STRATEGY TODAY

Definitions of Strategy
Strategy: a plan, method, or series of actions designed to achieve a specific
goal or effect.
— Wordsmyth Dictionary (http://www.wordsmyth.net)

Strategy is the pattern of objectives, The determination of the

purposes, or goals and the major policies
and plans for achieving these goals, stated
in such a way as to define what business
the company is in or is to be in and the
kind of company it is or is to be.
—Kenneth Andrews, The Concept of
Corporate Strategy (Irwin, 1971)
long-run goals and objectives
of an enterprise, and the
adoption of courses of action
and the allocation of
resources necessary for
carrying out these goals.
— Alfred Chandler, Strategy
and Structure (MIT Press, 1962)

“Strategy is the creation of a unique and differentiated position

involving a different set of activities.”
— Michael Porter
 The purpose of Strategy:
Achieving superior performance
• The purpose of strategy is to achieve superior performance

• Basic to this is the need to survive and to prosper, which in turn

requires that over the long term the firm earn a rate of return on its
capital that exceeds its cost of capital

• There are two possible ways of achieving this:

1. By choosing to locate within industries where overall rates of
return are attractive (Corporate Strategy)
2. By attaining a position of advantage vis-à-vis competitors within
an industry, allowing it to earn a return that exceeds the industry
average (Business Strategy)
2
STRATEGY TODAY
Sources of Superior Profitability

Includes choices over Diversification, Vertical

Integration, Acquisitions, and new ventures,
CORPORATE and the allocation of resources between the
STRATEGY
different businesses of the firm: Who is in
charge? (Top) Corporate Managers

Includes choices over establishing a

BUSINESS Competitive Advantage over rivals: Who is
STRATEGY in charge? Division or BU Senior Managers
THE ROLE OF STRATEGY IN SUCCESS

The four factors of the Successful Strategy

Successful strategy

EFFECTIVE IMPLEMENTATION

Long-term, Profound
Objective
simple and understanding of the
appraisal of
agreed competitive
resources
objectives environment
THE BASIC FRAMEWORK FOR STRATEGY ANALYSIS
Strategy as the Link between the
Firm and its Environment
• The four elements of a successful strategy shown in are recast into
two groups
• Strategy forms a link between the two

THE FIRM THE

• Goals & INDUSTRY
Values ENVIRONMENT
STRATEGY
STRATEGY
• Resources & • Competitors
Capabilities
• Structure &
• Customers
Systems (effective • Suppliers
implementation)
FROM ENVIRONMENTAL ANALYSIS TO INDUSTRY ANALYSIS

Layers of the business External

Environment

MACRO
GENERAL
ENVIRONMENT
ENVIRONMENT

OPERATING
OPERATING
ENVIRONMENT
Social ENVIRONMENT Economic
component component
International GANIZAT Supplier
OR IO
component E component
H

N
T THEINTERNAL
ORGANIZATION
ENVIRONMENT
Planning aspects
GOALS,
Organizing aspects
VALUES,
Influencing aspects
RESOURCES
Controlling &
aspects
Labor CAPABILITIES Competition
component component
Political Technology
component component
Customer
component

Legal
component
THE ROLE OF STRATEGY IN SUCCESS

Strategic Fit

• Strategic Fit refers to the consistency of a firm's strategy:

– (1) with the firm's external environment and
– (2) with its internal environment, especially with its goals, values, resources
and capabilities

• A major reason for the decline and failure of some companies comes from their
having a strategy that lacks consistency with either the internal or the external
environments

• The decline of Nokia may be attributed to a strategy which failed to take

account of a major change in its external environment: the growing consumer
demand for smartphones
MARKET & INDUSTRY
 Industry: Supply Market: Demand

Strategic Group 1 Segment 1

Strategic Group 2
Segment 2

Strategic Group 3 Segment 3

Segment 4
Strategic Group 4

Strategic segmentation Market Segmentation

of an Industry Integrates Involves pairing Customers
Resources, Customers with Products to better
& Competitors target needs
Direct and Potential competitors

Substitutables
(industries related to
yours and substitutable
to some degree)

Industry

Strategic Group
(similar strategies in
the same industry)
 DEFINITION:
ECONOMIES OF SCALE
 Economies of scale

• Input–Output relationships:
– Is generally about spreading the costs of inputs (resources) over larger
volumes of output
– In many activities, increases in output do not require proportionate increases
in input
12
13

