Strategic Management Concepts and Cases

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Strategic Management Concepts and Cases Rothaermel Rothaermel 1st Edition Solutions Manual

Chapter 08 - Corporate Strategy: Vertical Integration and Diversification

CHAPTER 8 Corporate Strategy: Vertical

Integration and Diversification

Overview of the Chapter

Firms must decide in which industries and global markets to compete, and understand that these
choices are likely to change over time. Answers to these important questions are captured in a firm’s
corporate-level strategy. In this chapter, the first of three on corporate strategy, we define corporate-
level strategy and then look at two fundamental corporate-level strategy topics: vertical integration and
diversification. We will also cover make-or-buy decisions and identify when diversification can aid the
firm in gaining a competitive advantage.

Learning Objectives
LO 8-1 Define corporate-level strategy, and describe the three dimensions along which it is assessed.
LO 8-2 Describe and evaluate different options firms have to organize economic activity.
LO 8-3 Describe two types of vertical integration along the industry value chain: backward and forward vertical
integration.
LO 8-4 Identify and evaluate benefits and risks of vertical integration.
LO 8-5 Describe and examine alternatives to vertical integration.
LO 8-6 Describe and evaluate different types of corporate diversification.
LO 8-7 Apply the core competence–market matrix to derive different diversification strategies.
LO 8-8 Explain when a diversification strategy creates a competitive advantage, and when it does not.

Chapter Outline
1. CHAPTERCASE 8 Refocusing GE: A Future of Clean-Tech and Health Care?
2. What Is Corporate Strategy? (LO 8-1)
3. Transaction Cost Economics and Scope of the Firm (LO 8-2)
a. Firms vs. Markets: Make or Buy?
b. Alternatives along the Make-or-Buy Continuum
c. Strategy Highlight 8.1 Toyota Locks Up Lithium for Car Batteries
4. Vertical Integration along the Industry Value Chain
a. Types of Vertical Integration (LO 8-3)
b. Benefits and Risks of Vertical Integration (LO 8-4)
c. Strategy Highlight 8.2 Back to the Future: Forward Integration
d. Alternatives to Vertical Integration (LO 8-5)

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Chapter 08 - Corporate Strategy: Vertical Integration and Diversification

5. Corporate Diversification: Expanding Beyond a Single Market

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Chapter 08 - Corporate Strategy: Vertical Integration and Diversification

a. Types of Corporate Diversification (LO 8-6)

b. Strategy Highlight 4.3 ExxonMobil Diversifies into Natural Gas
6. Leveraging Core Competencies for Corporate Diversification (LO 8-7)
7. Gaining & Sustaining Competitive Advantage Corporate Diversification (LO 8-8)
a. Restructuring
b. Internal capital markets
8. Corporate Strategy: Combining Vertical Integration and Diversification
9. CHAPTERCASE 8 / Consider This…
10. Discussion Questions

Lecture Suggested Outline

I. Overview

We begin our study of corporate strategy with an opening case about the major changes in
company direction going on at General Electric.

II. ChapterCase 8 – Refocusing GE: A Future of Clean-Tech and Health Care?

This brief case is designed to be a clear example of how senior leadership, combined with
outside circumstances, can create major changes in where large (and also small) firms decide
to compete.

Show PowerPoint Slides 8.4 thru 8.6

Key Points of Case
 Teaching Tips
Most students will be familiar with General Electric from their long history and the many consumer products
they have produced over the years. The students, however, are less likely to know about GE’s large
investments in clean-technology and health care. If you would like to cover this transition and the entire
tenure-to-date for Jeff Immelt, there is a full case on GE at the back of the textbook.

Slides 8.5 and 8.6 are additional material brought in from the GE case at the end of the book. Slide 8.5 shows
a significant shift in the product mix, while Slide 8.6 shows there have also been extensive changes in the
geographic components of GE’s sales.

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III. What Is Corporate Strategy?

Consideration is given here to the three dimensions of corporate strategy. The dimensions
are NOT independent of each other and, as noted in the “Consider This…” extension to the
chapter opener, they can either reinforce each other or conflict with one another.

