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Vertical integration

Vertical integration is a strategy used by a company to gain control over its

suppliers or distributors in order to increase the firms power in the marketplace,
reduce transaction costs and secure supplies or distribution channels.

Two issues have to be considered before integration:


An organization should vertically integrate when costs of making the product inside the
company are lower than the costs of buying that product in the market.

Scope of the firm.

A firm should consider whether moving into new industries would not dilute
its current competencies.
New activities in a company are also harder to manage and control.
The answers to previous questions determine if a company will pursue none,
partial or full VI.

1.10 Types of vertical integration

Vertical integration takes place in two forms:-

a) Forward integration

Forward integration is a strategy where a firm gains ownership or increased

control over its previous customers (distributors or retailers).

b) Backward integration

Backward integration is a strategy where a firm gains ownership or

increased control over its previous suppliers.

a) Forward integration

If the manufacturing company engages in sales or after-sales industries it

pursues forward integration strategy.
This strategy is implemented when the company wants to achieve higher
economies of scale and larger market share.
Forward integration strategy became very popular with increasing internet
Many manufacturing companies have built their online stores and started
selling their products directly to consumers, bypassing retailers.

Forward integration strategy is effective when:

Few quality distributors are available in the industry.

Distributors or retailers have high profit margins.
Distributors are very expensive, unreliable or unable to meet firms
distribution needs.
The industry is expected to grow significantly.
There are benefits of stable production and distribution.
The company has enough resources and capabilities to manage the new

b) Backward integration

When the same manufacturing company starts making intermediate goods

for itself or takes over its previous suppliers, it pursues backward integration
Firms implement backward integration strategy in order to secure stable
input of resources and become more efficient.
Backward integration strategy is most beneficial when:

Firms current suppliers are unreliable, expensive or cannot supply the

required inputs.
There are only few small suppliers but many competitors in the industry.
The industry is expanding rapidly.
The prices of inputs are unstable.
Suppliers earn high profit margins.
A company has necessary resources and capabilities to manage the new

1.30 Advantages &disadvantages of vertical integration

a) Advantages

Lower costs due to eliminated market transaction costs

Improved quality of supplies
Critical resources can be acquired through VI
Improved coordination in supply chain
Greater market share
Secured distribution channels
Facilitates investment in specialized assets (site, physical-assets and humanassets)
New competencies

Higher costs if the company is incapable to manage new activities efficiently


The ownership of supply and distribution channels may lead to lower quality products
and reduced efficiency because of the lack of competition

Increased bureaucracy and higher investments leads to reduced flexibility

Higher potential for legal repercussion due to size (An organization may become a

New competencies may clash with old ones and lead to competitive disadvantage


Horizontal Integration

Horizontal integration is a strategy where a company acquires, mergers or

takes over another company in the same industry value chain.
It is the process of acquiring or merging with competitors, leading to industry
It is a type of integration strategies pursued by a company in order to
strengthen its position in the industry.
A corporate that implements this type of strategy usually mergers or acquires
another company that is in the same production stage.

The purpose of horizontal integration (HI) is to grow the company:_

in size,
increase product differentiation,
achieve economies of scale,
reduce competition
access new markets.

When many firms pursue this strategy in the same industry, it leads to industry
consolidation (oligopoly or even monopoly).

HI can occur in a form of mergers, acquisitions or hostile takeovers.

Merger is the joining of two similar sizes, independent companies to make

one joint entity. Acquisition is the purchase of another company.
Hostile takeover is the acquisition of the company, which does not want to
be acquired.

HI may be an effective strategy when:

Organization competes in a growing industry.

Competitors lack of some capabilities, competencies, skills or resources that
the company already possesses.

HI would lead to a monopoly that is allowed by a government.

Economies of scale would have significant effect.
The organization has sufficient resources to manage M&A.

The following diagram illustrates HI in manufacturing industry:

Advantages of horizontal integration

a) Lower costs.

The result of HI is one larger company, which produces more services

and products.
The higher output leads to greater economies of scale and higher

b) Increased differentiation.

The combined company can offer more product or service feature

c) Increased market power.

The larger company has more power over its suppliers and
c) Reduced competition.

The result of industry consolidation is fewer companies operating in the industry and less
intense competition.

d) Access to new markets.

New markets and distribution channels can be accessed by integrating with a

company that produces the same goods but operates in a different region or
serves different market segment.

Disadvantages of the strategy

a) Destroyed value.

