Strategic Management An Integrated Approach 10th Edition Hill Solutions Manual

CHAPTER 9
Corporate-Level Strategy: Horizontal

Integration, Vertical Integration, and Strategic
Outsourcing
SYNOPSIS OF CHAPTER
This chapter and Chapter 10 concern corporate-level strategy. This chapter focuses on the different
strategic choices that companies make with regard to horizontal and vertical integration. In particular,
we consider the arguments for and against horizontal and vertical integration and examine cooperative
relationships such as strategic outsourcing as alternatives. Successful corporate strategy adds value by
enabling the company to perform one or more of the value creation functions at a lower cost or in a way
that allows differentiation and brings a premium price. For a company to be successful its corporate
strategy must assist in the process of establishing a distinctive competency at the business level.
To a certain extent, this view conflicts with the received wisdom of the strategic management literature.
It is often claimed that a company’s corporate-level strategy sets the context for its business-level
strategy. Our position is that if a corporate-level strategy is to succeed, the reverse should be the case.
That is, the process of establishing a sustainable competitive advantage at the business level defines the
set of appropriate corporate-level strategies.
Another theme stressed in the chapter is that the existence of bureaucratic diseconomies implies a
fundamental limit to the profitable pursuit of horizontal and vertical integration. As companies become
more diversified or vertically integrated top management begins to lose control leading to the
dissipation rather than the creation of value.
A final theme of this chapter is that strategic alliances and strategic outsourcing are often viable
alternatives to horizontal and vertical integration. That is, these strategies can achieve many of the same
benefits without encountering the same bureaucratic costs.
TEACHING OBJECTIVES
1. Discuss how corporate-level strategy can be used to strengthen company’s business model and
business-level strategies
2. Define horizontal integration and discuss the primary advantages and disadvantages associated
with this corporate-level strategy
3. Explain the differences between a company’s internal value chain and the industry value chain
4. Define horizontal integration and describe the primary advantages and disadvantages associated
with this corporate-level strategy
5. Describe why, and under what conditions, cooperative relationships such as strategic alliances and
outsourcing may become a substitute for vertical integration
OPENING CASE
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Chapter 9: Horizontal Integration, Vertical Integration, and Strategic Outsourcing 117
THE RAPID CONSOLIDATION OF THE U.S. AIRLINE INDUSTRY

This case details the U.S. airline industry pathway to consolidation. In 2008, at the height of
competition, the airline industry was faced with rising oil prices, financial recession, decreases in
demand, especially among business travelers, and resulting financial losses. With bankruptcies
abounding, merger requests, expanded route requests, and the need to reduce cost structures,
government intervention became present. With government approval, horizontal integration took place
in the airline industry. The shakeout revealed that Southwest had rapidly expanded its route structure
and made powerful acquisitions to become one of the largest U.S. carriers by 2011. As a low cost
strategy provider, where will Southwest rank in the years ahead? and what consolidations will take
place to narrow the number of airlines operating?
Teaching Note:
This case illustrates how horizontal integration changed the airline industry along with how
Southwest’s corporate strategy was used to increase company and industry profitability. Southwest used
its corporate strategy to identify 1) which businesses and industries a company should compete in now
and in the future, 2) which value creation activities it should perform in those businesses, and 3) how it
should enter or leave businesses or industries to maximize its long-run profitability.
LECTURE OUTLINE
I. OverviewThis chapter is the first of two that deals with the role of corporate-level strategy in
repositioning and redefining a company’s business model.
Three corporate level strategies-horizontal integration, vertical integration, and strategic
outsourcing—that are primarily directed toward improving a company’s competitive
advantages and profitability in its present business or product market
Different levels of strategy contribute to the creation of a successful and profitable business
model.
II Corporate-Level Strategy and the Multibusiness Model
The principal concern of corporate strategy is to enable a company or one or more of its business
divisions or units to perform value-chain functional activities 1) at a lower cost and/or 2) in
a way that results in increased differentiation. Only when it selects the appropriate
corporate-level strategies can a company choose the pricing option that will allow it to
maximize profitability. When a company decides to expand into new industries, it must
construct its business model at two levels.
1. It must develop a business model and strategies for each business unit or division in every
industry in which it competes.
2. It must develop a higher-level multibusiness model that justifies its entry into different
businesses and industries.
II. Horizontal Integration: Single Industry Corporate Strategy
Staying within one industry allows a company to focus all of its managerial, financial,
technological, and functional resources and capabilities on competing successfully on one area.
Another advantage of staying within a single industry is that a company “sticks to the knitting”
meaning that it stays focused on what it knows and does best.
Horizontal integration is the process of acquiring or merging with industry competitors to
achieve the competitive advantages that come with large scale and scope.
Horizontal integration may be achieved by acquisition, as when a company purchases another
company, or by a merger, meaning an agreement in which equals pool their operations and
create a new entity.
118 Chapter 9: Horizontal Integration, Vertical Integration, and Strategic Outsourcing
A. Benefits of Horizontal Integration: The popularity of this strategy is due to the benefits that
horizontally integrated firms realize. Profitability increases when horizontal integration
1) lowers the cost structure, 2) increases product differentiation, 3) replicates the business
model, 4) reduces rivalry within the industry, and 5) increases bargaining power over
suppliers and buyers.
1) Lower Cost Structure: Horizontal integration allows companies to grow, and