Show PowerPoint Slide 8.7 thru 8.10

Corporate Strategy

 Teaching Tips
We find it valuable here in Chapter 8 to note that we are finally at the part of strategy that many students
thought was all they knew of strategy before they started this course. The “corner office” approach to strategy
in many organizations tends to focus on strategic plans and corporate strategies emanating from the CEO’s
office.

Students are sometimes surprised at the relative simplicity of the dimensions in Exhibit 8.1 and yet the
interaction of these dimensions yields a rich variety and depth of possible corporate actions (which we will be
exploring in Chapters 8, 9, and 10).

Show PowerPoint Slides 8.12 thru 8.17

Make or Buy?
A. Transaction Cost Economics
This is a powerful yet relatively simple framework that explains much about the
underlying causes of why firm boundaries are established within markets.

 Teaching Tips
Some students are not comfortable with the term “transaction cost economics,” but the idea it portrays is
actually not too difficult to understand. In many ways, we face make-or-buy decisions all the time and choose
based on our often unexpressed understanding of the trade-offs. “I will stop to buy fast food on the way
home from school because I want to spend my time at home making study cards for my upcoming exam.”
This simplistic example says in essence, I’m going to buy my food raw materials so that my time is spent
creating cognitive learning for a more successful outcome on my exam tomorrow.
Slide 8.15 may be important to spend a few minutes on. The underlying principal–agent problem is touched
on several times in the textbook (including the stakeholder discussion brought up in Chapter 1 and again in
Chapter 12). While terms such as information asymmetries sound difficult, the foundational concepts are
pretty simple and are certainly important for students to understand.
To help students grasp these ideas more thoroughly, a McGraw-Hill Connect online interactive exercise is
available that covers the concepts behind Exhibits 8.2 and 8.3 in greater detail. You may wish to assign this as

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an auto-graded homework for the students. It covers Learning Objective 8.2. It is a video-based exercise on
the need for alignment between firms, governments, and markets to address urban transportation problems.
This context is used for several application-oriented questions related to this text material.

Show PowerPoint Slide 8.18

Toyota Locks Up Lithium

B. Strategy Highlight 8.1

This highlight touches on an area of growing concern in the 21st century. The production
of many of our electronics requires access to “rare earth metals,” and there are
currently relatively few active mines for these materials. Lithium mining is also not
widely commercialized, thus spurring firms like Toyota to vertically integrate to assure
critical supplies.

 Teaching Tips
Slide 8.18 contains an embedded video link to a six-minute video on China’s vital role in the supply of global
rare earth metals. In the fall of 2010, China restricted export of the materials. The video was produced by The
New York Times in November 2010. The link is also pasted here:
http://video.nytimes.com/video/2010/11/11/world/asia/1248069298846/china-halts-shipments-of-rare-
earths.html?scp=1&sq=rare%20earth&st=cse

IV. Vertical Integration along the Industry Value Chain

Here we look at vertical integration and tie it back to earlier discussions from Chapter 4 on
firm-level internal value chain analysis.

Show PowerPoint Slides 8.20 thru 8.23

Vertical Integration

 Teaching Tips
Slide 8.23 may be useful to spend a few minutes on. We find students often are intrigued with the stages their
valued smartphones and other electronics go through before arriving at the store for them to purchase.
A McGraw-Hill Connect online interactive exercise is available that covers the concepts behind Exhibits 8.4
and 8.5 in greater detail. You may wish to assign this as an auto-graded homework for the students. It covers
Learning Objectives 8.3 and 8.4. HTC is but one example of how several Asian firms are starting at one point
in the value chain and integrating BOTH forward and backward to command ever more profitable portions
of the chain.

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V. Benefits and Risks of Vertical Integration

A. In some industries, vertical integration can be critical to long-term success, but it must be
approached carefully so as not to create large inflexible organizations.
B. The DVD available with the textbook contains an eight-minute audio clip on PepsiCo that is
very relevant to Strategy Highlight 8.2.

