242 CHAPTER 8 Corporate Strategy: Vertical Integration and Diversification
AS A MULTIBUSINESSenterprise, GE has been changing its corporate strategy in several ways. One, it has moved away from slow-growing businesses, such as appliances and entertainment, and turned to future-growth industries, such as clean-tech and health care. Two, Jeffrey Immelt reduced GE’s exposure to the financial markets by trimming the GE Capital unit. Although during the first decade of the 2000s GE Capital produced roughly half of GE’s profits based on one-third of its revenues, it made GE more vulnerable to changes in the macro environment such as the 2008–2009 financial crisis. Three, GE is also focusing more on faster growing international markets such as those in Asia, Eastern Europe, and the Middle East.
T hese changes in GE’s portfolio of businesses and geographic focus illustrate that firms must decide in which industries and global markets to compete. Moreover, these choices are likely to change over time in response to opportunities and threats in the external environ-ment. Answers to the important question of where to competeare captured in a firm’s corpo-rate strategy,which we cover in the next three chapters. In this chapter, we define corporate strategy and then look at two fundamental corporate strategy topics: vertical integration and diversification. We conclude the chapter with Implications for the Strategist that provide a practical application of dynamic corporate strategy at Nike and adidas.
8.1 What Is Corporate Strategy?
Strategy formulation centers around the key questions of where and how to compete. Busi-ness strategyconcerns the question of how to competein a single product market.As dis-cussed in Chapter 6, the two generic business strategies that firms can pursue in their quest for competitive advantage are to increase differentiation (while containing cost) orlower costs (while maintaining differentiation). If trade-offs can be reconciled, some firms might be able to pursue an integration strategy by increasing differentiation andlowering costs. As firms grow, they are frequently expanding their business activities through seeking out new markets both by offering new products and services and by competing in different geographies. When this happens, managers must formulate a corporate strategy. To gain and sustain competitive advantage, therefore, any corporate strategy must align with and strengthen a firm’s business strategy, whether it is differentiation, cost leadership, or an integration strategy.
Corporate strategycomprises the decisions that senior management makes and the goal-directed actions it takes in the quest for competitive advantage in several industries and markets simultaneously.
3It provides answers to the key question of where to compete.
Corporate strategy determines the boundaries of the firm along three dimensions: industry value chain, products and services, and geography (regional, national, or global markets). Executives must decide:
1. In what stages of the industry value chain to participate.The industry value chain describes the transformation of raw materials into finished goods and services along distinct vertical stages. This decision determines the firm’s vertical integration.
2. What range of products and services to offer.This decision determines the firm’s level of diversification.
3. Where to competein terms of regional, national, or international markets. This decision determines the firm’s geographic scope.
Although many managers have input to this important decision-making process, the responsibility for corporate strategy ultimately rests with the CEO. We noted in C hapterCase 8, for example, General Electric CEO Immelt’s attempt to refocus the con-glomerate on future-growth industries through the ecomaginationand healthymagination
LO 8-1
D efine corporate strategy and describe the three dimensions along which it is assessed. corporate strategy The decisions that senior management makes and the goal-directed actions it takes to gain and sustain competitive advantage in several industries and markets simultaneously; addresses where to competealong three dimensions: products and services, industry value chain, and geography (regional, national, or global markets).
CHAPTER 8 Corporate Strategy: Vertical Integration and Diversification 243
strategic initiatives. In his 2010 letter to shareholders, Mr. Immelt confirmed GE’s back-to-its-roots corporate strategy: “As we grew, financial services became too big and added too much volatility. GE must be an indus-trial company first. We have increased our investment in industrial growth.”
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W here to compete in terms of industry value chain, products and services, and geography are the fundamen-tal corporate strategic decisions. The underlying strate-gic management concepts that will guide our discussion of vertical integration, diversification, and geographic competition are core competencies, economies of scale, economies of scope,and transaction costs.
■ Core competenciesare unique strengths embedded deep within a firm (as discussed in Chapter 4). Core competencies allow a firm to differentiate its products and ser-vices from those of its rivals, creating higher value for the customer or offering prod-ucts and services of comparable value at lower cost. According to the resource-based view of the firm,a firm’s boundaries are delineated by its knowledge bases and com-petencies.5Activities that draw on what the firm knows how to do well (e.g., Honda’s core competency in small, highly reliable engines, or Google’s core competency in developing proprietary search algorithms) should be done in-house, while non-core activities such as payroll and facility maintenance can be outsourced. In this per-spective, the internally held knowledge underlying a core competency determines a firm’s boundaries.
■ Economies of scaleoccur when a firm’s average cost per unit decreases as its output increases (as discussed in Chapter 6). Anheuser-Busch InBev, the largest global brewer (producer of brands such as Budweiser, Bud Light, Stella Artois, and Beck’s), reaps significant economies of scale. Given its size, it is able to spread its fixed costs over the millions of gallons of beer it brews each year, in addition to the significant buyer power its large market share affords. Larger market share, therefore, often leads to lower costs.
■ Economies of scope,in turn, are the savings that come from producing two (or more) outputs or providing different services at less cost than producing each individually, though using the same resources and technology (as discussed in Chapter 6). Lever-aging its online retailing expertise, for example, Amazon benefits from economies of scope: It can offer a large range of different product and service categories at a lower cost than it would take to offer each product line individually.
■ Transaction costsare all costs associated with an economic exchange. The concept is developed in transaction cost economics, a strategic management framework, and enables managers to answer the question of whether it is cost-effective for their firm to expand its boundaries through vertical integration or diversification. This implies taking on greater ownership of the production of needed inputs or of the channels by which it distributes its outputs, or adding business units that offer new products and services.
We begin our study of corporate strategy by drawing on transaction cost economics to explain vertical integration, meaning the choices a firm makes concerning its boundar-ies. Later, we will explore managerial decisions relating to diversification, which directly affect the firm’s range of products and services in multi-industry competition.