therefore to realize economies of scale. This is especially important in industries with
high fixed costs.Another benefit of horizontal integration is the cost savings due to
reducing duplication between the two companies—for example, eliminating duplicate
headquarter offices.
2) Increased Product Differentiation: Horizontal integration may also increase
profitability when it increases product differentiation by increasing the flow of
innovative new products that a company’s sales force can sell to customers at premium
prices. Other ways horizontal integration may increase differentiation are:
FOCUS ON DELL
Beating Dell: Why HP Acquired Compaq
HP shocked the business world when it announced its acquisition of rival PC maker Compaq. To justify
the acquisition, HP indicated that it would create cost savings by eliminating redundant administrative
functions and layoffs, capture scale economies, and compete more efficiently with Dell. While critics
placed doubt, HP utilized outsourcing for production and differentiation to competitively advantage
themselves against Dell. As a result, Dell was forced to find ways to differentiate and defend. Dell
resorted to the imitation of Apple’s strategy, acquisitions, and less costly materials to no avail. With
Apple’s continuous innovation in the industry, Dell and HP are now, both, looking for new ways to
lower costs and differentiate their products against even more competition.
Teaching Note:
The HP-Compaq merger was made for a number of sound reasons which were successful. However,
outsourcing was the key to their better financial results. But will that be enough to
defeat powerful rival Dell, Apple, etc? Ask students to debate this issue in class. Will outsourcing, now,
be HP’s downfall? What are the disadvantages of outsourcing?
a) In addition, horizontal integration can allow the company to offer a wider range
of products that can be sold together for a single price, a strategy called product
bundling. Customers value the convenience of bundled products, leading to
differentiation. b) Horizontal integration facilitates another strategy,
similar to bundling, called a “total solution.” This is an important strategy, for
example, in the computer industry, where corporate customers prefer the ease and
coordination of purchasing all their hardware and service from a single source.
c) Horizontal integration also aids in value creation by supporting cross selling, as
occurs when a company tries to leverage its relationship with customers by
acquiring additional product categories that can be sold to them. Again,
customers’ preference for convenience leads to differentiation.
3. Replicating the Business Model: A company that can replicate its successful business
model in new market segments within its industry can also increase its profitability.
Strategy in Action 9.1 Larry Ellison Wants Oracle Strives to Become the Biggest and the Best
This case describes Oracle’s strategy to become the leader in corporate applications software. Oracle
has acquired numerous companies to build competencies in the corporate market. This strategy allows
the company access to cutting edge applications as well as new cohorts of customers. Oracle’s CEO,
Larry Ellison, has invested heavily to acquire more than 20 leading suppliers of corporate software and
hardware. Oracle expects several competitive advantages to result from its use of acquisitions to pursue
the corporate strategy of horizontal integration: (1) melding or bundling the best software applications
of the acquired companies, (2) access to thousands of new customers, and (3) consolidation of the
industry. Oracle has become the second largest supplier of corporate software and is better positioned to
compete with leader SAP.
Teaching Note:
The Oracle case illustrates the use of corporate strategy to identify (1) which businesses and industries a
company should compete in, (2) which value creation activities to perform in those businesses, and (3)
how it should enter or leave businesses to maximize long-term profitability. Oracle has used horizontal
integration to increase the size and competitiveness of the company
3. Reduced Industry Rivalry: Horizontal integration can help to reduce industry rivalry
in two ways.
a) Acquiring or merging with a competitor helps to eliminate excess capacity in an
industry, which triggers price wars.
b) By reducing the number of competitors in an industry, horizontal integration often
makes it easier to implement tacit price coordination between rivals or coordination
reached without communication.
5. Increased Bargaining Power: Some companies use horizontal integration because it
allows them to obtain bargaining power over suppliers or buyers and increase their
profitability at the expense of suppliers or buyers. The company then has more power
to raise prices and profits because customers have less choice of suppliers and are more