Show PowerPoint Slides 8.25 thru 8.30

Benefits and Risks of Vertical Integration

VI. Corporate Diversification: Expanding Beyond a Single Market

A. Here we cover types of corporate diversification.

Show PowerPoint Slides 8.31 thru 8.35

Types of Corporate Diversification
 Teaching Tips
We have included a shortened version of Small Group Exercise 1 on Slide 8.34. The actual exercise
references a video link, which we provide next for your convenience:
www.youtube.com/watch?v=JJRy82i8e5Q

Also, an embedded video is at the bottom of Slide 8.35. It is a news report on the ExxonMobil acquisition of
XTO. It lasts 90 seconds and was produced by The New York Times.
http://video.nytimes.com/video/2009/12/14/business/energy-environment/1247466126026/exxon-mobil-
will-buy-xto-energy.html?scp=1&sq=exxon%20xto&st=cse

VII. Leveraging Core Competencies for Corporate Diversification

A. This section covers the use of the core competence–market matrix and provides examples
for each of the four quadrants produced in Exhibit 8.8.

Show PowerPoint Slides 8.37 and 8.38

Leveraging Core Competencies for Corporate Diversification

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VIII. Gaining & Sustaining Competitive Advantage Corporate Diversification

A. Here we present empirical findings from prior research showing that some types of
diversification produce better performance than others (on the average… but what CEO thinks
they will get “average” results?!).
B. In this section, we also introduce the widely discussed corporate portfolio planning tool, the
BCG growth-share matrix.

Show PowerPoint Slides 8.39 thru 8.45

Competitive Advantage and Corporate Diversification

 Teaching Tips
A McGraw-Hill Connect online interactive exercise is available that covers the concepts behind Exhibits 8.9
in more depth. You may wish to assign this as an auto-graded homework for the students. It covers Learning
Objectives 8.8.

IX. Corporate Strategy: Combining Vertical Integration and Diversification

A. We bring together the concepts of this chapter’s internal analysis with those of Chapter 3
regarding the outside of the firm in the SWOT analysis.

Show PowerPoint Slides 8.46 and 8.47

Oracle Example of Integration and Diversification

X. CHAPTERCASE 4 / Consider This…

We revisit the opening case with extended information focusing on the corporate redirection of
GE under the leadership of Jeffery Immelt. Suggested thoughts/answers to the case
questions are provided in the following.

Show PowerPoint Slide 8.48

GE Consider This…

XI. Take-Away Concepts

Here we list the take-aways for a student review of key points from the chapter.

XII. Key Terms

Here we show the key items from the chapter for a review and a test of understanding.

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END OF CHAPTER ANSWER GUIDE

 Teaching Tips
A variety of case, discussion, ethics, and explicit small group questions are provided at the end of every
chapter. Instructors may find it useful to assign some for homework and some for general class discussion.
Many concepts in strategy do not yield hard and fast answers, and if the students have a chance to interact
some early on in the class, it helps stimulate better discussions on issues of nuance or context, which are
internalized best through discussion or intensive written assignments.

CHAPTERCASE 8 / Consider This…

Thinking about this chapter’s opening case, answer the following questions.
Jeffery Immelt has been aggressively moving the conglomerate General Electric into global energy
technologies and heath care. The following questions cover the ChapterCase 8 opener and the Consider
This section.

1. Where do ecomagination and healthymagination fit on the core competence–market

matrix for GE? (See Exhibit 8.8.)

➢ The “consider this” material on energy technologies indicates that GE is looking to build
upon some of their excellent engineering skills and expand into new energy markets,
particularly internationally. This would correspond to the lower right box of Exhibit 8.8
(existing competence and new market).

➢ The ChapterCase opener notes that GE plans to spend $6 billion dollars on health care
between 2009 and 2015. We could take this as an indication that GE needs to invest in
new core competencies. GE already has a substantial health care business and it would
seem, based on the data available in this chapter (and also in Chapter 7 on innovations
such as the handheld ultrasound scanner), that GE is extending an existing market with
new core competencies, which is the upper left quadrant of Exhibit 8.8.

2. Take either the health care or energy industry and draw the industry value chain.
What areas of potential vertical integration should GE consider?

➢ If we look at the health care picture, and place GE in the medical devices industry, we
can think through a simple industry value chain. Medical devices need raw materials and
components from a number of different suppliers. Once the devices are assembled and
tested, they are sold through several channels. Let’s assume they sell to large hospitals
directly. Then, once a major device such as an MRI is operational in the hospital, doctors
will refer patients to the lab for various MRI scans. The patients pay for the scans,
typically through a combination of personal and insurance funds.
➢ One potential area for integration is that GE could start to invest in the ownership of
either entire hospital systems or the supporting scanning laboratories used by the
hospital. This would be a forward integration, moving GE closer to the medical

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customers from its customary position of designing and manufacturing large medical
systems.