Economies of scale
CONTEMPORARY STRATEGY ANALYSIS

tenth edition

Robert M. Grant
John Wiley & Sons Ltd., 2019

Vertical Integration and the

Vertical Scope of the Firm

Franck NASSIRI
2020
14
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

Corporate strategy is concerned with the

scope of the firm

• The dimensions of scope are:

üVertical
üProduct
üGeographical
The Value Chain for Steel Cans
Iron ore
mining

Steel
production

Steel strip
production

Can
making

Canning of
food, drink,
oil, etc. Sources:
https://www.indiamart.com/triton-metal-alloys/metal-foil.html
https://www.thamesdownrecycling.co.uk/aluminium-and-steel-cans/
https://www.alcircle.com/news/top-five-aluminium-can-manufacturers-in-the-us-29137
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

The Scope of the Firm: Specialization versus

Integration in the Packaging Industry
tion
Vertical ra
scope l integ
tica
er
V • In the case of Vertical Scope, which
Specialized Bauxite situation offers higher efficiencies?
firms linked
by markets
Aluminum 1. Three independent companies—one
producing raw materials (e.g.,
bauxite), the next producing
Cans
semi-finished packaging materials
(e.g., aluminum foil), and the third
producing finished packaging (e.g.,
Single
cans)
integrated Bauxite
firm
Aluminum 2. Or having all three stages undertaken
Cans by a single company? Might help to
achive economies of scope?
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

The Scope of the Firm: Specialization versus

Integration in the Packaging Industry
Product n
scope ca t io
rs ifi
e
Div
Specialized Cans Cartons
firms linked
by markets Bottles • In the case of Product Scope, should
aluminum cans, plastic containers,
and paper cartons be produced by
three separate companies or are
there efficiencies from merging all
three into a single company?
Single
integrated
firm Cans Bottles Cartons
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

The Scope of the Firm: Specialization versus

Integration in the Packaging Industry
t io n
a liza
Geographical
t ion
scope rn a
In t e
Specialized
firms linked US Brazil EU
by markets • In the case of Geographical Scope,
which is more efficient?
1. Three independent companies
producing cans in the US,
Brazil, and the European
Union, or
Single 2. a single multinational company
integrated owning can-making plants in
firm all three countries?
US Brazil EU
 DEFINITION:
INDUSTRY VALUE CHAIN
 Industry Value Chain:
21

Supplier-Customer Relationship

Mining International & Fabs/ Component Assembly Distribution /

Industry Local commodity Foundries Manufacturers firms service
Traders

Source: www.mineralinfo.fr/ecomine/lunion-europeenne-compte-encadrer-commerce-minerais-conflits
Industry Value Chain
Supplier-Customer: a Vertical Relationship

Supplier’s
supplier

Supplier

Firm

Customer

Customer’s
customer

Source: https://www.strategicmanagementinsight.com/topics/vertical-integration.html 22
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

Vertical Integration and the Scope of the Firm

Compare the supply of mainframe computers with that of personal computers:

HP's laptop computers: IBM's System z mainframe

Manufactured by Flextronics, computers:
Quanta, and other companies – Assembled by IBM,
Using components produced by – Using IBM microprocessors and
firms such as Intel, Seagate,
IBM's z/OS operating system,
Nvidia, and Samsung
– Run IBM applications software
Customer support is outsourced
to companies located in India and
South-East Asia
 The Vertical Scope of the Firm
Specialized firms Single integrated firm
Vertical LG (Battery) T Battery
scope: Ford E
Electric Focus Magna (Drivetrain) S Drivetrain
cars Electric L
Ford (Final assembly) A Assembly

The drivetrain of a motor vehicle is the group of components that deliver power to
the driving wheels
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

Our role

Our role here is to identify the factors that determine which

of Vertical Integration or Outsourcing is the better
approach for a particular company in a particular situation
TRANSACTION COSTS AND THE SCOPE OF THE FIRM

The “Transaction Cost Theory”: TCT

• Question: What is determining which activities should be undertaken
within a firm and which through market contracts (outsourcing or buying)?