M&A rarely add value to the companies. More often M&A fail and destroy
the value of the companies involved in it because expected synergies
never materialize.

b) Legal repercussions.

HI can lead to a monopoly, which is highly discouraged by many

governments due to lack of competition.
Therefore, governments usually have to approve any larger M&A before
they can happen.

c) Reduced flexibility.

Large organizations are harder to manage and they are less flexible in introducing
innovations to the market.

Licensing is a contractual agreement between two parties which gives permission to
one party to lease a legally protected entity, such as a name, likeness, logo or
character from the other.
Generally, licenses are contracts that allow a person or entity (the "licensee") to use
the property of another (the "licensor").
Licenses often involve intellectual property, and, when they do, their characteristics
include the following:
a limited right to use the intellectual property;
little access to the knowledge source (i.e., the licensor); and
the application of a "packaged solution," rather than a customized one.
Licensing works by the licensor (brand owner) fixing a royalty rate of usually
about 5% to the sales of products using its name.
The licensee, therefore, pays the licensor a percentage of its sales income
above the pre-agreed minimum.
There is also usually an upfront fee paid to the brand owner.
Licensing rates (royalty rates) are essentially profit sharing mechanisms between
brand owner and licensee. To determine an appropriate royalty rate a number of
factors need to be considered: benchmarked royalty rates already in existence;
operating profitability of the brand; the amount of turnover that can be attributed to
the brand alone; brand strength and potential revenues the license will generate.
1. A licence allows a company to take a product to market without the expense
of setting up locally and all the risks and costs associated with that.
2. A larger and more powerful licensee in a new market can provide instant
market access and deter competitors and imitators.
3. A licence can be used to enable products to be supplied locally where there is
no opportunity to manufacture in the locality.

4. It is possible with the right kind of licence and overseas business partner to
create an extensive market presence very early on in the products life cycle.
This will help make maximum profits for the licensor.
5. In certain circumstances it is possible to divide up a particular market so that
different companies can licence the same product but apply it in different
areas. For example, it is possible to take disinfection kits and divide up the
market into human and animal markets then find different companies with
the right market presence.
6. It is possible to work with a licensee in a foreign market and learn from them.
For example, it may be possible to improve products or to adjust them so that
they meet local market needs. This can often be done early on in the
products life cycle to help achieve better market coverage.
7. An overseas licensee may well save a lot of expense in terms of research and
development. For example, reciprocal licensing in the car and
telecommunications industries enables companies to exploit the fruits of
research carried out by one company alone.
8. Where well known brands are licensed overseas, the local licensee can take
advantage of an established brand with a known name and goodwill. It is very
important for the licensor to ensure that brand standards are maintained in
an overseas market.
9. It is possible to negotiate further income streams from support services and
1. It is important for the company to find the right partner to licence with in a
local situation. Understanding what an overseas partner can do is essential to
making licensing a success.
2. It is important to ensure that there are proper control provisions in the
licence. It is especially important with licensing to have a well-drafted licence
drawn up by experts. The licence should contain things such as full audit
provisions and as licensor it may be important to police those audit
3. In the long term, royalty payments from a licence may not provide the
maximum for a licensor. It could be that setting up locally can generate
better profits in the long run.
4. It is absolutely key to the success of the licence for it to be properly
negotiated and drafted. Licensing can be a complex arrangement and it is
important for a licensor to be properly guided in terms of royalty payments,
audit provisions and minimum sales.
5. The licensor is often required to provide technical assistance and training in
brand standards etc. depending upon where the licensee is based. This will
need to be factored into the licensing arrangements.
6. The licensor must be satisfied that the licensee can make a local market from
the products. Some products are more popular in some cultures than in

4.0 Mergers & Acquisitions

When two or more companies agree to combine their operations, where one
company survives and the other loses its corporate existence, a merger is
The surviving company acquires all the assets and liabilities of the merged
The company that survives is generally the buyer and it either retains its
identity or the merged company is provided with a new name.

