GARETH R. JONES /CHARLES W. L.

HILL

Theory of Strategic Management 10th ed.

Corporate-Level
Chapter
Strategy: Horizontal
9 Integration, Vertical
Integration, and
Strategic Outsourcing
 THE RAPID CONSOLIDATION OF
THE U.S. AIRLINE INDUSTRY
 When the oil prices, which constitute 35% of an
airline’s total operating cost, began rising, and the
recent financial recession occurred, a significant
decrease in the number of business travelers led
to billions of dollars in losses for most major
airlines.
 A horizontal integration of U.S. airlines allowed
them to reduce their cost structures by reducing
the number of flights, mothballing hundreds of
older planes, adding surcharges, and laying off
thousands of employees.
(continued)
 THE RAPID CONSOLIDATION OF
THE U.S. AIRLINE INDUSTRY
 While the other airlines lost billions, Southwest
Airlines made $439 million in 2010.
 Southwest raised its fares in response to the
moves of other airlines.
 Many analysts, watching Southwest’s ever-
changing online fares, wondered if it would simply
use its low-cost structure to outperform its high-
cost rivals, and only reduce prices when falling
demand warranted the reduction.

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Learning Objectives

• discusses how corporate-level strategy can be used to

strengthen a company’s business model and business-
level strategies
• define horizontal integration and describe the primary
advantages and disadvantages associated with this
corporate-level strategy
• define vertical integration and describe the primary
advantages and disadvantages associated with
corporate-level strategy
• describe why, and under what conditions, cooperative
relationships such as strategic alliances and outsourcing
may become a substitute for vertical integration
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 CORPORATE-LEVEL STRATEGY AND
THE MULTIBUSINESS MODEL

 Corporate-level strategies drive a company’s

business model over time.
 It determines which types of business- and
functional-level strategies managers will
choose to maximize long-term profitability.
 CORPORATE-LEVEL STRATEGY AND
THE MULTIBUSINESS MODEL
 Only when a company selects a corporate-level
strategy 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 a business model at
two levels:
1) It must develop a business model and strategy
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 these businesses.
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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

 An advantage of staying within one industry is

that it allows a company to focus all of its
managerial, financial, technological, and
functional resources and capabilities on
competing successfully in one area.
 Company “sticks to the knitting”- it stay
focused on what it knows and does the best.
 E.g.
 Wal-Mart – Retail Discounting
 McDonald’s – Global Fast-food Business 9-7
 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

 Even when a company stays within one

industry, it is easy for strategic managers to
fail to see the changing nature of the industry
because they are focusing only on how to
position current products.
 A focus on corporate-level strategy can help
managers anticipate future trends.

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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

 Horizontal integration is the process of acquiring or

merging with industry competitors to achieve the
competitive advantages that arise from a large size
and scope of operation.
 An acquisition occurs when one company uses its
capital resources, such as stock, debt, or cash, to
purchase another company.

 A merger is an agreement between two companies to

pool their resources and operations and join together
to better compete in a business

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20 Game Changing Consumer Tech Merger & Acquisitions
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Mergers & Acquisitions 9-11
 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

Benefits of Horizontal Integration

 Lower Cost Structure

 Horizontal integration can lower a
company’s cost structure because it creates
increasing economies of scale.
 A company can lower its cost structure
when horizontal integration allows it to
reduce the duplication of resources between
two companies.

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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

Benefits of Horizontal Integration

 Increased Production Differentiation.
 A company can benefit by increasing the flow
of innovative new products that a company’s
sales force can sell to customers at premium
prices.
 Product bundling involves offering
customers the opportunity to purchase a
range of products at a single combined price.

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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

Benefits of Horizontal Integration

 Cross-Selling
 Cross-selling is when a company takes
advantage of, or “leverages,” its established
relationship with customers by way of
acquiring additional product lines or
categories that it can sell to customers.
 Cross-selling provides a “total solution” and
satisfies all of a customer’s specific needs.

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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

Benefits of Horizontal Integration

 Reduced Industry Rivalry

 Acquiring or merging with a competitor helps to
eliminate excess capacity in an industry, thus
create a more benign environment in which
prices might stabilize—or even increase.
 Horizontal integration often makes it easier to
implement tacit price coordination between
rivals.
 Increased Bargaining Power
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 HORIZONTAL INTEGRATION: SINGLE-
INDUSTRY CORPORATE STRATEGY

Problems with Horizontal Integration

 Implementing a horizontal integration strategy is

not an easy task for managers.
 There are problems associated with merging very
different company cultures.
 When the acquisition is a hostile one, there is high
management turnover.
 Using horizontal integration to grow, companies
face conflict with the FTC due to antitrust laws.
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Vertical Integration

 A company pursuing a strategy of backward

vertical integration expands it operations
backwards into an industry that produces inputs
for the company’s products.
 If it pursues this strategy forward into an
industry that uses, distributes, or sells the
company’s product, it is known as forward
vertical integration.
Raw Materials-to-Customer
Value-Added Chain

