CORPORATE STRATEGIES:

VERTICAL INTEGRATION
AND DIVERSIFICATION
12-10-2021 Prof. Francesca Di Pietro
 AMAZON.COM
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¨ From a mere online book retailer into the “everything store.”

¨ In the process, it transformed into the world’s largest online
retailer.
¨ From books it diversified into consumer electronics, media
content, cloud computing services, and other business
endeavours.
¨ Jeff Bezos decided to compete in a number of different
industries, some related to Amazon’s core business of online
retailing, some unrelated.
¨ How does a business decide exactly where to compete?
¨ In terms of products and services offered, or of geographic
markets—are captured in a firm’s corporate strategy.
 Strategy: Where and how to
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compete?
¨ Strategy formulation centers around the key
questions Where and how to compete?
¨ Business strategy concerns the question of how to
compete in a single product market.
¨ Corporate strategy answers to the key question of
where to compete
Corporate strategies
¨ Corporate strategy determines the boundaries of
the firm along three dimensions:
¨ Vertical integration (along the industry value chain)
¨ Diversification (of products and services)
¨ Geographic scope (regional, national, or global
markets).
 Managers shall ask:
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¨ 1. In what stages of the industry value chain should

the company participate (vertical integration)? The
industry value chain describes the transformation of
raw materials into finished goods and services
along distinct vertical stages.
¨ 2. What range of products and services should the
company offer (diversification)?
¨ 3. Where should the company compete
geographically in terms of regional, national, or
international markets (geographic scope)?
Growth strategies

¨ Horizontal scope is the range of product and service

segments that a firm serves within its focal market.
¤ New market segments
¤ Expansion of the geographical area

¨ Vertical scope is the extent to which a firm’s internal

activities encompass one, some, many, or all of the
activities that make up an industry’s entire value chain
system
¤ from raw-material production to final sales and service
activities
 Expanding the scope
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¨ Advantages J
¤ Improving the efficiency of its operations
¤ Increase diversification

¤ Reducing market rivalry

¤ Reduce risk

¤ Increasing the firm’s bargaining power over

suppliers and buyers
¤ Reduce costs- economies of scale

¤ Revenues
 Expanding the scope
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¨ Risks L
¤ Strategic Issues
n Cost savings may prove smaller than expected.
n Gains in competitive capabilities take longer to realize or
never materialize at all.
¤ Organizational Issues
n Cultures, operating systems and management styles fail to
mesh
n Loss of key employees at the acquired firm.
 The Boundaries of the Firm
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¨ Determining the boundaries of the firm so that it is more

likely to gain and sustain a competitive advantage is
the critical challenge in corporate strategy.
¨ A theoretical framework in strategic management
called transaction cost economics explains and
predicts the boundaries of the firm
¨ Insights gained from transaction cost economics help
managers decide what activities to do in-house
versus what services and products to obtain from the
external market.
Transaction costs
¨ Transaction costs are all internal and external costs
associated with an economic exchange, whether it
takes place within the boundaries of a firm or in
markets
¨ They include:
¤ costs of searching for an attractive target
¤ costs of evaluating its worth

¤ Bargaining/negotiation costs

¤ costs of completing the transaction.

 Any example?
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¨ I will stop to buy fast food on the way home,

because I want to spend my time at home studying
introduction to business economics.
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¨ I will stop to buy fast food on the way home,

because I want to spend my time at home studying
introduction to business economics.
¨ I will pay my brother to prepare food because I
want to spend my time to the gym
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¨ I will stop to buy fast food on the way home,

because I want to spend my time at home studying
introduction to business economics.
¨ I will pay my brother to prepare food because I
want to spend my time to the gym
¨ I will buy the bus ticket to go to school (instead of
walking) because I want to save time for studying at
the library
 Transaction costs
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When companies transact in the open market, they incur external transaction costs:
the costs of searching for a firm or an individual with whom to contract, and then negotiating,
monitoring, and enforcing the contract.

Internal transaction costs, economic exchange within a firm. The costs of recruiting and
retaining employees; providing office space and computers; and organizing, monitoring,
and supervising work. Administrative costs associated with coordinating economic activity
between different business units
 Firms vs markets
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¨ Firm Advantages:
¤ Control, coordination, retain knowledge,
¨ Firm Disadvantages
¤ Administrative Costs, innovation
¨ Market Advantages
¤ Flexibility, exploit innovation
¨ Market disadvantages
¤ Search costs
¤ Opportunism
¤ Information asymmetry
 Fitness gyms
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¨ Should they do maintenances on cardio machinery

in –house or outsource the task to a specialized
company?
¨ Advantages?
¨ Disadvantages?
 Retailer
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¨ Should a retailer run its own e-commerce or

outsource it to amazon?
¨ Advantages?
¨ Disadvantages?
 Make or buy?
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Transaction cost economics allows us to explain which activities a firm should pursue
in-house (“make”) versus which goods and services to obtain externally (“buy”).

