Globalization and Corporate Strategy – Exam

Duration: 3 hours.

This is an open-book exam: students can use the handbook of strategy and the slides
of the course.

Students are not allowed to use any electronic device.

Read the following article and answer the four following questions. Each question is
marked on 5 points for a total of 20 points. The subject has 2 pages.

With Alcoa's Split, A Faux Strategy Bites The Dust

Ken Favaro Contributor

Another one bites the dust. Alcoa Inc.’s chief executive Klaus Kleinfield recently announced that
it will split into an “upstream” business that mines bauxite, smelts alumina and produces
aluminum, and a “downstream” business that manufacturers various aluminum parts for planes,
cars and other industries. Until recently, Kleinfield had cited Alcoa’s “vertical integration”
strategy – that is, putting upstream and downstream businesses under one corporate roof – as
having many benefits such as stronger innovation, customer relationships, purchasing power and
recruitment. Now we are told that there’s value to be “unlocked” by not pursuing this strategy.
Instead, Kleinfield himself will be running the downstream business as a separate corporate entity
and someone else (not announced as of this writing) will lead the upstream business.

Alcoa’s restructuring raises two big questions for long-term investors:

 Why did its vertical integration strategy fail (because it won’t be the last such
strategy they will see)?
 Does the split offer an investment opportunity (because such corporate moves are
common by sprawling companies in a slump)?

Taking the first question, Alcoa’s vertical integration strategy failed because it did not meet two
critical conditions. One is a market failure hurting a company’s business that vertical integration
can ameliorate. The most common are supply risk, demand risk, and profit-gouging. Consider the
following examples:

 Starbucks Corporation buys and roasts its own coffee because it does not trust
industry suppliers to provide the quality its coffee drinks business requires.
 Ferrero SpA, the maker of Nutella, recently bought a hazelnut processor, breaking
its long-standing refusal of M&A, because it feared a disruption in supply of the
essential ingredient in its most important product.
  Alphabet Inc. (formerly Google Inc.) has set up its own mobile network to
demonstrate that better Internet service is possible so customers will demand more
from established operators, which will in turn drive more Internet traffic and thus
greater demand for its search business.
 Apple Inc. built its own stores to display, sell and support its products on the
ground in a manner that is consistent with its brand values because it doesn’t trust
other retailers to do that.
 Netflix Inc. is backward-integrating into programming because it says that the cost
per hours viewed is reduced significantly by producing a series such as House of
Cards instead of licensing all its content.

All five companies are pursuing vertical integration to mitigate some form of perceived market
failure, from supply (Starbucks and Ferrero) to demand (Google and Apple) to profit-gouging
(Netflix). However, for these strategies to work, a second condition must be met: having enough
power and capabilities to fix and even exploit market failures.

Returning to the examples above, Starbucks and Ferrero are among the biggest buyers of coffee
and hazelnuts, respectively, in the world; thus, they have the firepower to be their own suppliers
at scale. Because their main businesses are so dominant, Google and Apple can afford to forward-
integrate into different businesses that are not all that profitable and force market change to its
benefit. Netflix now has sufficient scale with enough access to new capital to make an end-run
around content providers by producing its own programming. These companies are betting on
vertical integration in order to protect their main profit engines from the risk of market failure,
and they have the power to do so. As long as those engines retain their horsepower, vertical
integration will continue to be a good play for them.

Questions to be answered

1. Based on the class and the document, what are the different criteria to be taken
into account in considering vertical integration? How can vertical integration
improve the value chain? Illustrate your arguments with some examples.
2. Think about Apple’s case of supply risk. How can you connect it with the modes
of international entry? For the five companies above – Alphabet, Apple, Ferrero,
Netflix and Starbucks, describe what should be their entry mode internationally
(based on their core business).
3. Run the PESTLE and the five forces for one of the companies of your choice.
4. Consider one company of your choice (you must pick another company than in
question 3). Run the capabilities analysis.