3. What related diversification would you suggest for GE in reference to its focus for the
future?

If we stick with the health care example from question 2 earlier, one could suggest that GE
look into building on some of its risk management and health systems expertise and move
into providing health care insurance. This would be a tightly related diversification. Further
afield could be taking some of the scanning technologies from GE medical devices and
applying them in the security field, say, for container inspections at seaports around the
globe.

4. How do GE’s corporate-level strategic initiatives of energy, health care, and

globalization reinforce each other? How might they generate conflicts in the
company?
➢ The future-oriented strategic initiatives can reinforce each other in several ways. At
a very basic level, success in one or two initiatives can provide investment resources
for other areas of GE to grow and develop. More directly, they can reinforce each
other, particularly in rural or underdeveloped areas. Many medical facilities around
the globe do not have a reliable source of power. Clearly, steady electricity is needed
at clinics large enough to have something like an MRI or CT SCAN system. The clean
energy business could develop a wind or solar electricity option for use in a medical
facility at the far reaches of the globe. This “off-grid” solution could integrate the
power and medical needs of hard-to-reach populations.
➢ Conflicts are possible of course as different businesses vie for resources even within
large organizations such as GE. It is also not hard to imagine situations where global
solutions vary and the European team, for example, has very different ideas about
development of future energy products than say South American GE teams.

Discussion Questions

1. When Walmart decided to incorporate grocery stores into some locations and created
“supercenters,” was this a business-level strategy of differentiation or a corporate-level
strategy of diversification? Explain your answer.

We discussed business-level strategies in Chapter 6. The argument for differentiation is

somewhat valid if you consider the industry context to be “big box retail” or some fairly
broad definition. More commonly though, this would be a corporate-level diversification
decision. The grocery industry was quite distinct from clothing retailers until a few
organizations started to bring them together. Walmart made a decision to move the
whole of the company into the related industry of perishable foods and other grocery
items. This decision is answering the “where to compete” question, which is corporate,
rather than the “how to compete” query, which would be business-level.

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2. How can related diversification create a competitive advantage for the firm?

As discussed in the Gaining & Sustaining Competitive Advantage section, previous

research has shown related diversification has the highest level of performance
improvement.

3. Franchising is widely used in the casual dining and fast-food industry, yet Starbucks is
quite successful with a large number of company-owned stores. How do you explain this
difference? Is Starbucks bucking the bandwagon effect, or is something else going on?

Students may have several thoughts on this question. We expect most have been to a
variety of fast-food restaurants and coffee shops. Howard Schultz, the leader who took
Starbucks across the U.S. and the globe, was quite concerned about the atmosphere of
the outlets and believed this was better controlled with mostly company-owned
locations.

Ethical/Social Issues
Ethical/Social Issues
1. The chapter notes that many firms choose to outsource their human resource
management systems. If a firm has a core value of respecting its employees and rewarding
top performance with training, raises, and promotions, does outsourcing HR management
show a lack of commitment by the firm?
A firm can make the argument that outsourcing to full-time HR professionals who focus only on
providing superb HR services is indeed the best way to show respect for the employees of your
firm. The text discusses strategic outsourcing and notes that many firms indeed will outsource
their HR management systems to firms such as PeopleSoft or Perot systems. This could be the
best way to show a commitment to a strong HR ethic of the firm by outsourcing to an industry
leader. Some students will argue that if the firm is truly committed they should build their own
competencies inside the firm. Indeed, it would be difficult to argue that the firm is going to be a
differentiator and build competitive advantage around an HR system that is in common usage by
a wide variety of firms.

2. Nike is a large and successful firm in the design of athletic shoes. It could easily decide
to forward-integrate to manufacture the shoes it designs. Therefore, the firm has a credible
threat over its current manufacturers. If Nike has no intention of actually entering the
manufacturing arena, is its supply chain management team being ethical with the current
manufacturers if the team mentions this credible threat numerous times in annual pricing
negotiations? Why or why not?

