1 THEME 9: GROWTH STRATEGIES 1st Part: Vertical integration and Scope of the Firm 2nd Part: Internal and external growth
2 1st Part: Vertical Integration and The Scope of the Firm
3 Vertical Integration and The Scope of the Firm OUTLINE Transactions Costs and the Scope of the Firm. The Costs and Benefits of Vertical Integration. Designing Vertical Relationships.
4 From Business Strategy to Corporate Strategy: The Scope of the Firm Business Strategy is concerned with how a firm competes 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: geographical scope; product scope; vertical scope.
5 Market Economy: Two Economic Organizations Market Mechanism: Individuals and firms make independent decisions that are influenced by market prices. Administrative Mechanism: Firm decisions concerning production, supply and purchased inputs are made by managers and enforced through the system of hierarchy.
6 Transactions Costs and the Scope of the Firm Vertical Product Geographical Scope Scope Scope [A] Single Integrated Firm V 1 V 2 P 1 P 2 P 3 G 1 G 2 G 3 V 3 [B] Several Specialized Firms linked by Markets V 1 V 2 V 3 P 1 P 2 P 3 G 1 G 2 G 3 In situation [A] the business units are integrated within a single firm. In situation [B] the business units are independent firms linked by markets. Are the administrative costs of the integrated firm less than the transaction costs of markets?
7 Cure Ham Industry V1: raising pigs. V2: slaughtering pigs. V3: curing hams. Key issue: transaction costs in the market vs administrative costs of a firm.
8 Transactions Costs and The Existence of the Firm Transaction cost theory explains not just the boundaries of firms, also the existence of firms (see note). In 18th century English woollen industry, no firms-independent spinners and weavers linked by merchants. Residential remodeling industry -- mainly independent selfemployed builders, plumbers, electricians, painters. Where market transaction costs are high, firm is a more efficient means of organization. Note: -Firm understood as an organization consisting of a group of individuals who are interconnected by contracts with a central contracting authority (contractual approach of the firm). -Transaction costs comprise costs of search and contract negotiating and enforcement.
9 Determinants of Changes in in Corporate Scope : Expanding scale and scope of industrial corporations due to declining administrative costs of firms: Advances in transportation, information and communication technologies. Advances in management: accounting systems, decision sciences, financial techniques, organizational innovations, scientific management : Shrinking size and scope of biggest industrial corporations. Increasingly Increased no. of managerial Admin. costs of turbulent decisions. Need for fast firms rise relative external responses to external to transaction environment change costs of markets 1995 onwards: Rapid increase in global concentration (steel, aluminium, oil, beer, banking, cement). Key drivers: quest for market power and scale economies. Also, large corporations better at reconciling size with agility.
10 Vertical Integration: a related diversification Depends on a firm s ownership of vertically related activities. When a firm owns and controls numerous stages of the value chain of its product, then there is a high degree of vertical integration.
11 Types Backward integration, when a firm owns and controls the production of its products components and inputs. Forward integration, when a firm owns and controls activities that were previously done by its customers, such as distribution. Partial vertical integration, when the internal production is not self-sufficient and the purchase of a little amount of supplies is necessary to support further production. Full vertical integration between two stages of production, when during transference between the two no sales or purchases are realized from third parties.
13 The Costs and Benefits of Vertical Integration: BENEFITS Technical economies from integrating processes, e.g. iron and steel production. -but doesn t necessarily require common ownership. Superior coordination. Avoids transactions costs of market contracts, specially in situations where there are: -small numbers of firms; -transaction-specific investments; -opportunism and strategic misrepresentation; -taxes and regulations on market transactions.
14 The Costs and Benefits of Vertical Integration: COSTS Administrative costs of internalization. Differences in optimal scale of operations between different stages prevents balanced Vertical Integration (VI). Strategic differences between different vertical stages creates management difficulties. Inhibits development and exploitation of core competencies. Limits flexibility: -in responding to demand cycles; -in responding to changes in technology, customer preferences, etc. But where system-wide flexibility is required, VI allows speed and coordination in achieving simultaneous adjustment throughout the vertical chain (see Making VI Work: Zara ). Compounding of risk: any problem in one stage can threaten all other stages.
15 Assessing the Pros and Cons Within the same industry, different companies can be successful with very different degrees of vertical integration. When external circumstances are the same, the fact that different companies have different resources and capabilities and pursue different strategies means that they will make different decisions. Key criteria in the next slide.
16 When is is Vertical Integration more attractive than Outsourcing? How many firms are available to undertake the activities? Is transaction-specific investment needed? Does limited information permit cheating? Are taxes or regulation imposed on transactions? Do the different stages have similar optimal scales of operation? Are the two stages strategically similar? How great the need for entrepreneurship & continual upgrading of capabilities. How uncertain is market demand? Are risks compounded by linkages between vertical stages? The fewer the companies the more attractive is VI. If yes, VI more attractive. VI can limit opportunism. VI can avoid them. Greater the similarity, the more attractive is VI. Greater the strategic similarity, the more attractive is VI. Greater the need, the greater the disadvantages of VI. Greater the unpredictability, the more costly is VI. VI increases risk.