dependent on the company for their products.
B. Problems with Horizontal Integration: However, horizontal integration also has some
drawbacks and limitations.
1) Mergers and acquisitions are difficult to implement successfully, and therefore
may destroy value rather than creating it. Problems include disparate cultures,
high management turnover, an underestimation of integration expenses, and a
tendency to overestimate the expected benefits and to overpay. This topic is
discussed in more detail in Chapter 10.
2) Antitrust law is designed to provide protection against the abuse of market power
and tends to favor industries with numerous smaller companies rather than
consolidated industries. The U.S. Justice Department sometimes blocks proposed
mergers and acquisitions because of these concerns about reducing competition
and raising prices for consumers.
IV. Vertical Integration: Entering New Industries to Strengthen the “Core” Business Model
A company pursuing a strategy of vertical integration expands its operations either backward
into an industry that produces inputs for the company’s products (backward vertical
integration) or forward into an industry that uses, distributes, or sells the company’s
products (forward vertical integration). There are four main stages in a typical raw
materials-to-consumer value-added chain: raw materials, component part manufacturing,
final assembly, and retail. For a company based in the assembly stage, backward integration
involves moving into intermediate manufacturing and raw-material production. Forward
integration involves movement into distribution. See Figure 9.1 for details.
Figure 9.1: Stages in the Raw-Materials-to-Consumer Value-Added Chain
Figure 9.2: The Raw-Materials-to-Customer Value-Added Chain in the PC Industry
At each stage in the chain value is added to the product. The difference between the price
paid for inputs and the price at which the product is sold is a measure of the value
added at that stage. Thus, vertical integration involves a choice about which value-
added stages of the raw materials-to-consumer chain in which to compete.
A. Increasing Profitability through Vertical Integration: Firms pursuing a strategy of vertical
integration realize some benefits. Vertical integration increases product differentiation,
lowers costs, or reduces industry competition when it 1) facilitates investments in efficiency-
enhancing specialized assets, 2) protects product quality, and 3) results in improved
scheduling.
1) Facilitating Investments in Specialized Assets: Vertical integration facilitates
investment in specialized assets. A specialized asset is an asset that is designed to
perform a specific task and whose value is significantly reduced in its next best
use. It may be a tangible or an intangible asset.
(a) Specialized assets lower the costs of value creation and provide better
differentiation, and thus provide the basis for achieving a competitive
advantage.
(b) It may be difficult to persuade companies in an adjacent stage of the
production chain to invest in specialized assets because there is a risk that
one will take advantage of the other, demanding more favorable terms after
the companies commit to the relationship. This is referred to as holdup.
(c) Instead, the company may vertically integrate and invest in specialized
assets for itself.
Strategy in Action 9.2 Specialized Assets and Vertical Integration in the Aluminum Industry
Aluminum refineries are designed to refine bauxite ore and produce aluminum. Refinery designs are
very specialized—each factory must be designed for a particular type of ore, which is produced only at
one or a few bauxite mines. Using a different type of ore would raise production costs by 50%.
Therefore, the value of the aluminum company’s investment is dependent on the price it must pay the
bauxite company. Recognizing this, once the aluminum company has made the investment in a new
refinery, the bauxite company can raise prices to hold up the refiner. The aluminum company can
reduce this risk by purchasing the bauxite company. Vertical integration, by eliminating the risk of
holdup, makes the specialized investment worthwhile.
Teaching Note:
The case reports that over 90% of aluminum refiners own the bauxite mine. Ask students to consider
whether there are any other effective methods of reducing holdup. If so, what are they? If not, why not?
2) Enhancing Product Quality: By entering industries at other stages of the value-added chain, a
company can often enhance the quality of the products in its core business and strengthen its
differentiation advantage. By enhancing product quality, vertical integration enables a company to
become a differentiated player in its core business, leading to more pricing options.
3) Improved Scheduling: Strategic advantages arise from the improved scheduling,