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Students will have a variety of viewpoints on this matter. There are many negotiation tactics that
can be considered borderline at best in the ethics arena. In this situation, many business
managers would point out that saying you COULD enter the manufacturing business is quite
different than saying you ARE adding manufacturing processes to your own firm. Also, remember
the idea of taper integration is that even after you start a new process internally, you still can
maintain external firms as well.

Small Group Exercise 1

Agriculture is one of the largest and oldest industries in the world. In the U.S. and
many other countries, farmers often struggle to turn a profit given the variances of
weather and commodity prices. Some working farms are turning to tourism as an
additional and complementary revenue source. A study from the U.S. Census of
Agriculture in 2007 found nearly 25,000 farms providing some level of agritourism
and recreation services. (There were 2.2 million farms in the 2007 census, almost
triple the number from 2002.) In 2010, the Department of Agriculture announced a
new grant program aimed at providing public access to private farms for such
purposes. Small farms worldwide are participating in this trend by offering “pick
your own” crops in season as well as small bed-and-breakfast experiences.
Perhaps one of the most successful large companies leading this marriage of
industries is a dairy farm in Indiana: Fair Oaks Farms is home to 30,000 cows and
produces enough milk to feed 8 million people. It also hosts nearly 500,000 tourists
each year, who come to see the hands-on adventure center and the working milking
operations. (A video of the operation is available at
http://www.youtube.com/watch?v=JJRy82i8e5Q .)
This ingenious business diversification offers many benefits to the agricultural
industry.

1. What other industrial or commercial industries could benefit from such potential tourist
or recreational revenues?

As the number of assembly and manufacturing locations decreases within industrialized nations,
those remaining have increasing possibilities to add tours and souvenir shops and other
consumer-focused educational activities. Traditionally, automotive and aircraft plants have
opened at least several times a year for such tours. In the 21st century, there are opportunities to
allow tours of computer “server farms” to give Internet users a sense for what it takes to keep
the Internet running so reliably and speedily.

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2. In your group, list other industry combinations that you have seen to be successful.
Students will likely have many examples from their own experience or knowledge. Here are two
examples to get the conversation going… In Louisville Kentucky, a Louisville Slugger baseball bat
factory opened right along a major tourist road downtown. They give tours, have games for the
kids, and sell bats and other baseball-related items. In Vacaville, California, a Jelly Belly jelly bean
factory routinely has an hour wait for the factory tour (and free jelly bean samples at the end).
They run the guided tour with photos at the workstations when the factory processes are closed
or otherwise not running.

Small Group Exercise 2

Target and Walmart are significant rivals in the retailing industry. Though Walmart is the
world’s largest company (2010 sales of over $400 billion), Target had been growing faster
than Walmart until the 2008 recession. From 2003 to 2007, same-store sales at Target grew
an average of 4.6 percent, while Walmart’s comparable growth was 2.9 percent.
However, in 2008 Target’s same-store sales fell 2.6 percent, while Walmart’s rose 3.3
percent. What drove this difference? Product mix seems to be a large factor. Target
devotes less than 20 percent of its space to consumables such as health and beauty products
and food. Walmart, by contrast, has 45 percent of its shelf space for consumables, with
groceries being a major component. Though an obvious answer for Target is to continue
following Walmart into groceries, consider that the average net profit of the grocery
industry was less than 1.4 percent from 2002 to 2008. As a team, assume you’ve been called
in to consult with Target on the problem.

1. What should Target do to get back on a growth track?

Target may well want to continue following Walmart into groceries, but they need to recognize that
the logistical challenges for highly perishable products are more complex than for their typical
houseware and clothes products. The advantages of carrying food items that require consumers to
shop more frequently is a big positive. However, Target may want to consider diversifying in a
direction different than Walmart to set itself apart. Perhaps an eat-in salad bar or other healthy
restaurant options inside their stores could be something to explore.

2. Is Target’s problem strategy or execution?

This is a difficult question. Many times we can’t tell if poor performance is actually related to a good
strategy poorly implemented or just a poor strategy. The end result of both situations is poor
performance. There are some indications though that Target’s issues are related to poor execution or
the timing of store upgrades during the recession of 2008.

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Chapter 08 - Corporate Strategy: Vertical Integration and Diversification

3. What action plan would you recommend?

Students will have a variety of answers here. In keeping with the subject of this chapter, our goal is
to bring out options for vertical integration or diversification for the firm. We have found the healthy
salad bar idea mentioned earlier useful in preparing the room for a discussion of ideas.

