VERTICAL INTEGRATION – CORPORATE STRATEGY Ghatika Sannidhya Ramadhani 9004920190 WHAT IS VERTICAL INTEGRATION? 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 THE VALUE OF VERTICAL INTEGRATION – (VRIO – VALUE) 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 INTEGRATON (VRIO – ORGANIZATION) 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 policies 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 committee 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.