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 Increasing Profitability
through Vertical Integration

 A specialized asset is one that is designed to

perform a specific task and whose value
significantly reduced in its next-best use.
 A company might invest in specialized
assets to lower their cost structure or to
better differentiate their product.
 Might invest in specialized equipment
Toyota
 Might invest in advanced technology
Apple
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 Increasing Profitability
through Vertical Integration
 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.
 Sometimes important strategic advantages can be
obtained when vertical integration makes it quicker,
easier, and more cost-effective to plan, coordinate,
and improve scheduling of transferring the product
between adjacent stages of the value-added chain.
 E.g. Ford integrated backward

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 Problems with Vertical Integration

 When the disadvantages of vertical integration are

so great that vertical integration reduces
profitability, a company is engaged in vertical
disintegration.
 E.g. GM disintegrated vertically by selling off component
operations in Delhi
 What are the disadvantages of vertical integration?
 Vertical integration can raise costs if, over time, a
company makes mistakes.
 Company-owned suppliers to not have to compete
with independent, outside suppliers for orders, thus
they have less incentive to look for ways to reduce
operating costs or improve component quality. 9-21
 Problems with Vertical Integration

 When technology is changing fast, vertical

integration locks a company into an old, inefficient
technology and prevents it from changing to a new
one that would strengthen its business model.
 If the demand for a company’s product wildly
fluctuates and is unpredictable, the firm may find
itself burdened with warehouses full of component
parts it no longer needs, which is a major drain on
profitability.
 When demand is unpredictable, vertical integration
makes it hard to manage volume flow.

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 The Limits of Vertical Integration

 Vertical integration may weaken when:

1) Bureaucratic costs increase 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.
• Companies should be as willing to vertically
disintegrate as they are to vertically integrate, to
strengthen their core business model.

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 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

 Companies have found that they can realize many

of the benefits associated with vertical integration
by entering into long-term cooperative
relationships with companies in industries along
the value-added chain.

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 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

 Strategic alliances are long-term agreements

between two or more companies to jointly develop
new products or processes that benefit all
companies concerned.
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 sell their final products to
distributors or retailers.
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 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

Short-Term Contracts and Competitive Bidding

 Short-term contracting does not result in the

specialized investments that are required to
realize differentiation and cost advantages
because it signals a company’s lack of long-
term commitment to its suppliers.
 When there is a need for cooperation, the use
of short-term contracts and comprehensive
bidding can be a serious drawback.
 E.g. Temporary NSU Food stalls (Jan-June 2018)
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 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

Strategic Alliances and Long-Term Contracting

 A strategic alliance becomes a substitute for
vertical integration because it creates a relatively
stable long-term partnership that allows both
companies to obtain the same kinds of benefits
that result from vertical integration.
 Component suppliers benefit from strategic
alliances because their business and profitability
grow as companies they supply grow.

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 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

Building Long-Term Cooperative Relationships

 There are several strategies that companies can

adopt to promote the success of a long-term
cooperative relationship and lessen the chance
that one company will default on its agreement
and cheat the other.
 Hostage taking is essentially a means of
guaranteeing that each partner will keep its
side of the bargain.

(continued) 9-28
 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

Building Long-Term Cooperative Relationships

 A credible commitment is a believable
commitment or pledge to support the
development of a long-term relationship
between companies.
 A company that forms a strategic alliance
with an independent component supplier runs
the risk that its alliance might become
inefficient over time.

(continued) 9-29
 ALTERNATIVES TO VERTICAL INTEGRATION:
COOPERATIVE RELATIONSHIPS

Building Long-Term Cooperative Relationships

 Because long-term contracts are

renegotiated every 3-5 years, the supplier
knows that if it fails to live up to its
commitments, its partner may refuse to
renew the contract.
 Many companies use parallel source
policies—they enter into long-term contracts
with two suppliers for the same component.

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 STRATEGIC OUTSOURCING

 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
of their skills and knowledge on just one kind of
activity.
 It may encompass an entire function or it may be
just one kind of activity that a function performs.
 There has been a clear move to outsource
activities that managers regard as “noncore.”
 E.g. Microsoft outsourced its Xbox consoles
 Bata outsourced school shoes line in BD 9-31
STRATEGIC OUTSOURCING

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 STRATEGIC OUTSOURCING

Benefits of Outsourcing

 Outsourcing will reduce costs when the price

that must be paid to a specialist is less than it
would cost a company internally.
 Specialists are more likely to obtain the cost
savings associated with learning effects much
more rapidly than a company that performs an
activity just for itself.
 Specialists are also often able to perform
activities at lower costs than a specific company.

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 STRATEGIC OUTSOURCING

Risks of Outsourcing

 In the context of outsourcing, holdup refers to

the risk that a company will become too
dependent upon the specialist provider of an
outsourced activity and that the specialist will
use this fact to raise prices beyond some
previously agreed-upon rate.
 A company that is not careful could suffer loss of
important competitive information when it
outsources an activity.

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