strengthen its business model

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 Strategic Outsourcing (2)
Many companies outsource activities that managers regard as being “noncore” or
“nonstrategic,” meaning they are not a source of a company’s distinctive competencies
and competitive advantage

More than 60% of all global product manufacturing is outsourced to manufacturing

specialists because of pressures to reduce costs

These products are made under contract at low-cost, global locations by contract
manufacturers that specialize in low-cost assembly
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 Benefits of Outsourcing

Lower its cost structure

Increase product differentiation

Focus on the distinctive competencies that are vital to firms

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 Lower Cost Structure
Specialists are often able to perform an activity at a lower cost than the company

They are able to realize scale economies or other efficiencies not available to the company

• For manufacturing activities, it requires a significant investment in manufacturing facilities

• By aggregating the manufacturing needs of many individual companies, companies that
specializes in manufacturing can obtain huge economies of scale in manufacturing facilities

Specialists are also likely to obtain the cost savings associated with learning effects

• Because a firm is manufacturing similar products for several different companies, it is able to
build up cumulative volume more rapidly
• It learns how to manage and operate the manufacturing process more efficiently than any of its
clients could
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 Increase Product Differentiation (1)

For this to occur, the quality of the activity performed by specialists must be
greater than if that same activity was performed by the company

Reliability Excellence

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 Increase Product Differentiation (2)

Reliability
• A specialist may be able to achieve a lower error rate in performing an activity,
because it focuses solely on that activity and has developed a strong distinctive
competency in it

• Flextronics (偉創力) have adopted Six Sigma methodologies and driven down
the defect rate associated with manufacturing a product
Excellence
• Carmakers often outsource specific kinds of vehicle component design
activities, such as microchips or headlights, to specialists that have earned a
reputation for design excellence in this particular activity
• JUSTTOP (佳欣光電)
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 Focus on the Core Business

It allows managers to focus their energies and their company’s resources on

performing those core activities that have the most potential to create value and
competitive advantage

Companies can enhance their core competencies and create more value for their
customers

• Apple & Nike focused on building its competencies in product design and
marketing and sales

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 Risks of Outsourcing

Holdup

Increased Competition

Loss of Information and Forfeited Learning Opportunities

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 Holdup

Holdup refers to the risk that a company will become too dependent upon a
specialist provider of an outsourced activity

The specialist will use this fact to raise prices beyond some previously agreed-
upon rate

The risk of holdup can be reduced by outsourcing to several suppliers and

pursuing a parallel sourcing policy
• Apple: Mobile phone assembly-Foxconn & Luxshare

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 Increased Competition

The contract manufacturer can progress down its own learning curve

The contract manufacturer’s capability improve, putting it at a greater manufacturing advantage

over the firm

Contract manufacturer increase the scope of their activities over time, adding a wider range of
services

Eventually, they produce their own and products in competition with their customers

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 Loss of Information and Forfeited Learning Opportunities

A company that is not careful can lose important competitive information when it outsources an
activity

Many computer hardware and software companies have outsourced their customer technical support
function to specialists
• A critical point of contact with the customer, and a source of important feedback, is lost

Customer complaints can be useful pieces of information and valuable inputs into future product
design
• Losing opportunities for improving its capabilities in product design

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 The End~~

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