Corporate Strategy Lecture 9 1 Overview Horizontal integration Vertical integration The process of acquiring or merging with industry competitors Acquisition and merger Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company s products Strategic outsourcing Letting some value creation activities within a business be performed by an independent entity 2 Benefits of Horizontal Integration Reducing costs Increasing value Product bundling e g Worldcom MS Office Cross selling common in travel finance industries Managing industry rivalry Increasing bargaining power HP claims 2 5bn saving per annum in overhead Horizontal integration in health care first HMOs then hospital groups Market power monopoly power Why did HP acquire Compaq 3 Drawbacks and Limits of Horizontal Integration Majority of mergers and acquisitions do not create value only 30 create value for the acquiring company although total value is usually positive Implementing a horizontal integration strategy is not easy Mergers and acquisitions often fail to produce the anticipated gains HP Compaq Can bring the company into conflict with antitrust law e g Worldcom with Sprint acquisition 4 HP stock performance Merger May 2002 5 Vertical Integration Stages in the Raw Material to Consumer Value Chain 6 The Raw Material to Consumer Value Chain in the Personal Computer Industry 7 Full and Taper Integration 8 Increasing Profitability Through Vertical Integration Builds entry barriers to new competitors by denying them inputs and distributors Facilitates investment in specialized assets subject to holdup Protects product quality through control of input quality and distribution and service of outputs eg Alcoa Alcan bought all known bauxite sources McDonalds sometimes takes over a franchise General Foods bought banana plantations McDonalds owns farms and trucks in Russia Improves internal scheduling e g JIT inventory systems providing fast response to changes in demand 9 Arguments Against Vertical Integration Cost disadvantages Rapid technological change Tying a company to an obsolescent technology Demand unpredictability Company owned suppliers that have higher costs than external suppliers Telecom Australia DOD Difficulty of achieving close coordination among vertically integrated activities Bureaucratic costs 10 Alternatives to Vertical Integration Cooperative Relationships Short term contracts and competitive bidding Poor treatment of suppliers makes them reluctant to invest in specific assets that may create value for the buyer e g quality technology Strategic alliances and long term contracting Building long term cooperative relationships Hostage taking credible commitments Maintaining market discipline Periodic renegotiation of the contractual relationship Parallel sourcing policy 11 Strategic Outsourcing of Primary Value Creation Functions 12 Benefits of Outsourcing Reducing costs Differentiation The specialist company is less than what it would cost to perform the activity internally The quality of the activity performed by the specialist is greater than if the activity were performed by the company Focus Distractions are removed the company can focus attention and resources on activities important for value creation and competitive advantage 13 Identifying and Managing the Risks of Outsourcing Holdup Scheduling of activities The company can become too dependent on the provider of the outsourced activity so that the provider can raise prices Loss of control can result in distorted signals in the supply chain e g Cisco s 2bn blunder and eHub Loss of information Contact with the customer may be lost 14 Exercises Comparing vertical integration strategies Seagate vs Quantum Closing case AOL Time Warner 15