ü Transactions using the Markets mechanism are not costless:

those Costs include the costs of: searching for a suitable supplier,
monitoring the relationship, negotiation, drawing up contracts, and
monitoring and enforcing the terms of contracts (including the costs of
litigation in case of disputes)
ü Conversely, if an activity is internalized within a firm, then the firm
incurs Management & Administrative Costs

If the Transaction Costs of organizing an activity through the market are

higher than the Administrative Costs of organizing it within a firm, we
can expect that activity to be organized within a firm

The question is: Should we make or shoud we buy?

 The “Transaction Cost Theory” Oliver Williamson (1985)
Goal: Saving transaction cost by chosing the most efficient governance structure
How: By understanding and using TCT assumptions & attributes
Assumptions
Limited Rationality
Ø Bounded rationality leads to
incomplete contracts with
possible negative legal
consequences (H. Simon 1947)
Opportunism
Ø Vendors may act to their self-
interest through information
asymmetry (hiding or lack of
information)
Ø Opportunism can lead to
situations of « hold up »
(Demsetz 1972)
Takeaway: These assumptions
suggest that high cost might be
required to safeguard interests in
a Buyer-Supplier relationship.
Attributes
Asset specificity
Ø Bilateral Dependency in a supplier-
customer contractual relationship:
Narrow/Single purpose tool or
machine, highly specialized
resource (or skill) required or how
unique a component is to the buyer
Uncertainties
Ø Behavioral Uncertainty of
Partners, Potential for
opportunism & Uncertainty of
supply
Ø Internal : Risks related to internal
coordination of activities and
know-how
Frequency
Ø Only recurrent transactions should
be considered for vertical
integration
Governance Structures
Market
Ø When the transaction takes
place between two firms
(with no dependency)
Hierarchy
Ø Wholly owned, total
administrative control over
assets and activities by
keeping the property rights
within the firm
Hybrid
Ø Partnership: Strategic
Alliance, Equity Joint
Venture, Licensing,
Franchising
 The “Make or Buy” decision flow

Standard Asset ? YES Market

No threat from procuring
the good from the market
NO

Asset Specificity HIGH Vertical integration

Potential in supplier opportunism,
More complex contract needed
LOW

50:50 Equity Joint

HIGH Venture (Any strategic
Behavioural Uncertainties change or decision
of Partner requires all partners
Higher level of control
needed over partner approval, lower risk of
opportunistic behaviour,
LOW lower investment risks)

More flexible governance structures

(Strategic alliances, licensing, …)
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The example of the Can industry

7
The Value Chain for Steel Cans
Iron ore
mining

Steel
production

Steel strip
production

Can
making

Canning of
food, drink,
oil, etc. Sources:
https://www.indiamart.com/triton-metal-alloys/metal-foil.html
https://www.thamesdownrecycling.co.uk/aluminium-and-steel-cans/
https://www.alcircle.com/news/top-five-aluminium-can-manufacturers-in-the-us-29137
 The Value Chain for Steel
Iron ore Cans
mining
MARKET
CONTRACTS • There are technical economies from
Steel hot-rolling steel as soon as it is poured
production from the furnace:
VERTICAL
Ø Steel makers and strip producers
INTEGRATION must invest in integrated facilities
Steel strip and processes
production Ø Linking the two stages of production
MARKET at a single location reduces
CONTRACTS transportation and energy costs
Can
making
VERTICAL
INTEGRATION &
MARKET
CONTRACTS
Canning of
food, drink,
oil, etc.
What factors explain why some stages are vertically
integrated,
while others are linked by market transactions?
 The Value Chain for Steel
Iron ore Cans
mining
MARKET
CONTRACTS

Steel
production
VERTICAL
INTEGRATION
• Low transaction costs in the market
Steel strip
production for steel strip:
Ø there are many buyers and
MARKET
CONTRACTS sellers, information is readily
Can available, and the switching
making costs for buyers and suppliers
VERTICAL are low.
INTEGRATION &
MARKET
CONTRACTS
Canning of
food, drink,
oil, etc.
What factors explain why some stages are vertically
integrated,
while others are linked by market transactions?
 Not only a matter of cost!

