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Chapter 8 summary

Ghatika Sannidhya Ramadhani 9004920190
A value chain is a set of activities that must be accomplished to bring a product or service from raw
materials to the point that It can be sold to a final customer. In addition, a firms level of vertical
firm’s level of backward vertical integration is when it incorporates more stages of the value chain
vertical integration is when a firm incorporates more stages of the value chain within its boundaries and
those stages bring it closer to the end of the value chain.
If a firm wants to integrate vertically, it can acquire a strategic alliance, or a joint venture. Vertical
integration can increase a firm’s revenues or decrease its costs compared with not vertically integrating
companies. There are three most influential opportunities a vertical integration can create value for a
firm: Threat of opportunism, capability, and flexibility
In order to gain CA, the value of the vertical integration has to investigated.
If a firm possesses valuable, rare, and costly to imitate resources in a business activity, it should
vertically integrate into that activity; otherwise, no vertical integration.
Vertical integration and Flexibility Flexibility refers to how costly it is for a firm to alter its strategic and
organizational decisions. Flexibility is high when the costs of changing strategic choices is low; flexibility
is low when the cost of changing strategic choices is high. Research shows that vertically integrated
companies are less flexible. Flexibility is only valuable when the decision-making setting a firm is facing
is uncertain. A decision making setting is uncertain when the future value of an exchange cannot be
known when an investment is made.
Flexibility based approach to vertical integration suggests that rather than vertically integrating into a
business activity whose value is highly uncertain, firms should not vertically integrate but should instead
form a strategic alliance to manage this exchange. A strategic alliance is more flexible than vertical
integration, gives a firm enough info about exchange to estimate value over time. Another advantage is
that investment in strategic alliance the costs and risk are known and fixed. Which is mostly equal to
the costs of maintaining and creating the alliance.
In conclusion: These strategies for vertical integration serve as a toolkit. Because you cannot integrate
them all at the same time, since it will create contradiction. Thus, opportunism based explanations
suggest that vertical integration is necessary because of the high transaction specific investment;
capabilities based explanation caution about the cost of developing the resources and capabilities
necessary to vertically integrate; and flexibility concerns caution about the risk that committing to a
vertical integration imply and the costs and benefits of whatever vertical integration decision is
ultimately made can be understood very clearly. High flexibility = when the cost of changing strategic
choices is low Low flexibility = when the cost of changing strategic choices is high
Organizing to implement vertical integration involves the same organizing tools as implementing any
business or corporate strategy: 1. Organizational structure 2. Management controls 3. Compensation
1. Organizational structure and implementing vertical integration The organizational structure that is
used to implement a cost leadership and product differentiation strategy – the functional or U form
structure is also used to implement a vertical integration strategy. Functional conflicts are common in
organizations, because e.g. the sales department wants variety of products but the manufacturing wants
to produce only few. To resolve this you need to make use of the management controls. 2.
Management controls and implementing vertical integration
Although having the correct organizational structure, it is important for firms implementing their vertical
integration strategies, that structure must be supported by a variety of management controls. One of
the most important is budgeting process and the management committee oversight process.
- The budgeting process
The budgeting is one of the most important control mechanisms available to CEOs in vertically
integrated U-form organizations. These organizations use allocated budgets to review the performance.
The negative consequence is that functional managers might emphasize short-term behavior.
- The management committee oversight process
In addition to budgets, vertically integrated U-from organizations can use internal management
committees as management control devices.
- Executive committee = CEO + 2/3 key functional senior managers, weekly, reviews the performance of
the firm in a short-term basis, to track the short-term performance of the firm, to note and correct any
budget variances for functional managers, and to respond to any crises that might emerge - Operations
3. Compensation in implementing vertical integration strategies
There are 3 compensation policies that a firm can undertake to pursue vertical integration. (Mostly ALL,
based on their function and wanted behavior of employees, there is not 1 best one)
- Opportunism based: Suggest that individual-based compensation
– including salaries and cash bonus and stock grants based on individual performance
- Capabilities based: Suggest group based compensation
– including cash, bonuses and stock based on corporate or group performance.
- Flexibility based: Suggests flexible compensation
– including stock options based on individual, group or corporate performance.
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