which includes easier planning, coordination, and scheduling of adjacent processes
made possible in vertically integrated organizations. This can be particularly important
in companies trying to realize the benefits of just-in-time inventory systems
B. Problems with Vertical Integration: However, vertical integration has some
disadvantages which include 1) increasing cost structure, 2) technology is changing fast,
and 3) demand is unpredictableBecause of these disadvantages the benefits of vertical
integration are not always as substantial as they might seem initially and result in vertical
disintegration and exits industries adjacent to its core industry in the industry value
chain.
1) Increasing Cost Structure: Although often undertaken to gain a cost advantage,
vertical integration can raise costs if a company becomes committed to
purchasing inputs from company-owned suppliers when low-cost external
sources of supply exist.
(a) Company-owned suppliers might have high operating costs relative to
independent suppliers because they know that they can always sell their
output to other parts of the company. The fact that they do not have to
compete for orders with other suppliers reduces their incentive to minimize
operating costs. In-house suppliers simply pass on cost increases to
divisions in the form of higher transfer prices, the prices one division of a
company charges other divisions for its products. The term bureaucratic
costs refers to the costs of solving the transaction difficulties that arise from
managerial inefficiencies and the need to manage the handoffs or exchanges
between business units to promote increased differentiation or to lower a
company’s cost structure.
1) Technological Change: When technology is changing rapidly, vertical
integration poses the hazard of tying a company to an obsolescent technology.
Vertical integration can inhibit a company’s ability to change its suppliers or its
distribution systems to match the requirements of changing technology.
3) Demand Unpredictability: Vertical integration can be risky in unstable or
unpredictable demand conditions because it may be difficult to achieve close
coordination among vertically integrated activities along the value-added chain.
C. The Limits to Vertical Integration: Vertical integration may weaken a company