Strategy Term Project

Project Overview

The goal of the strategy term project is to give the student practical experience with the
elements of strategic management. We will briefly discuss project module questions. We will
also offer some guidance for the modules at the end of each chapter
Module 8: Vertical Integration
In this section, you will study the boundaries of the firm you have selected for your strategy
project in reference to the vertical value chain activities of its industry.
In this section, you will study the boundaries of the firm you have selected for your strategy
project in reference to the vertical value chain activities of its industry.
The following are some general thoughts on the type of information students would have in
response to the questions for this module of the project.

1. Draw out the vertical value chain for your firm’s industry. List the major firms in each
important activity along the chain (see Exhibits 8.3 and 8.4 as examples in this task).
Note that a firm’s name may appear multiple times in the value chain. This indicates
some level of vertical integration by the firm. If your firm is in many different industries
(as is GE), then choose the dominant industry or the one that intrigues you the most and
use only that one for this analysis.
We have found the noted exhibits and text discussion useful for our students to perform this
exercise for their selected firms. It is a bit harder to do with service companies, so make sure
the students think through all of the major “raw materials” carefully. For example, a
consulting company will have educated employees as a major raw material supply into the
firm.

2. Is your firm highly vertically integrated? If yes, does it also employ taper integration?
Remember, taper integration is when a firm for example will produce a raw material for the its
focal product AND also purchase from an outside firm some of the same material. It can be a
very useful idea if the input is key to the success of the product, yet the internal organization
should be motivated to remain competitive with the market.

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3. Are any of the vertical value chain operations off-shored? If so, list some of the pros and
cons of having this part of the value chain outside the home country.
Remember off-shoring is taking part of the industry value chain to another country from the one
producing the focal items.

4. Use the vertical value chain cited earlier to identify the corporate strategy of the firm.
In other words, where within the industry has the firm chosen to compete? Based on
where it competes, describe what you now see as its corporate strategy.

Here we suggest working with the students to think through the firm’s boundaries, meaning the
make-or-buy question from this chapter. What has the firm selected to keep internal to the firm?
What does this say about what it views as important?

5. In Module Two, you were asked to identify the mission and major goals for your
selected company. Go back to that information now and compare the mission and goals
to what you have found as the corporate strategy. Are the mission, goal, and corporate
strategy in alignment? Do you see any holes or conflicts among these three elements?
Can you relate the performance of the firm to this finding in any way? (If all three are
consistent, is this a well-performing unit?) If there is a conflict between the corporate
strategy and the mission, does this lack of alignment contribute to performance
problems? Why or why not?

We find a surprising number of firms with fairly significant conflicts between the mission and
goals and the actual actions and business segment the firm is invested in. For example, many
firms will have a heavy emphasis on customer value creation or satisfaction, yet they will enter
the value chain several steps prior to contact with the actual end user so the firm actually has
very limited contact with its own end consumers.

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Strategic Management Concepts and Cases Rothaermel Rothaermel 1st Edition Solutions Manual

Chapter 08 - Corporate Strategy: Vertical Integration and Diversification

myStrategy 8: HOW DIVERSIFIED ARE YOU?

Using Exhibit 8.7 as a guide, list each of your major activity areas. Think of each of these as
a business. (If you are literally “all work and no play,” you are a single-business type of
personal diversification.) Instead of revenues, estimate the percentage of time you spend
per week in each activity. (Most people will be diversified, though some may be dominant
perhaps in school or work.) To assess your degree of related- and unrelatedness, consider
the subject matter and community involved with each activity. For example, if you are
studying ballet and working as an accountant, those would be largely unrelated activities
(unless you are an accountant for a ballet company!).

1. What conclusions do you derive based on your personal diversification strategy?

This is intended as a mostly fun exercise; however, we have found some students who have
benefited from spending a few minutes reflecting on what they view to be important versus how
they actually spend their time.

2. Do you need to make adjustments to your portfolio of activities? Explain the reasons for
your answer.
We are of the view that strategy can have benefits at all levels, including those of the individual.
Thinking about how a person will choose to spend their time is helpful in setting up a “portfolio”
of integration and diversification activities, leading to improved “outcomes” for the student.

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