Alliance School of Business

Business Strategy
ASSIGNMENTS
Prof: Mr. Subbaraman Kumaran
Question 1

It is possible for a company to be the lowest cost producer in its industry and simultaneously
have an output that is the most valued by customers. Discuss this statement.

Answer:
Introduction:

The general assumption states that the input costs dictate the output. That is to say, the greater
the input cost - which can be cost for quality, cost for quantity – the final product may be that
much the better in these aspects. That is also a logical assumption.

However, there are cases which have proved otherwise. The Walmart story is a classic example
of this. In this piece we discuss how Walmart succeeded in becoming the lowest cost producer
who also gave a high-quality product and also succeeded in exceeding customer expectation
over time.
The McDonald story is also worth visiting in this context.

The Walmart Story:

When Sam Walton started the Wal-Mart Stores, Inc in 1962, there were already established
players in the market. While he was clear of his business model – which centred on providing
goods at discounted prices – the strategy was difficult to implement, because for a small player
with limited margins the challenges were huge. Hence the strategy he adopted to capture the
market was:
➔Earlier on, the target was smaller towns which can only support one discounter. Here,
marketing costs are saved, so that aids in the cost factor
➔well managed inventory
➔Once he established himself in the smaller towns, and once his order book was relatively rich,
he could start negotiating with the suppliers for better rates
➔Supply chain: Walmart used Go-downs in centralised locations which used to cater to the
stores within a certain periphery. Thereby, the holding costs of individual stores were very
limited, which translated again into cost benefits. The stock could be supplied within 24 hours
from the central go down.

Above stated are some ways in which Walmart managed to control its costs. Without fail,
Walmart was successful in passing on these to the customers. Hence, the Customers always
valued a shopping experience at Walmart, which, without fail used to be a most valued
experience.

The McDonald story:

The McDonald story was based on the simple formula: give consumers value for money, good
quick service, and consistent quality in a clean environment. McDonald has by and large been

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successful in doing this across the globe, with their standardised processes and looks and
service levels.

While Walmart played with the supply chain to deliver value for money, McDonald introduced
standardised processes in its entire store, which made for efficient usage of resources and
quality. The productivity of the employees increased much by standardised processes, which
helped in cost control, and thereby delivering the value theme.

Like the Walmart story, McDonald with its reach and buying power, was able to negotiate with
its suppliers better and achieve a better rate for its inputs, which also led to cost savings which
was duly passed on to the consumer by providing a value for money meal.

The consistent story one experienced in a McDonald store, encouraged brand loyalty. When
repeat customers enabled growth, this again increased the bargaining power and purchasing
power of McDonald, which always find a way back into the wallets of the customers.

Conclusion:

Above are just two stories which belie the myth that good quality necessitates higher prices.
The above stories just go on to prove that the lowest cost producers in an industry by rights
would be able to provide a much better customer experience.

Question 2

Why was it profitable for GM and Ford to integrate backward into component-parts
manufacturing in the past, and why are both companies now buying more of their parts from
outside suppliers?

Answer

Introduction:

Vertical integration or disintegration have had their own pros and cons. Certain Business Cycles
have necessitated companies to go for vertical integration. The cases discussed in question that
of two of the leading Car manufacturers in the US, shows the situation that necessitated the
companies from going for vertical integration.

Before we dwell into the cases, it would be of use to understand what is meant by Vertical
integration and Horizontal integration, and what Backward integration or Froward integration
are.

When two firms whose Products and Production lines are the same, combine, this is called
Horizontal integration. Companies do this merger to eliminate competition, to increase the
market share and to increase the size of the business.

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Vertical integration, on the other hand, involves merging companies that are either side of the
supply chain. When the company acquires or merges with a company that is a supplier to the
company, it is backward integration, and when the company merges or acquires a company
that is, perhaps, a distributor, it is forward integration.

In the case of Ford and GM, the companies in the beginning resorted to backward integration.
We shall discuss the same in greater detail ahead.

Background:

The early part of the 20th century was pretty bad for the overall global economy and
particularly for the automobile industry. The economic downturns were quite frequent and
deep. The First World War had a devastating effect on the supply lines. This had a direct impact
on the production lines of companies like Ford and GM, who found their supply lines disrupted.
The supply lines were too small to supply the burgeoning needs of the automobile industry,
particularly the big two.

Ford initially tried to stockpile the inventories and the necessary parts. However, the inventory
costs, it was soon realised turned a huge drain on their resources. This was the background
when Ford and GM decided on backward integration.

The Backward Integration Story

Given the background stated above, Ford and GM decided on one thing – owning the whole
supply chain.

By the 1920s, Ford owned coal and iron ore mines, timberlands, rubber plantations, even a
railroad, sawmills, freights, blast furnaces, and much more. Then, they had the big factory at
Michigan, which built the parts and assembled the cars. This strategy of vertical / backward
integration served to help maintain schedules and take care of the production lines at Ford and
GM.

2.1.4. Issues of Backward / Vertical integration and moving back to different supplier groups
While the strategy of backward / vertical integration served the purposes of the Automobile
majors, in due course of time the top-heaviness, complacency and stifling of competition
eventually pushed them out of fashion.

Most of the majors also seem to have overestimated the ability of their supply chains to cope
with the demands of the core business. Further, there grew another school of thought that said
companies should focus on their core competencies. Meaning, a car maker should perhaps not
work on creating the tyres of the car, which job should be left to the professional tyre makers,
who have specialised in the same. This could lead to cost savings while helping the car maker
concentrate on reaping economies focussing on the rest of the vehicle.

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Hence, after the industry tried vertical integration because of particular political and economic
factors, the companies made a switch back to going for different suppliers for components. The
cost factor made the move to this strategy more immediate.

2.1.5. Latest Movements

Companies having tried both strategies have now been seen going back to vertical integration
mode. The cost factor which drew the companies to multiply supplier mode, have had a
destabilising effect. Many of the low-cost producers, especially from China, have wound up,
causing a rethink of this strategy. General Motors is seeking to buy back operations run by
Delphi. Many Chinese steel makers, owing to rising commodity prices, have resorted to buying
mines in Australia.

So now the world is once again witnessing a move back to Vertical / Backward integration.

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