INSTRUCTOR MANUAL EXPERIENCED FACULTY

CHAPTER 8
CORPORATE STRATEGY: VERTICAL INTEGRATION AND
DIVERSIFICATION

CHAPTER OUTLINE Overview

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

8.2 The Boundaries

of the Firm Learning Objectives
8.3 Vertical LO 8-1 Define corporate strategy and describe the three dimensions along
Integration along the which it is assessed.
Industry Value Chain
LO 8-2 Describe and evaluate different options firms have to organize
8.4 Corporate economic activity.
Diversification:
Expanding Beyond a LO 8-3 Describe the two types of vertical integration along the industry
Single M arket value chain: backward and forward vertical integration.

LO 8-4 Identify and evaluate benefits and risks of vertical integration.

8.5 Im plications for
the Strategist
LO 8-5 Describe and examine alternatives to vertical integration.
Strategy Term Project LO 8-6 Describe and evaluate different types of corporate diversification.

my STRATEGY 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.

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CHAPTER CASE Consider This Discussion Questions

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.
In the “Consider This”
section at the end of the
chapter set, the firm’s
strategy changes in the
context of global trends.
Most students will be familiar with General Electric because of the company’s
long history and many consumer products they have made over the years. The
students, however, are less likely to know about GE’s large investments in clean
technology and health care. AACSB 2013 Standard 9 Analytical thinking (able to
analyze and frame problems)
Where do ecomagination and healthymagination fit on the core competence–
market matrix for GE? (See Ex hibit 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 Chapter Case 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.
Take either the energy or health care 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 customers from its
customary position of designing and manufacturing large medical systems.
What related diversification would you suggest for GE in reference to its focus for the future?

Suggest that students learn what businesses the firm is already in. 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.
How do GE’s corporate strategic initiatives of clean-tech, 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 the development of future energy products than say the South American GE teams.

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8.1 WHAT IS CORPORATE STRATEGY? [LO 8-1]

End of Chapter Discussion Question 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? Why? Ex plain your
answer. AACSB 2013 Standard 9 Application of knowledge (able to translate knowledge of business and management into
practice)

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.

Exercise
The Walt Disney Company is a firm with which students are familiar that provides a good example of all three elements of
corporate strategy. Ask students to review the firm’s portfolio of businesses and identify examples of geographic
diversification, industry diversification, and vertical integration. Then, ask them to identify competences that are being
leveraged across businesses. If you want to add an analytical component to this exercise, you could ask the students to
review this data (excerpted from the Walt Disney Company’s 2012 10K filing with the Securities and Exchange
Commission) and identify where each business might fit in the BCG matrix. AACSB 2013 Standard 9 Analytical thinking
and Financial theories, analysis, reporting, and markets

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8.2 THE BOUNDARIES OF THE FIRM [LO 8-2]

Examples
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.

Exhibit 8.2 may be important to spend a few minutes on depicting the advantages and disadvantages of firms versus
markets. While terms such as information asymmetries sound difficult, the foundational concepts are pretty simple and are
certainly important for students to understand. You might want to work through a simple example for students using this
exhibit to consider a make versus buy decision. One such example would be for a fitness gym: Should they do
maintenance on cardio machinery in-house or outsource it to a specialized firm? What are the relative advantages and
disadvantages? Similarly, should a retailer run its own e-commerce site or outsource everything to Amazon?

As illustrated by the lemons example, information asymmetries in markets can lead to perverse effects. Applying this
insight to the market for collaborative R&D projects in biotechnology, empirical research supports the lemons hypothesis.
In particular, the research suggests that biotechnology startups have a tendency to develop the most promising R&D
projects internally, while at the same they offer inferior R&D projects (“lemons”) to large pharmaceutical companies for
joint development through strategic alliances.

Exhibit 8.3 offers important insights for students with limited work experience. They have a clear understanding of the
two ends of the diagram—buy or make in-house, but the intermediate alternatives are less obvious. Firms often structure
their businesses using more than one of these options. For example, Starbucks has company-owned-and-operated
locations, as well as franchised operations (probably the version seen on campus). McDonald’s has company-owned-and-
managed sites, but relies much more heavily on franchises. Gasoline is marketed through arm’s-length transactions,
through an arrangement similar to franchises, through company-owned / independently operated sites, and through
company-owned-and-operated sites.