when 1) bureaucratic costs increase because company-owned suppliers lack the
incentive to reduce operating costs and 2) changing technology or uncertain
demand reduces a company’s ability to change its business model to protect its
competitive advantage.
II. Alternatives to Vertical Integration: Cooperative Relationships
Under certain conditions companies can realize the gains associated with vertical integration
without having to bear the associated bureaucratic costs if they enter into long-term
cooperative relationships with companies in industries along the value-added chain.

Strategic alliances are long-term agreements between two or more companies to jointly
develop new products or processes that benefit all companies concerned. A. Short-Term
Contracts and Competitive Bidding: Many companies use short-term contracts that last for
a year or less to establish the price and conditions under which they will purchase raw
materials or components from suppliers or sell their final products to distributors or retailers.
Short-term contracting does not result in specialized investments that are required to realize
differentiation and cost advantages because it signals a lack of long-term commitment to its
suppliers. This is not a problem when there is minimal need for close cooperation between
the company and its suppliers to facilitate investments in specialized assets, improve
scheduling, or improve product quality. Indeed, in such cases competitive bidding may be
optimal.
A. Strategic Alliances and Long-Term Contracting: In contrast to short-term contracts, strategic

alliances between buyers and suppliers are long-term, cooperative relationships; both companies
agree to make specialized investments and work jointly to find ways to lower costs or increase
product quality so that they both gain from their relationship.
This stable long-term relationship lets the participating companies share the value that might
be created by vertical integration while avoiding many of its bureaucratic costs. Thus
long-term contracts can be a substitute for vertical integration.
B. Building Long-Term Cooperative Relationships: Companies can take some specific steps to
ensure that a long-term relationship can succeed and to lessen the chances of one party taking
advantage of the other.
1. One way of designing long-term cooperative relationships to build trust and reduce the
possibility of a company reneging on an agreement is, for the company making
investments in specialized assets, to demand a hostage from its partner. This occurs
when companies both invest in specialized assets in order to serve each other, making
them mutually dependent and therefore less likely to renege.
2. A credible commitment is a believable commitment to support the development of a
long-term relationship between companies. Credible commitments involve long-term
and substantial investments, and therefore are believable guarantees of trust.
a) Hostage Taking: This essentially is a means of guaranteeing that each partner will
keep its side of the bargain.
Strategy in Action 9.3 Apple, Samsung, and Nokia Battle in the Smartphone Market
Apple, Samsung, and Nokia formed strategic alliances with one another despite being competitors.
Unfortunately, this highly profitable and growing smartphone market is filled with litigation among the
three.
Teaching Note:
This case demonstrates how a company can form strategic alliances but that they may result in long-
term disadvantage. Remind students of the importance of examining the value chain for opportunities
for integration. Ask students what might have prevented this stream of litigation? Assign students other
companies to examine for vertical integration ideas.
b) Credible Commitments: A credible commitment is a believable promise or

pledge to support the development of a long-term relationship between companies.
c) Maintaining Market Discipline:Building a cooperative long-term

relationship is more readily relied upon when a company can maintain some kind of
market discipline on its partner, to ensure that the partner doesn’t lack incentives to
maintain efficiency.
Strategy in Action 9.4 Ebay’s Changing Commitment to Its Sellers

Since its founding in 1995, eBay has always cultivated good relationships with the millions of sellers
that advertise their goods for sale on its Website. In order to improve the buyer experience, eBay
implemented major changes in policy, primarily, in fee structure and feedback. All of which negatively
impacted the sellers. Revolts and boycotts, on the part of sellers, proved that eBay’s level of
commitment to sellers had fallen dramatically. As a result, eBay reversed course with eliminating
several fee increases, revamped the feedback system. However, the old “community relationship” had
been destroyed.
Teaching Note:
This case demonstrates how a company should find ways to maintain cooperative relationships. Ask
students what eBay, specifically, could have done to be aware of seller feelings?
1) One way of maintaining market discipline is to periodically renegotiate the