When the costs of pursuing an activity in-house are less than the costs of transacting for that
activity in the market (Cin-house < Cmarket), then the firm should vertically integrate by
owning production of the needed inputs or the channels for the distribution of outputs
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¨ Strategic alliances are voluntary arrangements

between firms that involve the sharing of
knowledge, resources, and capabilities with the
intent of developing processes, products, or services
¨ In service industries, franchising is an example of
long-term contracting. In these arrangements, a
franchisor such as McDonald’s, Burger King
¨ In a joint venture, which is another special form of
strategic alliance, two or more partners create and
jointly own a new organization
 Vertical Integration
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Deciding whether to make or buy the various activities in the

industry value chain involves the concept of vertical integration
 Mobile phones value chain
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¨ The raw materials to make your cell phone, such as chemicals, ceramics, metals,
oil for plastic, and so on, are commodities. In each of these commodity businesses
are different companies, such as DuPont (U.S.), BASF (Germany), Kyocera (Japan),
and ExxonMobil (U.S.).
¨ Intermediate goods and components such as integrated circuits, displays,
touchscreens, cameras, and batteries are provided by firms such as ARM Holdings
(UK), Jabil Circuit (U.S.), Intel (U.S.), LG Display (Korea), Altek (Taiwan), and BYD
(China).
¨ Manufacturing firms, such as Flextronics (Singapore) or Foxconn (China) typically
assemble cell phones under contract for consumer electronics and telecommunications
companies such as BlackBerry (Canada), Ericsson (Sweden), Microsoft (U.S., with
its acquired Nokia business unit), Samsung (South Korea), and others.
If you look closely at an iPhone, for example, you’ll notice it says, “Designed
by Apple in California. Assembled in China.”
¨ Finally, to get wireless data and voice service, you pick a service provider such as
AT&T, Sprint, T-Mobile, or Verizon in the United States; América Móvil in Mexico; Oi
in Brazil; Orange in France; T-Mobile or Vodafone in Germany; NTT Docomo in
Japan; Airtel in India; or China Mobile in China, among others.
 Types of vertical integration strategies

¨ Backward integration involves

entry into activities previously
performed by suppliers or
other enterprises positioned
along earlier stages of the
industry value chain system
¨ Forward integration involves
entry into value chain system
activities closer to the end user

6–23
Backward integration
¨ Integrating Backwards By:
¤ Achieving same scale economies as outside suppliers—
low-cost based competitive advantage.
¤ Matching or beating suppliers’ production efficiency with no
drop-off in quality—differentiation-based competitive
advantage.
¨ Reasons for Integrating Backwards:
¤ Reduction of supplier power
¤ Reduction in costs of major inputs
¤ Assurance of the supply and flow of critical inputs
¤ Protection of proprietary know-how

6–24
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 Example
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Forward integration
¨ Reasons for Integrating Forward:
¤ To lower overall costs by increasing channel activity
efficiencies relative to competitors.
¤ To increase bargaining power through control of
channel activities.
¤ To gain better access to end users.

¤ To strengthen and reinforce brand awareness.

¤ To increase product differentiation.

6–27
Vertical integration: risks
¨ Increased business risk due to large capital investment.
¨ Less flexibility in accommodating shifting buyer
preferences that require non-internally produced parts.
¨ Internal production levels may not be of sufficient
volumes to allow for economies of scale.
¨ Capacity matching problems for efficient production of
internally-produced components and parts.
¨ Requirements for different resources and capabilities.

6–28
 Tapered Integration
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¨ Ascending
¤ production of a limited number of components to obtain
knowledge about a product
¨ Descending
¤ control of a limited number of points of sale
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 Disintegration
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¨ The vertical disintegration is the opposite of

integration
¤ Non-integrated firms can use the range of innovations
from the upstream or downstream firms, while
integrated firm can be forced to use components
(including non-innovative) from upstream divisions.
¤ In the long term, however, the integrated firm can
introduce an innovative product by virtue of the organic
connection or upstream (new technology) or
downstream (correct interpretation of new
requirements)
Outsourcing
¨ Outsourcing involves contracting out certain value chain
activities to outside vendors.

¨ Outsource an activity if it:

¤ Can be performed better or more cheaply by outside specialists.
¤ Is not crucial to achieving sustainable competitive advantage.
¤ Improves organizational flexibility and speeds time to market.
¤ Reduces risks due to new technology and/or buyer preferences.
¤ Assembles diverse kinds of expertise speedily and efficiently.
¤ Allows the firm to concentrate on its core business, leverage key
resources, and do even better what it does best.

6–32
The big risks of outsourcing
¨ Hollowing out resources and capabilities that the
firm needs to be a master of its own destiny.
¨ Loss of control when monitoring, controlling, and
coordinating activities of outside parties by means
of contracts and arm’s-length transactions.
¨ Lack of incentives for outside parties to make
investments specific to the needs of the outsourcing
firm’s value chain.