End of Chapter Ethical/Social Issues 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? What aspects of Nike’s agreement with its manufacturing partners do
you believe they emphasize in negotiations? AACSB 2013 Standard 9 Ethical understanding and reasoning (able to
identify ethical issues and address the issues in a socially responsible manner)

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.

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Strategy Highlight 8.1
“Toyota Locks Up Lithium for
Car Batteries”
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, most of which are in China. Lithium mining is also not widely
commercialized, thus spurring firms like Toyota to vertically integrate to
assure critical supplies. The New York Times produced a six-minute video
in 2010 on China’s vital role in the supply of global rare earth metals.

Exercise
This highlight offers an opportunity for an exercise in strategic decision-
making skills. Ask students to review the drivers for supplier power from
Chapter 3. Then, ask that they identify a strategy that a firm can use to
reduce its exposure to the high supplier power for this commodity in the
auto manufacturing industry. One such option is Toyota’s backward
integration strategy: It focuses on the threat of backward integration by the
focal industry. Another strategic option is to reduce the amount of rare
earth metals used in the car: It addresses the criticality of the supplier’s
product to the focal industry product. A third strategy is to design multiple
types of batteries that can be easily interchanged; this flexibility reduces
switching costs. Students may have other ideas. AACSB 2013 Standard 9
Thinking creatively

8.3 VERTICAL INTEGRATION ALONG THE VALUE CHAIN

Types of Vertical Integration [LO 8-3]

Exhibit 8.5 offers an engaging illustration of the value chain for an industry. 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. You
might want to ask where students see other parts of the smartphone ecosystem, such as app developers and the makers of cell
towers.

An example of vertical integration is steelmaker Nucor’s recent acquisition of SHV North America, providing Nucor with
global sourcing of scrap materials for its innovative technology using electric-arc furnaces.

Exercise
Fifty percent of Alliance Boots GmbH is now owned by Walgreens. The two companies then formed an alliance with
AmerisourceBergen, a pharmacy wholesaler, that has the potential to be converted to an equity joint venture. Part 1: This
example gives students an opportunity to draw out the industry value chain shown in Exhibit 8.5 for a different industry.
They should identify the research and manufacturing occurring in pharmaceutical firms, such as Teva, Amgen, and Merck,
the distribution and wholesaling function happening in AmerisourceBergen, and the consumer marketing and sales occurring
in Boots and Walgreens. Part 2: What are the advantages and disadvantages of this strategy? Students should refer to
Exhibit 8.10 to identify both sources of value creation and opportunities for cost savings. You can return to this example in
Chapter 9 to discuss the design of the alliance as a step to a potential joint venture. Part 3: You can also use this example to
tie back to Chapter 7 by discussing the entrepreneur, Stefano Pessina, who is reshaping this industry with process
innovations. (See “Stefano Pessina, the man shaking up U.S. pharmacy distribution,” The Wall Street Journal 5/20/13)
AACSB 2013 Standard 9 Analytical thinking (able to analyze and frame problems)

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8.3 VERTICAL INTEGRATION ALONG THE VALUE CHAIN

Benefits and Risks of Vertical Integration [LO 8-4]

Example
This humorous video illustrates that outsourcing can go too far.

Discussion Topics
Why did Pepsi exit the bottling industry in 1999? Why did they buy back into this segment in 2009? Pepsi exited out of the
capital-intensive, low-margin bottling industry in 1999 to concentrate on marketing. In 2009, they bought their major
bottlers for $7.8 billion to obtain more control over its quality, pricing, distribution, and in-store display, to improve
decision making, and to enhance flexibility to bring innovative products to the market faster.

Google forward-integrated into smartphone handset manufacturing in 2012 with its purchase of Motorola. In what ways
does Google both compete with and supply its customers? In this example of co-opetition, Google supplies Android
software, search engine, and apps to smartphone manufacturers and designers, including Samsung. Google is now in direct
competition with these firms. What competencies does Google bring to the smartphone manufacturing business? Google
can’t match its smartphone competitors in manufacturing competencies. What it hopes to bring to Motorola is improved
innovation processes. (See “Samsung and Google: From friends to frenemies,” The Wall Street Journal, 2/27/13 and
“Motorola is now the Apple of Google’s eye,” The Wall Street Journal, 5/24/12.)

