Chapter 6

Vertical Integration

Copyright © 2010 Pearson Education, Inc. publishing as Prentice Hall.

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Strategic Management & Competitive Advantage – Barney & Hesterly 6-2 2 . publishing as Prentice Hall. Inc.Vertical Integration Vertical Integration The Strategic Management Process External Analysis Strategic Choice Strategy Implementation Competitive Advantage Mission Objectives Internal Analysis Which Businesses to Enter? Corporate Level Strategy • Vertical Integration Copyright © 2010 Pearson Education.

publishing as Prentice Hall. Strategic Management & Competitive Advantage – Barney & Hesterly 6-3 3 . Inc.Vertical Integration 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 Copyright © 2010 Pearson Education.

Inc.Vertical Integration Vertical Integration What is Vertical Integration? Where your pizza comes from Dairy Farmers (milk) Seed Companies (Alfalfa & Corn) Pizza Chains Leprino Foods (Mozzarella Cheese) Crop Farmers (Alfalfa & Corn) End Consumer Food Distributors Copyright © 2010 Pearson Education. publishing as Prentice Hall. Strategic Management & Competitive Advantage – Barney & Hesterly 6-4 4 .

Inc. publishing as Prentice Hall. Strategic Management & Competitive Advantage – Barney & Hesterly .Vertical Integration Vertical Integration What is Vertical Integration? Backward Vertical Integration Pizza Chains Leprino Foods (Mozzarella Cheese) Dairy Farmers (milk) Seed Companies (Alfalfa & Corn) Crop Farmers (Alfalfa & Corn) End Consumer Food Distributors Forward Vertical Integration 6-5 5 Copyright © 2010 Pearson Education.

Vertical Integration Vertical Integration Value Chain Economies The Logic of Value Chain Economies • the focal firm is able to create synergy with the other firm(s) • cost reduction • revenue enhancement • the focal firm is able to capture above normal economic returns (avoid perfect competition) Copyright © 2010 Pearson Education. publishing as Prentice Hall. Inc. Strategic Management & Competitive Dairy Farmers (milk) Backward Vertical Integration Leprino Foods (Mozzarella Cheese) Food Distributors Forward Vertical Integration 6-6 6 Advantage – Barney & Hesterly .

Inc.Vertical Integration 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. publishing as Prentice Hall. Strategic Management & Competitive Advantage – Barney & Hesterly 6-7 7 . Copyright © 2010 Pearson Education.

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 Copyright © 2010 Pearson Education. publishing as Prentice Hall. Inc. Strategic Management & Competitive Advantage – Barney & Hesterly 6-8 8 .Vertical Integration 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.

Vertical Integration Vertical Integration Value of Vertical Integration Three Value Considerations Leverage Capabilities • firm capabilities may be sources of competitive advantage in other businesses Manage Opportunism • opportunism may be checked by internalizing (TSI) Exploit Flexibility • internalizing is usually less flexible • flexibility is prized when • internalizing must • if not. Strategic Management & Competitive Advantage – Barney & Hesterly 6-9 9 . Inc. then don’t uncertainty is be less costly than integrate exchange high opportunism Copyright © 2010 Pearson Education. publishing as Prentice Hall.

publishing as Prentice Hall.Vertical Integration Vertical Integration Rarity of Vertical Integration Integration vs. Non-Integration • a firm’s integration strategy may be rare because the firm integrates or because the firm does not integrate • thus. Inc. the question of rareness does not depend on the number of forms observed • a firm’s integration strategy is rare or common with respect to the value created by the strategy Example: Toyota’s Choice Not to Integrate Suppliers Copyright © 2010 Pearson Education. Strategic Management & Competitive Advantage – Barney & Hesterly 6-10 10 .

if: • the integrated firm possesses resource combinations that are the result of: • historical uniqueness • causal ambiguity • social complexity • small numbers prevent further integration • capital requirements are prohibitive Copyright © 2010 Pearson Education. publishing as Prentice Hall. per se. Function • the form. Strategic Management & Competitive Advantage – Barney & Hesterly 6-11 11 .Vertical Integration Vertical Integration Imitability of Vertical Integration Form vs. is usually not costly to imitate • the value-producing function of integration may be costly to imitate. Inc.

Inc. publishing as Prentice Hall. one firm may acquire a supplier while a competitor could imitate that strategy through internal development • in both cases. Strategic Management & Competitive Advantage – Barney & Hesterly 6-12 12 .Vertical Integration Vertical Integration Imitability of Vertical Integration Modes of Entry • acquisition and internal development are alternative modes of entry into vertical integration • thus. the boundaries of the firm would encompass the new business • strategic alliances can be viewed as a substitute for vertical integration—without the costs of ownership Copyright © 2010 Pearson Education.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-13 13 . publishing as Prentice Hall. Inc.Vertical Integration Vertical Integration Organizing Vertical Integration Functional Structure (U-Form) CEO’s Role Cooperation Accounting Finance Marketing HR Engineering Cooperation Conflict Original Business New Business Original Business New Business Original Business New Business Original Business New Business Original Business New Business Conflict Copyright © 2010 Pearson Education.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-14 14 . publishing as Prentice Hall. Inc.Vertical Integration Vertical Integration Organizing 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 Copyright © 2010 Pearson Education.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-15 15 .Vertical Integration Vertical Integration Organizing Vertical Integration Management Controls Budgets • separating strategic and operational budgets • strategic: inputs & outputs • operational: outputs Board Committees • provide oversight and direction to managers • help ensure that strategic direction is maintained These mechanisms focus management attention on achieving value chain economies Copyright © 2010 Pearson Education. publishing as Prentice Hall. Inc.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-16 16 .Vertical Integration Vertical Integration Organizing Vertical Integration Compensation Salary Opportunism Integration Cash Bonus: Individual Stock Grants: Individual Leveraging Capabilities Cash Bonus: Group Stock Grants: Group Stock Options: Individual Stock Options: Group Cooperation Exploiting Flexibility Time Horizon Copyright © 2010 Pearson Education. publishing as Prentice Hall. Inc.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-17 17 . is not rare nor costly to imitate Copyright © 2010 Pearson Education.Vertical Integration 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. publishing as Prentice Hall. Inc.

Strategic Management & Competitive Advantage – Barney & Hesterly 6-18 18 .Vertical Integration 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. publishing as Prentice Hall. Inc. 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! Copyright © 2010 Pearson Education.

publishing as Prentice Hall. publishing as Prentice Hall Copyright © 2010 Pearson Education. Strategic Management & Competitive Advantage – Barney & Hesterly 6-19 19 . or transmitted. Printed in the United States of America. mechanical. electronic. without the prior written permission of the publisher. Inc.Vertical Integration Vertical Integration All rights reserved. in any form or by any means. or otherwise. Copyright ©2010 Pearson Education. photocopying. recording. No part of this publication may be reproduced. stored in a retrieval system. Inc.