agreement. Thus, a partner knows that if it fails to live up to its side of the
agreement, the company may refuse to renew.
a) Another way to maintain market discipline is to enter into long-term
relationships with suppliers using parallel sourcing policies. Under this
arrangement, a company enters into a long-term contract with two suppliers for
the same part. The idea is that when a company has two suppliers for a single
part, each supplier knows that it must fulfill its side of the bargain, lest the
company terminate the contract and switch business to the other supplier.
III. Strategic Outsourcing
Vertical integration and strategic alliances are alternative ways of managing the value chain
across industries to strengthen a company’s core business model. Strategic outsourcing is the
decision to allow one or more of a company’s value-chain activities or functions to be performed
by independent specialist companies that focus all their skills and knowledge on just one kind of
activity. When a company chooses to outsource a value-chain activity, it is choosing to focus on a
fewer number of value-creation activities to strengthen its business model.
Strategy in Action 9.5 Apple Tries to Protect its New Products and the Workers Who Make Them
Apple’s PCs and mobile computing devises are assembled by huge specialists outsourcing companies
abroad. In the interest of secrecy, Apple has retaliated with litigation and company secrecy policies.
Many of their outsourcing contracts include confidentiality clauses with penalties for security breaches.
Appearing rather restrictive to employees regarding secrecy, Apple has been criticized and
contradictory in their approach to employee/employment policies. Unethical employee treatment on the
part of their outsourcer partners forced Apple to terminate some contracts. The question is: Which is
more important to Apple---secrecy or employee rights?
Teaching Note:
This case demonstrates how a company can outsource its operations and protect such aspects as secrecy
but fail in selecting outsource partners that enhance the image of the company. Ask students what
Apple should have done in this situation?
Figure 9.4: Strategic Outsourcing of Primary Value Creation Functions
The term virtual corporation has been coined to describe companies that have pursued extensive
strategic outsourcing.
A. Benefits of Outsourcing: There are several advantages of strategic outsourcing. It can help a
company to 1) lower its cost structure, 2) increase product differentiation, 3) focus on the
distinctive competencies that are vital to its long-term competitive advantage and
profitability.
1. Lower Cost Structure: Outsourcing will reduce costs when the price that must be
paid to a specialist company to perform a particular value-chain activity is less than
what it would cost the company to internally perform that activity in-house.
a) Suppliers may be more efficient due to economies of scale or learning effects.
b) Suppliers may also be more efficient because of a low-cost location.
2. Enhanced Differentiation: By outsourcing a noncore value creation activity to a
supplier that has a distinctive competency in that particular activity, the company may
be able to better differentiate its final product.
3. Focus on the Core Business: A third advantage of strategic outsourcing is that it
allows the company to remove distractions, focusing more resources on strengthening
its distinctive competencies.
B. Risks of Outsourcing: There are also some risks associated with strategic outsourcing such
as holdup and the possible loss of important information when activity is outsourced.
1. Holdup: There is a risk of holdup, or becoming too dependent on an outsourced
activity.
a) This risk can be reduced by outsourcing from several companies at once, using a
parallel sourcing policy.
b) Another way to manage this risk is simply to signal to the subcontractors the
company’s willingness to choose a different provider when the contract is up for
renewal.
2. Loss of Information: Another concern is the potential for a loss of important
competitive information. This risk can be managed by ensuring good communication
between the subcontractor and the company.
Teaching Note: Ethical Dilemma

This question should be used to question whether a proposed merger interferes with FTC antitrust
guidelines, would create unfair competition, or would otherwise be monopolistic. The instructor should
use this as a homework assignment to allow students to research two or three companies whose mergers
have presented concerns at the FTC level. As part of the assignment, then ask the students to conclude
their research with the answer to “what criteria they would use to make the determination”?
SUMMARY OF CHAPTER
ANSWERS TO DISCUSSION QUESTIONS