8.3 VERTICAL INTEGRATION ALONG THE VALUE CHAIN

Alternatives to Vertical Integration [LO 8-5]

End of Chapter Ethical/Social Issues 1

The chapter notes that some 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? HR management systems are soft- ware
applications that typically manage payroll, benefits, hiring and training, and performance appraisal. What are
the advantages and disadvantages of this decision? Think of ways that a firm can continue to show its
commitment to treat employees with respect. AACSB 2013 Standard 9 Social responsibility, including sustainability,
and ethical behavior and approaches to management

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.

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End of Chapter Discussion Question 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 ex plain 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.

8.4 CORPORATE DIVERSIFICATION: EXPANDING BEYOND A

SINGLE MARKET

Types of Corporate Diversification [LO 8-6]

Examples
Exhibit 8.7 illustrates types of corporate diversification and provides examples of each type.

This humorous video gives examples of unrelated diversification.

Discussion Topic
What makes a diversification related? While at first Ecolab’s (disinfectants and detergents for restaurants and hospitals)
2013 acquisition of Champion Technologies (oil and gas drilling chemicals) may appear unrelated, the firm viewed it as
related diversification. Certainly from a customer perspective they are unrelated. However, the underlying technology in
both cases is chemical and the business models are similarly designed around frequently recurring sales. The diversification
may also have been driven in part by the tremendous growth in gas drilling. So you can also use this example to emphasize
that diversification strategies should be predicated at least in part on a five forces analysis to assess industry profit
potential. (See “Ecolab to buy chemicals firm Champion Technologies,” The Wall Street Journal, 10/12/12.)

Strategy Highlight Exercise

8.2 “Tata Group: The Tata group is engaged in a wide range of diversified businesses. Ask students
Integration at the to create a grid with each business listed as both column headings and row
Corporate Level” headings. Then ask them to identify in each cell of the table any competencies that
might be leveraged across the two intersecting businesses.

Discussion
If you have international students from Asia in your class, you might invite a
discussion about why conglomerates and conglomerate-like structures (keiretsu
and chaebol) are so much more important to the competitive landscape than
unrelated diversified firms are in the U.S. and European markets. Western
investors have pushed firms to break up unrelated diversifications due to the
performance disadvantage illustrated in Exhibit 8.9, but this trend has not carried
into Asia. Collective cultures in some Asian countries place a stronger value on
relationships, which creates an important type of core competency that can be
leveraged across businesses, even unrelated businesses. AACSB 2013 Standard 9
Managing in a global context

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8.4 CORPORATE DIVERSIFICATION: EXPANDING BEYOND A

SINGLE MARKET

Leveraging Core Competencies for Corporate Diversification [LO 8-7]

End of Chapter Discussion Question 2

How can related diversification create a competitive advantage for the firm? Keeping the advantages of related
diversification in mind, think back to the ex ample in the chapter of Delta’s vertical integration decision to acquire
an oil refinery—clearly an unrelated diversification move. What challenges might Delta confront in operating this
refinery? Think of the strategic concepts you have learned and how they can help you evaluate Delta’s decision.

As discussed in the Corporate Diversification and Firm Performance section, previous research has shown related
diversification has the highest level of performance improvement. Although Exhibit 8.10 shows securing critical supplies
as a value-creating effect of vertical integration, Delta’s refinery acquisition seems to be an odd choice for vertical
integration. First, jet fuel is a fungible product widely available under short-term and long-term contracts worldwide.
Second, oil refining has traditionally been the least profitable segment of the oil industry, and the major integrated firms
have been divesting it. Third, the Trainor refinery that they purchased is particularly unlikely to be profitable because it is
old and has not been upgraded, so it is highly dependent on high-cost, easier-to-refine, crude oil feedstocks. (The refinery
lost $85 million between 4Q12 and 1Q13. See “Delta’s refinery hasn’t taken off -- yet,” The Wall Street Journal, 4/24/13,
and “Crude or refined: Delta’s fuel gambit,” The Wall Street Journal, 4/05/12.) Fourth, it would seem that very few of the
competencies (see Exhibit 8.8) needed to run an airline successfully would translate to the task of managing an oil refinery.
Given that Conoco, who does have relevant competencies, shut the refinery down because they could not operate it
profitably, it is hard to see what Delta hopes to gain. This example offers a great opportunity to explore alternatives on the
make or buy continuum in Exhibit 8.3 that might be less risky for Delta, but would enable them to participate in the profit
margin in the refining industry.