17 The value chain for steel cans Iron ore mining Steel production Steel strip production Can making Canning of food, drink, oil, etc. MARKET CONTRACTS VERTICAL INTEGRATION MARKET CONTRACTS VERTICAL INTEGRATION, AND MARKET CONTRACTS What factors explain why some stages are vertically integrated, while others are linked by market transactions?
18 Different Types of Vertical Relationships Low Formalization High Low Spot sales/ purchases Long-term contracts Agency agreements Informal supplier/ customer relationships Franchises Supplier/ customer partnerships Joint ventures Vertical integration Low Degree of Commitment High
19 Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical Integration Intermediate between spot transactions and vertical integration are several types of vertical relationships: such relationships may combine benefits of both market transactions and internalization. Key issues in designing vertical relationships: -How is risk allocated between the parties? Uncertainties over the course of the contract. For example: franchise agreements franchisee bears more risk. -Are the incentives appropriate, to minimize transaction cost? Very often, the most effective incentive is the promise of future business.
20 Recent Trends in Vertical Relationships 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 becoming increasingly blurred.
21 CASE STUDY
22 2nd Part: Internal and External Growth
23 Internal and External Growth OUTLINE Internal Development. Mergers and Acquisitions. Strategic Alliances.
24 INTERNAL DEVELOPMENT (ID): CONCEPT ID is where strategies are developed by building on and developing an organisation s own capabilities.
25 INTERNAL DEVELOPMENT (ID): MOTIVES Strategic capabilities: Highly technical new products. Direct involvement in new markets. Spread of costs over time. Environment: No other choice or no suitable target. Expectations: Avoiding a traumatic integration.
26 MERGER AND ACQUISITIONS (M&A): CONCEPTS Acquisition is where strategies are developed by taking over ownership of another organization. Merger: Voluntary amalgamation of two (or more) firms into one new legal entity. Mergers are effected by exchange of the pre-merger stock (shares) for the stock of the new firm. Owners of each pre-merger firm continue as owners, and the resources of the merging entities are pooled for the benefit of the new entity (http://www.businessdictionary.com/).
27 MERGER AND ACQUISITIONS Environment: Speed. (M&A): MOTIVES Competitive situation (avoiding excess capacity). Deregulation and financial motives. Strategic capabilities: Exploiting core competences or addressing a lack of resources or/and capabilities. Cost efficiency. Learning. Expectations: Continuing growth expected by shareholders. Senior managers ambitions. Speculative motives rather than strategic ones.
28 MERGER AND ACQUISITIONS (M&A): MAIN DIFFICULTIES Adding any value to the purchases. The integration of the new company. Organisational learning through the transfer of knowledge. Cultural fit ( clash of cultures ). As a result, in the majority of cases it leads to a poor financial performance.
29 EXERCISE GENERAL ELECTRIC FOCUSES ON EUROPE
30 STRATEGIC ALLIANCES: CONCEPT Two or more organisations share resources and activities to pursue a strategy.
31 STRATEGIC ALLIANCES: MOTIVES The need for critical mass. Co-specialisation. Learning from partners. Also important in the public sector: PPP.
32 STRATEGIC ALLIANCES: TYPES At one extreme, loose formulas: Networks: arrangements whereby two or more organisations work in collaboration without formal relationships (the airline industry). Opportunistic alliances: around particular ventures or projects.
33 STRATEGIC ALLIANCES: TYPES At the other extreme, involving ownership: Joint Ventures: arrangements where organisations remain independent but set up a newly created organisation jointly owned by the parents. Consortia: a particular kind of joint venture arrangement typically focused on a particular project (such as the European Airbus).
34 STRATEGIC ALLIANCES: TYPES Intermediate arrangements (contractual in nature, but unlikely to involve ownership), Franchising: the franchise holder undertakes specific activities such as manufacturing, distribution or selling, whilst the franchiser is responsible for the brand name, marketing and usually training (e.g. McDonald s). Licensing: Commonly when the right to manufacture a patented product is granted for a fee (e.g. science-based industries). Subcontracting: when a company chooses to outsource particular services or part of a process (e.g. IT services).
35 STRATEGIC ALLIANCES: TYPES
37 STRATEGIC ALLIANCES: SUCCESS A clear strategic purpose and senior management support. Compatibility at the operational level. Defining and meeting performance expectations. TRUST: competence based and character based.
38 APPLICATION CO-OPS
39 MEMBERS -Needs. -Commitment. -Autonomy and Independence. -Credibility of / Trust on the Board of Directors. KEYS FOR SUCCESS PROFESSIONAL MANAGERS -To be aware of and tuned with the idiosyncrasy of the cooperative formula. Management based on: -Quality/Innovation. -Training. -Planning. RELATIONSHIP BETWEEN MEMBERS & MANAGERS -Social discipline (rules by consensus). -Personal contact, proximity to members. -Information, transparency. -Communication & mutual trust.
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