Part III
Corporate Strategies
Chapter #6
Vertical Integration
Opening Case
 Outsourcing
Definitions
 Corporate Strategy
– A firm’s theory of how to gain
competitive advantage by operating
several businesses simultaneously.
 Vertical Integration
– The number of steps in a value chain
that a firm accomplishes within its
boundaries
Backward and forward
 Backward to secure raw materials or
resources
 Forward to secure markets
What is the value of integration?
 Do we ignore the invisible hand of the
market
 Centralized planning
Transaction cost theory
 Transaction specific investments
 Transaction specific investments make
parties to an exchange vulnerable
 Vertical integration solves this
vulnerability problem
Capabilities theories of vertical
integration
 Emphasizes vertical integration to
exploit the valuable, rare and costly to
imitate resources and capabilities a firm
may control
Vertically integrate?
 Should
– Integrate into those business activities
where they possess valuable, rare and
costly to imitate resources and capabilities
 Should not
– Integrate into business activities where
they do not possess the resources
necessary to gain competitive advantages
Real Options Theories of Vertical
Integration
 In conditions of “high uncertainty”, when
the future value of an exchange cannot
be known when investments in that
exchange are being made, less vertical
integration is better than more vertical
integration.
 Pharmaceuticals
 Blue Tooth
Alliance instead of Integration
 Down side costs are known
 Still maintain access to the upside
potential
Research on the three theories
 Transaction costs
– Oldest (most research)
– Transaction specific costs lead to vertical
integration (empirical evidence)
 Add uncertainty
– Less vertical integration than predicted by
transaction specific costs
 All three work together
Transaction costs and call centers
 What were the costs
early on
 Now
– Call center
employees follow
scripts
– Only a few problems
cannot be diagnosed
from the script
Capabilities and managing call centers
 Early, call centers
were a source of
competitive
advantage
 Now easy to
duplicate
Real options and managing call centers
 Will outsourcing call
centers really work?
 Try it with different
call centers
 No incentive to
internalize nor invest
in a particular
technology
Ethics
 Who is outsourcing?
The rarity of vertical integration
 Technology
 Rare capabilities
 Resolve uncertainty
Substitutes for vertical integration
 Alliances (chapter 7)
Organizing for vertical integration
 Organizational structure
– Functional
 Management controls
 Compensation policies
Entrepreneurship and Small business
 Oprah, Inc
Resolving functional conflics
 Conflict not necessarily bad
 Manufacturing versus Sales
The budgeting process
 Making it work for functional managers
– The process used in developing
budgets is open and participative
– The process reflects the economic
reality facing functional managers and
the firm
– Quantitative evaluations augmented
by qualitative
Committee Oversight
 Executive committee
 Operations committee
Compensation
 Firm specific costs
– US versus Japanese
 Capabilities
– Socially complex
 Real options
– High risks, known downside
– Upside potential