4.10 Types of Mergers

Horizontal Mergers
Vertical Mergers
Conglomerate Mergers

a) Horizontal Mergers

This type of merger involves two firms that operate and compete in a similar
kind of business.
The merger is based on the assumption that it will provide economies of scale
from the larger combined unit.

b) Vertical Mergers

Vertical mergers take place between firms in different stages of

production/operation, either as forward or backward integration
The basic reason is to eliminate costs of searching for prices, contracting,
payment collection and advertising and may also reduce the cost of
communicating and coordinating production.
Both production and inventory can be improved on account of efficient
information flow within the organisation.
c) Conglomerate Mergers

Conglomerate mergers have been sub-divided into:

Financial Conglomerates

Managerial Conglomerates

Concentric Companies

Financial Conglomerates
These conglomerates provide a flow of funds to every segment of their operations, exercise
control and are the ultimate financial risk takers. They not only assume financial responsibility
and control but also play a chief role in operating decisions. They also:

Improve risk-return ratio

Reduce risk

Improve the quality of general and functional managerial performance

Provide effective competitive process

Provide distinction between performance based on underlying potentials in the product

market area and results related to managerial performance.

Managerial Conglomerates

Managerial conglomerates provide managerial counsel and interaction on

decisions thereby, increasing potential for improving performance.
When two firms of unequal managerial competence combine, the
performance of the combined firm will be greater than the sum of equal parts
that provide large economic benefits.

Concentric Companies

The primary difference between managerial conglomerate and concentric

company is its distinction between respective general and specific
management functions.
The merger is termed as concentric when there is a carry-over of specific
management functions or any complementarities in relative strengths
between management functions.


The term acquisition means an attempt by one firm, called the acquiring firm, to gain a majority
interest in another firm, called target firm.
The effort to control may be a prelude

To a subsequent merger or

To establish a parent-subsidiary relationship or

To break-up the target firm, and dispose off its assets or

To take the target firm private by a small group of investors.

There are broadly two kinds of strategies that can be employed in corporate acquisitions.
a) Friendly Takeover

The acquiring firm makes a financial proposal to the target firms

management and board.
This proposal might involve the merger of the two firms, the consolidation of
two firms, or the creation of parent/subsidiary relationship.

b) Hostile Takeover

A hostile takeover may not follow a preliminary attempt at a friendly

For example, it is not uncommon for an acquiring firm to embrace the target
firms management in what is colloquially called a bear hug.

Benefits of a Merger or Acquisition

There are many good reasons for growing your business through an acquisition or

Obtaining quality staff or additional skills, knowledge of your industry

or sector and other business intelligence. For instance, a business with
good management and process systems will be useful to a buyer who
wants to improve their own. Ideally, the business you choose should
have systems that complement your own and that will adapt to
running a larger business.
Accessing funds or valuable assets for new development. Better
production or distribution facilities are often less expensive to buy than
to build. Look for target businesses that are only marginally profitable
and have large unused capacity which can be bought at a small
premium to net asset value.
Your business underperforming. For example, if you are struggling with
regional or national growth it may well be less expensive to buy an
existing business than to expand internally.
Accessing a wider customer base and increasing your market share.
Your target business may have distribution channels and systems you
can use for your own offers.


Diversification of the products, services and long-term prospects of

your business. A target business may be able to offer you products or
services which you can sell through your own distribution channels.
Reducing your costs and overheads through shared marketing budgets,
increased purchasing power and lower costs.
Reducing competition. Buying up new intellectual property, products or
services may be cheaper than developing these yourself.
Organic growth, ie the existing business plan for growth, needs to be
accelerated. Businesses in the same sector or location can combine
resources to reduce costs, eliminate duplicated facilities or
departments and increase revenue.

Demerits of Mergers

1. Higher Prices.

A merger can reduce competition and give the new firm monopoly power.
With less competition and greater market share, the new firm can usually
increase prices for consumers.

2. Less Choice.

A merger can lead to less choice for consumers.

3. Job Losses.

A merger can lead to job losses.

This is a particular cause for concern if it is an aggressive takeover by an
asset stripping company
A firm which seeks to merge and get rid of under-performing sectors of the
target firm.

4. Diseconomies of Scale.

The new firm may experience dis-economies of scale from the increased size.
After a merger, the new bigger firm may lack the same degree of control and
struggle to motivate workers.
If workers feel they are just part of a big multinational they may be less
motivated to try hard.

6.0 Joint ventures and strategic alliance


6.10 Introduction
A strategic alliance is a form of collaboration between two or more companies, which can take

on forms such as:

Technology transfer.

Purchasing and distribution agreements.

Marketing and promotional collaboration.

Joint product development.

Each partner in the alliance usually retains their independence while contributing towards a
mutual shared goal.
A joint venture
A joint venture involves a potentially long-term investment of funds, facilities and resources by
two or more companies to a combined venture, which benefits all companies. All involved will
have an equity stake in the new venture.
A joint venture may be formed to:

Run production facilities in another country.

