6 - Vertical Integration

Chapter 6
Vertical
Integration
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall. 6-1

Vertical
Vertical Integration
Integration
The Strategic Management Process

External
Analysis
Strategic Strategy Competitive

Mission Objectives
Choice Implementation Advantage
Which Businesses
Internal to Enter?
Analysis
Corporate Level • Vertical Integration
Strategy
Copyright © 2012 Pearson Education,

Strategic Inc. publishing as Prentice
Management Hall.
& Competitive Advantage – Barney & Hesterly 6-22
Vertical
Integration
Logic of Corporate Level Strategy

Corporate level strategy should create value:
1) such that the value of the corporate whole increases
2) such that businesses forming the corporate whole

are worth more than they would be under
independent ownership
3) that equity holders cannot create through

portfolio investing
• a corporate level strategy should create
synergies that are not available in equity
markets
• vertical integration = value chain economies
Management Hall.
Vertical
Integration
What is Vertical Integration?

Where your pizza comes from
Dairy Farmers
(milk)
Seed Companies Pizza Chains

(Alfalfa & Corn)
Leprino Foods
(Mozzarella Cheese)
Crop Farmers
(Alfalfa & Corn) End Consumer
Food Distributors

Management Hall.
Vertical
Integration
What is Vertical Integration?
Backward
Vertical
Dairy Farmers Integration
(milk)
Seed Companies Pizza Chains

(Alfalfa & Corn)
Leprino Foods
(Mozzarella Cheese)
Crop Farmers
(Alfalfa & Corn) End Consumer
Food Distributors Forward

Vertical
Integration
Management Hall.
Vertical
Integration
Value Chain Economies

The Logic of Value Chain Economies
Backward
Vertical
• the focal firm is able to Dairy Farmers Integration
(milk)
create synergy with the
other firm(s)
• cost reduction
Leprino Foods
• revenue enhancement (Mozzarella Cheese)
• the focal firm is able to

capture above normal
economic returns Forward
Food Distributors
(avoid perfect competition) Vertical
Integration
Management Hall.
Vertical
Integration
Competitive Advantage
If a vertical integration strategy meets the

VRIO criteria…
Is it Valuable?
Is it Rare?
Is it costly to Imitate?
Is the firm Organized to exploit it?
…it may create competitive advantage.

Management Hall.
Vertical
Integration
Value of Vertical Integration

Market vs. Integrated Economic Exchange
• markets and integrated hierarchies are ‘forms’ in which
economic exchange can take place
• economic exchange should be conducted in the form

that maximizes value for the focal firm
• thus, firms assess which form is likely to generate

more value
Integration makes sense when the focal firm can

capture more value than a market exchange provides
Management Hall.
Vertical
Integration
Value of Vertical Integration

Three Value Considerations
Leverage Manage Exploit

Capabilities Opportunism Flexibility
• firm capabilities • opportunism • internalizing is

may be sources may be checked usually less
of competitive by internalizing flexible
advantage in (TSI)
other businesses • flexibility is
• internalizing must prized when
• if not, then don’t be less costly than uncertainty is
integrate exchange opportunism high
Management Hall.
Vertical
Integration
Organizing Vertical Integration

Functional Structure (U-Form)
CEO’s Role
Cooperation
Accounting Finance Marketing HR Engineering
Cooperation
Conflict
Original Original Original Original Original

Business Business Business Business Business
New New New New New

Business Business Business Business Business
Conflict
Management Hall.
10
Vertical
Integration

Management Controls
What needs to be ‘controlled’ in a vertically integrated
firm?
• managers’ efforts to achieve the desired value

chain economies
• cooperation and competition among and between
functions
• the integration of new businesses into the
existing business
• time horizon of managers

Management Hall.
11
Vertical
Integration

Management Controls
Board
Budgets
Committees
• separating strategic and • provide oversight and
operational budgets direction to managers
• strategic: inputs • help ensure that strategic
& outputs direction is maintained
• operational: outputs
These mechanisms focus management attention

on achieving value chain economies
Management Hall.
12
Vertical
Integration

Compensation
Salary
Integration
Opportunism Cash Bonus: Individual
Stock Grants: Individual
Leveraging Cash Bonus: Group Cooperation

Capabilities
Stock Grants: Group
Stock Options: Individual

Exploiting Time Horizon
Flexibility Stock Options: Group

Management Hall.
13
Vertical
Integration
Summary
Vertical Integration…
• makes sense when value chain economies

can be created and captured
• may allow a firm to leverage capabilities
• may be a response to the threat of opportunism

and uncertainty
• as a form of exchange per se, is not rare nor

costly to imitate
Management Hall.
14
Vertical
Integration
Summary
Vertical Integration…
• is an important consideration in the decision

to expand internationally (range of possibilities)
• makes sense when done for the right reasons,

under the right circumstances
• can be a costly mistake if done wrong
Ownership is costly—integrate only when the

benefits outweigh the costs of integration!
Management Hall.
15
Vertical
Integration
All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the publisher. Printed in the
United States of America.
Copyright ©2012 Pearson Education, Inc.

publishing as Prentice Hall

Management Hall.
16

6 - Vertical Integration

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Chapter 6

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall. 6-1

The Strategic Management Process

Strategic Strategy Competitive

Copyright © 2012 Pearson Education,

Logic of Corporate Level Strategy

2) such that businesses forming the corporate whole

3) that equity holders cannot create through

What is Vertical Integration?

Seed Companies Pizza Chains

Copyright © 2012 Pearson Education,

What is Vertical Integration?

Seed Companies Pizza Chains

Food Distributors Forward

Value Chain Economies

• the focal firm is able to

If a vertical integration strategy meets the

Is the firm Organized to exploit it?

…it may create competitive advantage.

Copyright © 2012 Pearson Education,

Value of Vertical Integration

• economic exchange should be conducted in the form

• thus, firms assess which form is likely to generate

Integration makes sense when the focal firm can

Value of Vertical Integration

Leverage Manage Exploit

• firm capabilities • opportunism • internalizing is

Organizing Vertical Integration

Original Original Original Original Original

New New New New New

Organizing Vertical Integration

• managers’ efforts to achieve the desired value

Copyright © 2012 Pearson Education,

Organizing Vertical Integration

These mechanisms focus management attention

Organizing Vertical Integration

Stock Grants: Individual

Leveraging Cash Bonus: Group Cooperation

Stock Options: Individual

Copyright © 2012 Pearson Education,

• makes sense when value chain economies

• may allow a firm to leverage capabilities

• may be a response to the threat of opportunism

• as a form of exchange per se, is not rare nor

• is an important consideration in the decision

• makes sense when done for the right reasons,

• can be a costly mistake if done wrong

Ownership is costly—integrate only when the

All rights reserved. No part of this publication may be reproduced,

Copyright ©2012 Pearson Education, Inc.

Copyright © 2012 Pearson Education,

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