• TCT analysis helps find the most efficient form of governance: Cost is
central

• However, other factors are considered by businesses such as

walmart producing milk to apply control over a key traffic driver or
TESLA making its own Drivetrain to strenghten its differentiation
strategy
• So other factors than cost might have to be considered in some cases

• Besides, TCT does not consider the rôle of trust in a supplier-

buyer relationship

7
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The Benefits and costs

of Vertical Integration

7
 THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The Benefits of Vertical Integration

1. Technical economies from the physical integration of processes e.g.

iron ore and steel production
2. Avoids transactions costs of market contracts in situations where
there are:
ü Transaction-specific investments

ü High levels of opportunism and/or uncertainty

ü Taxes and regulations on market transactions

3. Superior coordination and control over the value-chain:

ü Greater control over product quality

ü Greater potential for trial and innovation

7
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

1. While vertical integration avoids the transaction costs of using the

market, it imposes an administrative cost

2. Too much vertical integration inhibits development of distinctive

capabilities:

a) A key advantage of a company specializing in a few

activities is its ability to develop distinctive capabilities in
those activities
ü UPS developing express delivery capabilities but also van making
capabilities?
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

b) As a result, businesses outsource IT activities

ü Sony, Philips & Xerox’s own IT services will never be as good as IBM,
TCS and Accenture’s. A major advantage of these IT specialists is the
learning they gain from working with multiple clients

c) But why Walmart keeps its IT in-house ?

ü The reason is that real-time information is central to Walmart's supply
chain management, in-store operations, and upper-level managerial
decision making

ü Walmart's need for tightly integrated information and communication

services customized to meet its unique business systems inclines it
toward in-sourcing.
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

3. Difficulties of managing strategically different businesses:

a) The previous points may be viewed as part of a wider set of problems—

that of managing vertically related businesses that are strategically very
different

b) These considerations explain the lack of vertical integration between

manufacturing and retailing: Zara (Inditex S.A.) and Gucci (Kering S.A.),
are unusual. Most of the world's leading retailers—Walmart, Gap,
Carrefour—do not manufacture
THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

c) These strategic dissimilarities are a key factor in the trend to vertically

de-integrate:

ü A major disadvantage of UPS owning a truck-manufacturing company

is that the management systems and organizational capabilities
required for truck manufacturing are very different from those required
for express delivery

ü Marriott's split into two separate companies, Marriott International

and Host Marriott, was influenced by the belief that owning hotels is
a strategically different business from operating hotels

ü Coca-Cola Company spun off its bottling activities as Coca-Cola

Enterprises Inc. partly because managing local bottling and
distribution operations is very different from managing the global
Coca-Cola brand and producing and distributing concentrates
 THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

4. The Profit-incentive problems
• Vertically integrated activities might comprise a lack of Profit-incentives that
exist in a supplier-customer relationship. Profit-incentives drive motivation
and effort

5. Vertical integration limits flexibility

• In responding to demand fluctuations (cyclical patterns of demand:
construction industry) or to changes in technology, customer preferences, etc

6. Compounding of risk
• If Disney animation studios fail to produce blockbuster animation movies that
introduce new characters, then the knock-on effects are felt through
plummeting DVD sales, lack of spin-off shows on the Disney Channel,
reduction of merchandise sales in Disney Stores, and a shortage of new
attractions at Disney theme parks
 THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

The challenges of Vertical Integration

7. Investing in an Unattractive Business

• Vertical integration may involve investing in an inherently unattractive

industry

• Irrespective of transaction costs and coordination benefits, McDonald's

chooses not to backward integrate into beef raising and potato growing,
because agriculture is a low-margin industry.
 APPLYING THE CRITERIA

“Make or Buy” decisions: Key Considerations

Characteristics of the vertical relationship Implications for VI
How many firms in the adjacent stage? The higher the number, the less advantageous is VI

Are transaction-specific investments The greater the need for transaction-specific investments,
necessary? the greater the advantages of VI

Is information evenly distributed across the The greater are information asymmetries, the greater the
stages? advantages of VI

Is there uncertainty over the period of the The greater the uncertainty, the more incomplete is the
relationship? contract and the greater the advantages of VI

How similar are two stages in terms of

optimal scale of the operation?
The greater the dissimilarity, the less advantageous is VI
How strategically similar are the two stages?

How critical is the continual upgrading of The greater the need for capability development the greater
capabilities in the adjacent activity? the disadvantages of VI

How important are profit incentives to The greater the need for high-powered incentives the
performance in the adjacent activity? greater the disadvantages of VI

How uncertain is market demand? Unpredictable demand reduces advantages of VI

Is the adjacent stage highly risky? VI tends to compound risk