1. Under what conditions might horizontal integration be inconsistent with the goal of maximizing
profitability?
Horizontal integration is not consistent with maximizing stockholder wealth when implementation
problems override value creation. A study by KPMG concluded that only 30% of 700 large
acquisitions increased the profitability of the acquiring company. Implementation will be difficult
if prospective targets have organizational cultures or business practices that differ sharply from
those of the acquiring firm.
When a firm already dominates its industry, it may not be possible to maximize profitability by
merger or acquisition due to antitrust law enforcement.
Finally, if a company is pursuing horizontal integration for any other reason (such as management
ego or to ward off a rival) than to increase differentiation and improve cost structure, then it will
be inconsistent with profit maximization goals.
2. What is the difference between a company’s internal value chain and the industry value chain?
What is the relationship between vertical integration and industry value chain?
A value chain runs across industries, and embedded within that are the value chains of companies
within each industry. A company pursuing a strategy of vertical integration expands its operations
either backward into an industry that produces inputs for the company’s products or forward into
an industry that uses, distributes, or sells the company’s products. To enter an industry, it may
establish its own operations and build the value chain needed to compete effectively in that
industry; or it may acquire a company that is already in the industry.
3. Why was it profitable for GM and Ford to integrate backward into component-parts
manufacturing in the past, and why are both companies now buying more of their parts from
outside suppliers?
Back in the 1920s, when Ford and GM originally began to vertically integrate backward there
were two main reasons for doing so. First, the component supply industry was not well developed,
so automakers had to manufacture some parts themselves. Second, they wanted to achieve tight
coordination between adjacent stages of production to lower their production costs.
By the 1980s, however, conditions had changed. A lack of competitive pressures led to internal
suppliers becoming inefficient (the bureaucratic costs were high). Also, unionization made
in-house suppliers’ labor expenses too high. Furthermore, capacity reductions meant that both
companies were experiencing excess capacity at in-house suppliers. Also, Japanese auto
companies had shown that entering into long-term contractual relationships with component
suppliers was a viable low-cost alternative to formal vertical integration.
4. What value creation activities should a company outsource to independent suppliers? What are the
risks involved in outsourcing these activities?
Companies should consider strategic outsourcing of functions that do not form the basis of its
competitive advantage. Thus, universities may outsource food preparation, but a restaurant should
not.
Companies should outsource when there are a number of independent suppliers that can provide
the activities more efficiently or more effectively than the firm can. Many companies outsource
functions such as janitorial services, payroll, or temp hiring.
Companies should outsource when there is a low risk of the firm becoming too dependent on its
supplier. The high number of suppliers for corporate legal counsel makes it unlikely that the firm
would become overly dependent on any one supplier.
Risks of outsourcing include loss of ability to learn from that activity and loss of the opportunity
to transform that activity into a distinctive competence. A further drawback of outsourcing is that
the company may become too dependent upon a particular supplier. Another concern is that, in its
enthusiasm for strategic outsourcing, a company might go too far and outsource value creation
activities that are central to the maintenance of its competitive advantage.
5. What steps would you recommend that a company take to build mutually beneficial long-term
cooperative relationships with its suppliers?
The main objective in building long-term stable relationships must be the establishment of mutual
trust. Therefore, the company should consider actions such as the creation of liaison roles in both
the firm and the supplier, with an emphasis on open, friendly communication. The firm should
ensure that all parties are aware of the opportunities for mutual benefit, and then design a system
that rewards innovations and suggestions. The firm must then follow through in investigating and
responding to suggestions and appropriately rewarding those responsible for any resulting
improvements.
The other important consideration is to ensure that the supplier does not exploit the relationship
for its exclusive benefit. This can be accomplished by creating a hostage through mutual
investment in specialized assets. Credible commitments, periodic contract renegotiation, and
parallel sourcing policies can also be used to ensure equity in the relationship.
PRACTICING STRATEGIC MANAGEMENT
SMALL-GROUP EXERCISE: COMPARING VERTICAL INTEGRATION

STRATEGIES
Students are asked to break into small groups and read a short case about Quantum Corporation and
Seagate Technologies. They are then asked to describe the costs and benefits of a vertical integration
strategy, as illustrated in the case. The students also should recommend a strategy for firms in the
computer disk drive industry.
Teaching Note:
Quantum uses a vertical integration approach to the manufacture of disk drives, which gives the firm
control over proprietary technology and product quality and enables better coordination between steps
as well. However, the firm faces high bureaucratic costs from that coordination, high operating costs
due to lack of competitive pressures, and risks of technological obsolescence. Seagate outsources mass
market production to an overseas supplier, which reduces costs and allows the company to focus on
what it does best, which is R&D. However, Seagate risks loss of control over scheduling and costs and
also risks losing its proprietary technology.
STRATEGY SIGN-ON
ARTICLE FILE 9
Students should find an example of a company whose vertical integration or diversification strategy
appears to have dissipated rather than created value. They should determine why this has happened and
what the company should do to rectify the situation.
Teaching Note:
Students should examine companies that have undergone a recent merger or acquisition to find good
candidates for this exercise. The students can evaluate the success of a merger or acquisition by looking
at profitability before and after the merger. If this proves difficult, another, perhaps easier, way to
examine performance is to look at stock price over time. If the stock price declines after the merger,
then the market values the merged companies less. Investors can be wrong about a firm’s future
performance, however, so use stock valuation cautiously.
STRATEGIC MANAGEMENT PROJECT: MODULE 9