Exercises
Here is an example that could be used to teach or assess critical reasoning skills. Rovio, the maker of the Angry Birds
game, has diversified into videos. (See “Rovio mines video with ‘Angry Birds Toons,’” The Wall Street Journal, 3/11/13.)
What type of diversification is this? What are the benefits and risks of diversification into media other than games? Can
you think of other related businesses that Rovio could profitably enter? On balance what diversification strategy would you
recommend for Rovio? Justify your position with logical reasoning based on theory from the textbook. Students should be
encouraged to refer to Exhibit 8.8 and provide arguments for their position that describe the applicability of Rovio’s core
competencies, such as their characters and story lines, to film and other media. They also should have arguments on the
impact of this diversification strategy on Rovio’s value creation and costs, using Exhibit 8.10.

Hon Hai, DBA Foxconn Technology Group, assembles PCs, video game consoles, mobile phones, and tablets for leading
tech firms. Its primary growth driver in recent years has been its contract manufacturing of Apple devices. As Apple’s
growth has slowed, Hon Hai has begun to consider diversification into accessories marketed under its own brand and into
contract manufacturing of TVs. It is also planning forward vertical integration into retail sales. Part 1: Ask students to
identify which box of the core competence matrix best describes each of these new businesses (Exhibit 8.8). Part 2: Ask
them to identify the sources of value creation that apply to these new business diversifications using Exhibit 8.10 as a
guideline. Part 3: Based on these two analyses, ask students to determine which of these opportunities should have the
highest priority for Hon Hai, and have the students provide their rationale for the choice. (See “As Apple feels the bite, Hon
Hai looks to diversify,” The Wall Street Journal, 5/27/13.) AACSB 2013 Standard 9 Analytical thinking (able to analyze
and frame problems)

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End of Chapter 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 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 ex periences.

Perhaps one of the most successful large companies leading this marriage of industries is a dairy farm in
Indiana: Fair Oaks Farms. Fair Oaks Farms is home to 30,000 cows and produces enough milk to feed 8 million
people. Fair Oaks is also participating in the education market as a popular destination for school field trips.
Other attractions include the “Birthing Barn,” where calf births can be viewed live; the Cheese Factory; and
Mooville—a themed outdoor play area. Fair Oaks Farm hosts some 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. Such
ingenious business diversification can offer many benefits to the agriculture industry.

What other industrial or commercial industries could benefit from such potential tourist or recreational revenues?
Discuss what new and complementary capabilities would need to be developed in order to succeed.

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.

In your group, list other industry combinations you have seen be successful. Consider why you think the
combination has been a success.

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.

8.4 CORPORATE DIVERSIFICATION: EXPANDING BEYOND A

SINGLE MARKET

Corporate Diversification and Firm Performance [LO 8-8]

Examples
Another reason why we see so much diversification is that interdependent competitors in oligopolistic industry structures
are forced to engage in diversification in response to moves by direct rivals. Based on research conducted on competitive
dynamics, following ExxonMobil’s acquisition of XTO Energy to move into the natural gas sector, other oil majors also
acquired natural gas companies in response. In January 2010, the French energy company Total acquired an equity stake in
Chesapeake Energy, the second-largest producer of natural gas in the U.S.

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Some researchers suggest that bandwagon effects occur—firms copying the moves of industry rivals. A bandwagon effect
can be observed, for example, in the recent related-diversification moves in the computer industry, in which hardware
companies have moved into the software and services sector and vice versa: IBM transformed itself from a hardware
company into a global-services company. To further strengthen its strategic position in IT services, IBM acquired
PricewaterhouseCoopers Consulting in 2002 for $3.5 billion and divested its low-margin PC business to the Chinese
technology company Lenovo in 2005. In 2008, computer maker HP bought EDS, an IT services company, for more than
$13 billion. HP followed the bandwagon pressure to expand in data analytics with an unfortunate acquisition of Autonomy
(see “Inside H-P’s missed chance to avoid a disastrous deal,” The Wall Street Journal 1/21/13). In 2009, Oracle, a leader in
enterprise software, acquired Sun Microsystems, a hardware company, for $7.4 billion. So as not to miss out on the
apparent business opportunities available by combining computer hardware and software and services, Dell purchased
Perot Systems for close to $4 billion in the fall of 2009. At about the same time, document-technology company Xerox
bought ACS, an IT services company for $6.4 billion.

