Because learning changes everything.

Corporate Strategy:
Vertical Integration and
Diversification

© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
 Corporate Strategy

The decisions that leaders make.

Goal-directed actions that they take in the quest for

competitive advantage.

Boundaries of the firm:

• Vertical integration.
• Diversification.
• Geographic scope.

© McGraw Hill
 Why Firms Need to Grow

To increase profits and shareholder returns.

To lower costs and achieve economies of scale.

To increase market power.

To reduce risk through diversification.

To motivate management.

© McGraw Hill
 Three Dimensions of Corporate Strategy

1. Vertical integration.

2. Diversification.

3. Geographic scope.

© McGraw Hill
 Transaction Costs

Associated with an economic exchange.

External transaction costs:

• Searching for contractors.
• Negotiating, monitoring, and enforcing contracts.

Internal transaction costs:

• Recruiting and retaining employees.
• Setting up a shop floor.

© McGraw Hill
 Internal and External Transaction Costs
Exhibit 8.2

Access the text alternate for slide image.

© McGraw Hill
 Make or Buy?

If Costsin-house < Costsmarket,

• Vertically integrate.
• Own production of the inputs.
• Or own output distribution channels.

If Costsmarket < Costsin-house,

• The firm should consider purchasing instead.

© McGraw Hill
 Organizing Economic Activity: Firms vs. Markets

Exhibit 8.3

Access the text alternate for slide image.

© McGraw Hill
 Alternatives on the Make-or-Buy Continuum

Exhibit 8.4

Access the text alternate for slide image.

© McGraw Hill
 Vertical Integration

The ownership of inputs or distribution channels.

• “What percentage of a firm’s sales is generated within the
firm’s boundaries?”

Backward Vertical Integration:

• Owning inputs of the value chain.

Forward Vertical Integration:

• Owning activities closer to the customer.

© McGraw Hill
 Backward and Forward Vertical Integration along an Industry
Value Chain

Exhibit 8.5

Access the text alternate for slide image.

© McGraw Hill
 The Vertical Value Chain of Your Cell
Phone
Raw materials:
• Chemicals, ceramics, metals, oil for plastic.

Intermediate goods and components:

• Integrated circuits, displays, touchscreens, cameras, and
batteries.

Final Assembly and manufacturing:

• Assembly.

Marketing, sales, after-sales service and support:

• Pick a service provider.
• Get wireless data and voice service.
© McGraw Hill
 HTC’s Backward and Forward Integration along the Industry
Value Chain in the Smartphone Industry

Exhibit 8.6

Access the text alternate for slide image.

© McGraw Hill
 Benefits of Vertical Integration

Lowering costs.

Improving quality.

Facilitating scheduling and planning.

Facilitating investments in specialized assets:

• Co-located assets, unique equipment, human capital.

Securing critical supplies and distribution channels.

© McGraw Hill
 Risks of Vertical Integration

Increasing costs.

Reducing quality.

Reducing flexibility.

Increasing the potential for legal repercussions.

© McGraw Hill
 When Does Vertical Integration Make
Sense?
When there are issues with raw materials.
• Example: Henry Ford ran mining operations.
To enhance the customer experience.
• Eliminate annoyances and poor interfaces.
Vertical market failure: when transactions are too
risky or costly.

© McGraw Hill
 Alternatives to Vertical Integration

Taper Integration: Strategic Outsourcing:

• Backward or forward • Moving internal value
integrated. chain activities.
• Plus reliance on outside • To other firms.
firms such as suppliers or • Example: HR
distributors. management system.

© McGraw Hill
 Taper Integration along the Industry Value Chain

Exhibit 8.7

Access the text alternate for slide image.

© McGraw Hill
 Types of Diversification

Product Diversification:
• Increase in variety of products / services.
• Active in several product markets.

Geographic Diversification:
• Increase in variety of markets / geographic regions.
• Regional, national, or international markets.

Product-Market Diversification:
• Product and geographic diversification.

© McGraw Hill
 Types of Corporate Diversification

1. Single business: low level of diversification.

2. Dominant business: additional business activity

pursued.

3. Related diversification:
• Constrained: all businesses share competencies.

• Linked: some businesses share competencies.

4. Unrelated diversification (conglomerate): no

businesses share competencies.
© McGraw Hill
 The Core Competence–Market Matrix
Exhibit 8.9
Source:. Adapted
from G. Hamel and
C.K. Prahalad
(1994), Competing
for the Future
(Boston: Harvard
Business School
Press).

Access the text alternate for slide image.

© McGraw Hill
 The Diversification-Performance Relationship

Exhibit 8.11
Source:. Adapted from L.E. Palich, L.B. Cardinal, and C.C. Miller (2001), “Curvilinearity in the diversification-performance linkage: An examination of
over three decades of research,” Strategic Management Journal 21: 155–174..
Access the text alternate for slide image.

© McGraw Hill
 How Diversification Can Enhance Firm
Performance

Provides economies of scale (reduces costs).

Exploits economies of scope (increases value).

Reduces costs and increase value.

© McGraw Hill
 Restructuring

Reorganizing and divesting business units and

activities.

Helps refocus a company.

Helps leverage core competencies more fully.

Helpful restructuring tool: BCG growth-share matrix.

• Guides portfolio planning.
• Each category warrants a different strategy.

© McGraw Hill