6–33
 Diversification
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¨ 2. What range of products and services should the

company offer (diversification)?
¨ single product market, vs several different product
markets

¨ 3. Where should the company compete

geographically in terms of regional, national, or
international markets (geographic scope)?
Diversification strategy
¨ Answers to questions about the number of markets
to compete in and where to compete
geographically relate to the broad topic of
diversification.
¨ A non-diversified company focuses on a single
market, whereas a diversified company competes in
several different markets simultaneously
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¨ If you have a dine-in restaurant in one town,

opening a second restaurant in the next town is
expansion, not diversification. Adding corporate
catering is an example of diversification.
Types of diversification
There are various general diversification strategies:
¨ A firm that is active in several different product

markets is pursuing a product diversification

strategy.
¨ A firm that is active in several different countries is

pursuing a geographic diversification strategy.

¨ A company that pursues both a product and a

geographic diversification strategy simultaneously

follows a product–market diversification strategy.
Types of diversification
¨ Related Businesses
¤ Have competitively valuable cross-business value chain and
resource matchups.
¨ Unrelated Businesses
¤ Have dissimilar value chains and resource requirements, with
no competitively important cross-business relationships at the
value chain level.
¨ Strategic fit: one or more activities constituting the value chains
of different businesses are sufficiently similar as to present
opportunities for cross-business sharing or transferring of the
resources and capabilities that enable these activities.
 Examples
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¨ An airline branching into setting up a hotel chain

(related diversification)
¨ A supermarket setting up a bank (rather unrelated diversification).
¨ Amazon.com, began business by selling only one product: books.
¨ Expanded into CDs and later gradually leveraged its online
retailing capabilities into a wide array of product offerings. As the
world’s largest online retailer, and given the need to build huge
data centers to service its peak holiday demand, Amazon decided
to leverage spare capacity into cloud computing, again benefiting
from economies of scope and scale.
¨ Amazon now also offers its Kindle line of tablet computers and
proprietary content, as well as instant video streaming via its Prime
service. Amazon follows a (related diversification)
Related businesses
¨ Opportunities:
¤ Transferring specialized expertise, technological know-
how, or other resources and capabilities from one
business’s value chain to another’s.
¤ Cost sharing between businesses by combining their
related value chain activities into a single operation.
¤ Exploiting common use of a well-known brand name.

¤ Sharing other resources (besides brands) that support

corresponding value chain activities across businesses.
 Honda
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 Auchan
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Core Business Diversification

 Conglomerate
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¨ A company that combines two or more strategic

business units under one overarching corporation and
follows an unrelated diversification strategy is
called a conglomerate
 Corporate portfolio planning
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¨ Corporate executives can restructure the portfolio

of their firm’s businesses, much like an investor can
change a portfolio of stocks. One helpful tool to
guide corporate portfolio planning is the Boston
Consulting Group (BCG) growth-share matrix
 The BCG Matrix
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¨ It describes the short and medium-term financial

equilibrium of the firm’s portfolio
¨ It is used to assess:
¤ Profiles of products/businesses
¤ The cash demands of products
¤ The development cycles of products
¤ Resource allocation and divestment decisions

¨ Businesses or products are classified as low or high

performers depending upon their market growth
rate and relative market share
 The BCG Matrix
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The two axis
¨ Market share is the percentage of the total market
served by the firm, measured either in revenue
terms or unit volume terms.
¤ The higher market share, the higher proportion of the
market is controlled.
¨ Market growth is used as a measure of a market s
attractiveness.
¤ Markets experiencing high growth are ones where the
total market share available is expanding, and there s
plenty of opportunity for everyone to make money.
The BCG Matrix J
¨ BCG matrix is simple and easy to understand.
¨ It helps you to quickly and simply screen the
opportunities open to you, and helps you think
about how you can make the most of them.
¨ It is used to identify how corporate cash resources
can best be used to maximize a company s future
growth and profitability.
The BCG Matrix L

¨ BCG matrix uses only two dimensions, market share

and market growth rate.
¨ Problems of getting data on market share and
market growth.
¨ High market share does not mean profits all the
time.
¨ Business with low market share can be profitable
too.
 Exercise!
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Work in group or individually and identify in

which area of the matrix these Google’s
products belong:
¤ Android ¤ Google search engine
¤ Google Finance ¤ Google Shopping
¤ Gmail ¤ Google Sites
¤ Google Adwords ¤ Google+
¤ Google Doc ¤ Youtube
¤ Google Drive ¤ Google hire
¤ Google Groups ¤ Self-driving car
¤ Google News
 Google BCG Matrix
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Question Marks Star

• Google Doc • Youtube
• Google Shopping • Maps
• Google Drive (cloud) • Google AdWords'
• Self-driving

Dogs Cash Cows

• Google News • Google search engine
• Google Groups • Android
• Google Site • Gmail
• Google+
 Exercise
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¨ How diversified are you? (exercise p. 210)

¨ How diversified is the company you choose for the
mid-term exam?