8.5 IMPLICATIONS FOR THE STRATEGIST

RESEARCH This research identifies corporate strategy implications from the innovation
business strategy discussed in Chapter 7. The authors find that innovation
UPDATE spurs portfolio changes by leading firms to enter new businesses through
acquisition and exit out of marginal businesses through divestment. The extent
Kaul, A. (2012), to which the innovative firm pursues these changes in scope is limited by the
“Technology and availability of investment capital. Innovations by rivals also have an impact on
corporate scope: Firm and corporate scope since knowledge spillover can drive reinvestment in existing
rival innovation as businesses. The work also links back to Chapter 4 by identifying resources as
antecedents of corporate
transactions,” Strat. Mgmt. drivers of firm direction and limits on growth.
J., 33: 347‒367.
doi: 10.1002/smj.1940

Exercise
In a recent article, McKinsey consultants argue that firms are too slow to change their corporate asset allocation. They
attribute this portfolio inertia to both internal resistance to change and the stock market’s aversion to the short-term pain of
the changes. They suggest that new CEOs should take quick bold action to reallocate resources. Choose a new CEO who
has just taken the helm of a firm at the time that your course is offered. At the time of this writing, for example, Microsoft
is seeking a new CEO. Have the students look on the firm’s website and map out its corporate strategy in terms of
diversification and vertical integration. Then, show this brief video in class (about 5 minutes). Ask students to work in
small groups to develop at least one suggestion for a reallocation of resources that the new CEO should consider. AACSB
2013 Standard 9 Leading in organizational situations

To illustrate a practical example of dynamic corporate strategy, invite students to explore IBM’s strategy for continually
adjusting their portfolio to generate higher value.

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End of Chapter Small-Group Exercise 2

Target and Walmart are significant rivals in the retailing industry. Though Walmart is the world’s largest
company (2012 sales of $466 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, utilizes 45 percent of its shelf space for
consumables, with groceries being a major component. AACSB 2013 Standard 9 Thinking creatively

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.

Is Target’s problem strategy or ex ecution?

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.

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.

As an example, take the computer-technology company Oracle, which earned $23 billion in revenues in 2009. Exhibit 8.12
depicts Oracle’s corporate strategy along the vertical value chain and levels of diversification. Oracle’s core competency
lies in enterprise software (see center of figure). Oracle engaged in related diversification through backward vertical
integration into computer hardware by acquiring Sun Microsystems, and forward vertical integration into human resource
management systems (HRMS) and customer relations management (CRM) software by acquiring PeopleSoft. In its
corporate strategy, moreover, Oracle pursues related as well as unrelated diversification. It leveraged its core competency
into intellectual property (IP) management for media and entertainment businesses by its acquisition of Sophoi. Finally,
Oracle pursued unrelated diversification into online identity theft and fraud protection through its acquisition of Bharosa. It
is also noteworthy that through organic growth, Oracle executed its corporate strategy along the vertical value chain and on
diversification through acquisitions. It now has over 40 subsidiaries, some of them quite large, such as BEA Systems.

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 INSTRUCTOR MANUAL EXPERIENCED FACULTY

STRATEGY TERM Term Project Module 8

PROJECT
AACSB 2013 Standard 9 Application of knowledge (able to translate knowledge
of business and management into practice) Draw out the vertical value chain
for your firm’s industry. List the major firms in each important activity
along the chain (see Ex hibits 8.4 and 8.5 as ex amples). 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 (e.g., 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.

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.

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.

Use the preceding vertical value chain 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?

In Module 2, you were asked to identify the mis- sion 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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m y STRATEGY How Diversified Are You?

Using Ex hibit 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,”
How to position yourself you are a single-business type of personal diversification.) Instead of
for career advantage 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 ex ample, 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!). AACSB 2013 Standard 9 Reflective
thinking (able to understand oneself in the context of society)

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.

Do you need to make adjustments to your portfolio of activities? Ex plain

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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