GARETH R. JONES /CHARLES W. L. HILL
Theory of Strategic Management 10th ed.
Chapter
9
Corporate-Level
Strategy: Horizontal
Integration, Vertical
Integration, and
Strategic Outsourcing
Student Version
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Prepared by C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
Learning Objective: After reading this chapter you
should be able to discuss how corporate-level
strategy can be used to strengthen a company’s
business model and business-level strategies.
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.
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CORPORATE-LEVEL STRATEGY AND
THE MULTIBUSINESS MODEL
 Only when a company selects the corporatelevel 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 business-level
model that justifies its entry into these businesses.
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Learning Objective: After reading this
chapter you should be able to define
horizontal integration and describe the
primary advantages and disadvantages
associated with this corporate-level strategy.
HORIZONTAL INTEGRATION: SINGLEINDUSTRY 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.
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HORIZONTAL INTEGRATION: SINGLEINDUSTRY CORPORATE STRATEGY
 A second advantage is that a company “sticks
to the knitting,” meaning that it stays focused
on what it knows and does best.
 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: SINGLEINDUSTRY 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 equals to
pool their operations and create a new entity.
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HORIZONTAL INTEGRATION: SINGLEINDUSTRY 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: SINGLEINDUSTRY CORPORATE STRATEGY
Benefits of Horizontal Integration
 Increased Production Differentiation:
 By increasing the flow of innovative new
products that a company 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.
(continued)
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HORIZONTAL INTEGRATION: SINGLEINDUSTRY 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: SINGLEINDUSTRY CORPORATE STRATEGY
Benefits of Horizontal Integration
 Reduced Industry Rivalry:
 Acquiring or merging with a competitor helps to
eliminate excess capacity in an industry, thus
creating a more benign environment in which
prices might stabilize—or increase.
 Horizontal integration often makes it easier to
implement tacit price coordination between
rivals.
 Increased Bargaining Power
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HORIZONTAL INTEGRATION: SINGLEINDUSTRY 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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9-11
Learning Objective: After reading this
chapter you should be able to define
vertical integration and describe the
primary advantages and disadvantages
associated with corporate-level strategy.
 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.
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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.
 It is often necessary that suppliers invest in
specialized assets to produce the inputs
that a specific company needs.
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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.
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9-14
THE LIMITS OF VERTICAL INTEGRATION
 When the disadvantages of vertical integration
are so great that vertical integration reduces
profitability, a company is engaged in vertical
disintegration.
 What are the disadvantages of vertical
integration?
 Vertical integration can raise costs if, over time, a
company makes mistakes.
 Company-owned suppliers do 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.
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(continued)
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THE LIMITS OF 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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9-17
Learning Objective: After reading this chapter you
should be able to describe why, and under what
conditions, cooperative relationships such as
strategic alliances and outsourcing may become a
substitute for vertical integration.
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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9-18
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 contacts 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:
COPPERATIVE 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 longterm 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.
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9-20
ALTERNATIVES TO VERTICAL INTEGRATION:
COPPERATIVE 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:
COPPERATIVE RELATIONSHIPS
Building Long-Term Cooperative Relationships
 There are several strategies companies can
adopt to promote the success of a long-term
cooperative relationship and lessen the chance
that one company will renege 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.
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(continued)
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ALTERNATIVES TO VERTICAL INTEGRATION:
COPPERATIVE 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.
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(continued)
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ALTERNATIVES TO VERTICAL INTEGRATION:
COPPERATIVE 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.”
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STRATEGIC OUTSOURCING
Benefits of Outsourcing
 Outsourcing has several advantages:
 It can help the company lower its cost structure.
 It can increase product differentiation.
 It can help a company focus on the distinctive
competencies that are vital to its profitability.
Risks of Outsourcing
 Outsourcer’s holdup refers to specialist raising
prices if a firm becomes too dependent.
 A company could suffer loss of important information.
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