Establish a marketing and distribution presence.

Use complementary technologies held by each participant.

Joint ventures can also be used to get around country trade barriers. In some cases a joint venture
with a local company may be required to enter some overseas markets.
6.20 The risks of joint ventures

Problems are likely to arise if:

the objectives of the venture are not totally clear and communicated to
everyone involved

the partners have different objectives for the joint venture

there is an imbalance in levels of expertise, investment or assets brought into

the venture by the different partners


different cultures and management styles result in poor integration and cooperation

the partners don't provide sufficient leadership and support in the early

6.30 Advantages of Joint Venture form of Business

The main advantages of a joint venture are:


Access to new markets


By engaging with a foreign collaborator, the products and services can be marketed
in a foreign country.

New and improved Technology

One partner may have the new and improved technology but do not have
the resources.
Other partner may have resources like capital but do not have the
In such causes joint venture can fetch new and improved technology as
well as great resources. By engaging a foreign partner, improved foreign
technology can be availed from it's foreign collaborator.

3. Ability and Experience

In joint venture the different venturers may be having different skills and
The benefit of their common wisdom will be available to the venture.

4. Spreading of Risk

The co-ventures agree to share the profits and losses in a particular ratio.

The implies that the risk is also borne by them in that ratio.

5. Shared knowledge
Sharing skills (distribution, marketing, management), brands, market
knowledge, technical know-how and assets leads to synergistic effects, which
result in pool of resources which is more valuable than the separated single
resources in the particular company.
6. Opportunities for growth

Using the partners distribution networks in combination with taking

advantage of a good brand image can help a company to grow faster
than it would on its own.
The organic growth of a company might often not be sufficient enough
to satisfy the strategic requirements of a company, that means that a
firm often cannot grow and extend itself fast enough without expertise
and support from partners
7. Complexity
As complexity increases, it is more and more difficult to manage all
requirements and challenges a company has to face, so pooling of
expertise and knowledge can help to best serve customers.
8. Cost
Partnerships can help to lower costs, especially in non-profit areas like
Research& Development.

9. Access to resources
Partners in a Strategic Alliance can help each other by giving access to
resources, (personnel, finances, technology) which enable the partner to produce
its products in a higher quality or more cost efficient way.
10.Economies of Scale
When companies pool their resources and enable each other to access
manufacturing capabilities, economies of scale can be achieved. Cooperating
with appropriate strategies also allows smaller enterprises to work together
and to compete against large competitors.

Disadvantages of Joint Venture form of Business

Disadvantages of strategic alliances include

1. Sharing
In a Strategic Alliance the partners must share resources and profits and often skills
and know-how.
This can be critical if business secrets are included in this knowledge.
Agreements can protect these secrets but the partner might not be willing to stick
to such an agreement.
2. Creating a Competitor


The partner in a Strategic Alliance might become a competitor one day, if it profited
enough from the alliance and grew enough to end the partnership and then is able
to operate on its own in the same market segment.
3. Opportunity Costs
Focusing and committing is necessary to run a Strategic Alliance successfully but
might discourage from taking other opportunities, which might be benefitial as well.
4. Uneven Alliances
When the decision powers are distributed very uneven, the weaker partner might be
forced to act according to the will of the more powerful partners even if it is actually
not willing to do so.
5. Foreign confiscation
If a company is engaged in a foreign country, there is the risk that the government
of this country might try to seize this local business so that the domestic company
can have all the market on its own.

6. Conflicts and Disputes

There is increased potential to have conflicts and disputes between the partners of
the business.
One partner may want to manage the company a certain way, while another
partner may have totally different ideas about the direction the company should

7. Limited Life
A joint venture forms for a limited time period.
The venture comes to an end automatically when the company fulfills the
purpose for which it was formed.
The death or withdrawal of a partner may cause the automatic termination of
a joint venture.
This will put the other partners of the joint venture at a disadvantage if they
want to continue the business.
8. Liability
One of the biggest disadvantages of a joint venture is that the structure
offers no liability protection to the parties involved.
This means a partner in a joint venture has a personal obligation for at least
his portion of the companys obligation, as explained by the


If the joint ventures assets do not cover the companys debts and
obligations, partners of the business may lose their personal assets up to the
point where the debt becomes satisfied.
In the case of a corporation, the company may lose assets as a result of the
ventures obligations