This module requires students to assess the horizontal and vertical integration strategy being pursued by
their companies. Students should describe the current level of horizontal and vertical integration, and
explain the reasons why the company integrated. They also must assess the potential for vertical
integration. The students then evaluate the company’s outsourcing and strategic alliances, making
recommendations for improvements in both areas.
Teaching Note:
Students will be able to find information about a company’s recent merger and acquisition activity by
examining its web site. An organization chart will show the current levels of integration. The remaining
questions are opinion questions, and students should be encouraged to look closely at the material in
this chapter for help in answering them.
In the General Task, students should readily find examples of firms that are using strategic outsourcing.
They may not be able to find detailed financial information about the costs and benefits of the
outsourcing, so allow them to answer this question in general or speculative terms.
CLOSING CASE
NEWS CORP FORGES AHEAD
This case details the media empire that Rupert Murdoch built. He started with a single newspaper in
Adelaide, Australia. Initially he followed a horizontal integration strategy, acquiring newspapers
throughout Australia, moving to England, and then ultimately to the U.S. Subsequently, he realized the
value of owning both content providers and channel providers and began acquiring media companies,
moving to a vertical integration strategy. He created Fox Broadcasting and Fox Movie studios. He also
increased his presence in satellite broadcasting. While he has created a huge media empire, it has not
always been profitable, at times having trouble servicing its debt. Recently, however, the company has
been performing strongly with new Internet acquisitions that create more value from his media assets.
Teaching Note:
The News Corp case illustrates the use of a corporate strategy to identify 1) which businesses and
industries a company should compete in now and in the future, 2) which value creation activities it
should perform in those businesses, and 3) how it should enter or leave businesses or industries to
maximize its long-run profitability. Rupert Murdoch has used both horizontal and vertical integration
strategies to grow his News Corp.
ANSWERS TO CASE DISCUSSION QUESTIONS

1. What kind of corporate-level strategies did News Corp pursue to build its multibusiness models?
News Corp has maintained, both, horizontal and vertical integration throughout its history.
2. What are the advantages and disadvantages associated with these strategies?
The advantages of horizontal integration is a lower cost structure, increased product
differentiation, replication of the business model, reduced industry rivalry, and increased
bargaining power, The disadvantages of horizontal integration are that mergers contribute to high
management turnover and governmental conflicts The advantages of vertical integration are
product differentiation, lower costs, and reduction in industry competition. The disadvantages of
vertical integration are increasing cost structure, technology changing fast, and demand being
unpredictable.

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CHAPTER 9

Corporate-Level Strategy: Horizontal

THE RAPID CONSOLIDATION OF THE U.S. AIRLINE INDUSTRY

1) Lower Cost Structure: Horizontal integration allows companies to grow, and

3) Improved Scheduling: Strategic advantages arise from the improved scheduling,

C. The Limits to Vertical Integration: Vertical integration may weaken a company

cooperative relationships with companies in industries along the value-added chain.

A. Strategic Alliances and Long-Term Contracting: In contrast to short-term contracts, strategic

b) Credible Commitments: A credible commitment is a believable promise or

c) Maintaining Market Discipline:Building a cooperative long-term

Strategy in Action 9.4 Ebay’s Changing Commitment to Its Sellers

1) One way of maintaining market discipline is to periodically renegotiate the

Teaching Note: Ethical Dilemma

ANSWERS TO DISCUSSION QUESTIONS

PRACTICING STRATEGIC MANAGEMENT

SMALL-GROUP EXERCISE: COMPARING VERTICAL INTEGRATION

STRATEGIC MANAGEMENT PROJECT: MODULE 9

ANSWERS TO CASE DISCUSSION QUESTIONS

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