SEU_MGT510_Module09_PPT_Ch10.ppt

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    CONTEMPORARY STRATEGY ANALYSIS

    tenth edition

    Robert M. Grant

    John Wiley & Sons Ltd., 2019

    Chapter 10

    Vertical Integration and the Scope of the Firm

    • Transaction Costs and the Scope of the Firm
    • The Benefits and Costs of Vertical Integration
    • Designing Vertical Relationships

    Vertical Integration and

    the Scope of the Firm

    Copyright © 2019 John Wiley & Sons, Inc.

    OUTLINE

    33

    • Business Strategy is concerned with how a firm computes within a particular market
    • Corporate Strategy is concerned with where a firm competes, i.e. the scope of its activities
    • The dimensions of scope are:
    • vertical scope
    • geographical scope
    • product scope

    From Business Strategy to Corporate Strategy: The Scope of the Firm

    Copyright © 2019 John Wiley & Sons, Inc.

    TRANSACTION COSTS AND THE SCOPE OF THE FIRM

    34

    Multiple specialist firms vs. integration within a single firm

    Specialized firms

    Single integrated firm

    Vertical scope:

    Electric cars

    Product scope:

    Entertainment

    Geographical

    scope:

    Banking

    LG (Battery)

    Ford (Final assembly)

    Magna (Drivetrain)

    S Video games

    O Consumer

    N electronics

    Y Movies

    Wells Fargo (US)

    Banco Bradesco (Brazil)

    Lloyds Banking Group (UK)

    T Battery

    E

    S Drivetrain

    L

    A Assembly

    Nintendo (Video games)

    MGM (Movies)

    Panasonic (Consumer electronics)

    Ford Focus Electric

    H US

    S UK

    B Brazil

    C + other countries

    TRANSACTION COSTS AND THE SCOPE OF THE FIRM

    Expanding Scale and Scope

    • scale economies from new technologies
    • new management tools
    • multidivisional structure
    • computers
    • international expansion

    Restructuring, Refocusing and Downsizing:

    • Quest for shareholder value: focus on core competences and core businesses
    • Turbulent business environment: inflexibility of large, complex hierarchies
    • Digital revolution

    Top 100 companies’ share of total employment (%)

    The changing scale and scope of large US companies

    Consolidation through mergers and acquisitions

    Quest for scale and market dominance in both mature and hi-tech sectors

    Second Industrial Revolution: Growth of industrial giants assisted by electricity, the telephone, innovations in

    management and organization

    Railways, canals, and telegraph expand firms geographical reach

    TRANSACTION COSTS AND THE SCOPE OF THE FIRM

    Copyright © 2019 John Wiley & Sons, Inc.

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    Chart1

    1800 1800 1800
    1810 1810 1810
    1820 1820 1820
    1830 1830 1830
    1840 1840 1840
    1850 1850 1850
    1860 1860 1860
    1870 1870 1870
    1880 1880 1880
    1890 1890 1890
    1900 1900 1900
    1910 1910 1910
    1920 1920 1920
    1930 1930 1930
    1940 1940 1940
    1950 1950 1950
    1960 1960 1960
    1970 1970 1970
    1980 1980 1980
    1990 1990 1990
    2000 2000 2000
    2010 2010 2010
    2020 2020 2020
    First Industrial Revolution: Mechanization and the factory system
    Series 1
    Column1
    Column2
    0.7
    0.5
    0.6
    0.7
    1
    1.7
    1.9
    2.3
    2.9
    3.1
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    4.9
    6
    6.7
    6.8
    9.6
    13
    14.4
    13.8
    11.6
    11.3
    11.5
    11.7

    Sheet1

    Series 1 Column1 Column2
    1800 0.7
    1810 0.5
    1820 0.6
    1830 0.7
    1840 1
    1850 1.7
    1860 1.9
    1870 2.3
    1880 2.9
    1890 3.1
    1900 4.2
    1910 4.9
    1920 6
    1930 6.7
    1940 6.8
    1950 9.6
    1960 13
    1970 14.4
    1980 13.8
    1990 11.6
    2000 11.3
    2010 11.5
    2020 11.7
    • Technical economies from integrating processes e.g. iron and steel production

    —but doesn’t necessarily require common ownership

    • Avoids transactions costs of market contracts in situations where there are:

    — small numbers of firms

    — transaction-specific investments

    — opportunism and strategic misrepresentation

    — taxes and regulations on market transactions

    • Superior coordination

    The Benefits of Vertical Integration

    7

    Copyright © 2019 John Wiley & Sons, Inc.

    THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

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    • Differences in optimal scale of operation between different stages of production prevent balanced vertical integration
    • Inhibits development of distinctive capabilities
    • Difficulties of managing strategically different businesses
    • Incentive problems: lack of “high-powered” incentives
    • Limits flexibility– in responding to demand fluctuations

    — in responding to changes in technology,

    customer preferences, etc.

    (But, may be conducive to system-wide flexibility)

    • Compounding of risk

    The Costs of Vertical Integration

    Copyright © 2019 John Wiley & Sons, Inc.

    THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

    40

    How many firms in the adjacent stage?

    Do transaction-specific investments necessary?

    The greater the need for transaction-specific investments, the greater the advantages of VI

    Is information evenly distributed across the stages?

    The greater are information asymmetries, the greater the advantages of VI

    Is there uncertainty over the period of the relationship?

    The greater the uncertainty, the more incomplete is the contract and the greater the advantages of VI

    How similar is optimal scale between the two stages?

    The greater the dissimilarity, the less advantageous is VI

    How strategically similar are the two stages?

    Do capabilities in the adjacent stage need to be continually upgraded?

    The fewer the number, the less advantageous is VI

    Are profit incentives critical to performance?

    The greater the need for high-powered incentives the greater the disadvantages of VI

    Unpredictable demand reduces advantages of VI

    Is market demand uncertain?

    The greater the need for capability development the greater the disadvantages of VI

    Is the adjacent stage highly risky?

    VI tends to compound risk

    Characteristics of the vertical relationship

    Implications for VI

    Vertical Integration v. Outsourcing: Key Considerations

    Do transaction-specific investments necessary?

    THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

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    Iron ore

    mining

    Steel

    production

    Steel strip

    production

    Can

    making

    MARKET

    CONTRACTS

    VERTICAL

    INTEGRATION

    MARKET

    CONTRACTS

    Canning of

    food, drink, oil, etc.

    VERTICAL

    INTEGRATION,

    AND MARKET

    CONTRACTS

    What factors explain why some stages are vertically integrated,

    while others are linked by market transactions?

    The Value Chain for Steel Cans

    Copyright © 2019 John Wiley & Sons, Inc.

    THE COSTS AND BENEFITS OF VERTICAL INTEGRATION

    • Choices not limited to vertical integration or arms-length market contracts:

    — Several intermediate types of vertical relationship: these may combine benefits of both market transactions and internalization

    • Key issues in designing vertical relationships:

    — No generic solution: depends upon the resources,

    capabilities and strategy of the individual firm

    — How is risk to be allocated between the parties?

    — Are the incentives appropriate?

    Long-Term Contracts and

    Quasi-Vertical Integration

    Copyright © 2019 John Wiley & Sons, Inc.

    DESIGNING VERTICAL RELATIONSHIPS

    41

    Spot sales/ purchases

    Long-term contracts

    Agency agreements

    Franchises

    Vertical integration

    Joint ventures

    Informal supplier/ customer relationships

    Supplier/ customer partnerships

    Degree of Commitment

    Formalization

    Different Types of Vertical Relationship

    Low

    High

    Low

    High

    Copyright © 2019 John Wiley & Sons, Inc.

    DESIGNING VERTICAL RELATIONSHIPS

    3

    • From competitive contracting to supplier partnerships, e.g. in autos
    • From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services).
    • Diffusion of franchising
    • Technology partnerships (e.g. IBM- Apple; Canon- HP)
    • Inter-firm networks

    General conclusion:- boundaries between firms and markets are becoming increasingly blurred.

    Recent Trends in Vertical Relationships

    Copyright © 2019 John Wiley & Sons, Inc.

    DESIGNING VERTICAL RELATIONSHIPS

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