Chapter 8

Corporate Strategy: Vertical Integration

and Diversification
 The AFI Strategy Framework

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description

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 Chapter 8 Outline (1 of 2)

8.1 What is Corporate Strategy?

– Why Firms Need to Grow
– Three Dimensions of Corporate Strategy
8.2 The Boundaries of the Firm
– Firms vs. Markets: Make or Buy?
– Alternatives on the Make-or-Buy Continuum
8.3 Vertical Integration along the Industry Value Chain
– Types of Vertical Integration
– Benefits and Risks of Vertical Integration
– When Does Vertical Integration Make Sense?
– Alternatives to Vertical Integration

©McGraw-Hill Education.
 Chapter 8 Outline (2 of 2)

8.4 Corporate Diversification:

Expanding Beyond a Single Market
– Types of Corporate Diversification
– Leveraging Core Competencies for Corporate Diversification
– Corporate Diversification and Firm Performance
8.5 Implications for the Strategist

©McGraw-Hill Education.
 Learning Objectives (1 of 2)

LO 8-1 Define corporate strategy and describe the three dimensions along
which it is assessed.
LO 8-2 Explain why firms need to grow, and evaluate different growth
motives.
LO 8-3 Describe and evaluate different options firms have to organize
economic activity.
LO 8-3 Describe the two types of vertical integration along the industry value
chain: backward and forward vertical integration.
LO 8-5 Identify and evaluate benefits and risks of vertical integration.

©McGraw-Hill Education.
 Learning Objectives (2 of 2)

LO 8-6 Describe and examine alternatives to vertical integration.

LO 8-7 Describe and evaluate different types of corporate diversification.
LO 8-8 Apply the core competence–market matrix to derive different
diversification strategies.
LO 8-9 Explain when a diversification strategy creates a competitive
advantage and when it does not.

©McGraw-Hill Education.
 What Is Corporate Strategy?

©McGraw-Hill Education.
 Corporate Strategy

• The decisions & actions taken to gain & sustain

competitive advantage in several industries and
markets simultaneously
• Addresses where to compete along three
dimensions:
– Products and services
– Industry value chain
– Geography (regional, national, or global markets)

©McGraw-Hill Education.
 Questions That Executives Ask to Determine
Corporate Strategy

• In what stages of the industry value chain should we

participate?
– Related to the topic of vertical integration
• What range of products and services should the we
offer?
– Related to the topic of diversification
• Where should we compete geographically?
– Related to the topic of geographic scope

©McGraw-Hill Education.
 Why Firms Need to Grow

• Increase profits
• Lower costs
• Increase market power
• Reduce risk
• Motivate management

©McGraw-Hill Education.
 Three Dimensions of Corporate Strategy

• Core Competencies (Chapter 4)

• Economies of Scale (Chapter 6)
• Economies of Scope (Chapter 6)
• Transaction Costs
– Determine whether it is cost effective to:
• Vertically integrate
• Diversify

©McGraw-Hill Education.
 The Boundaries of the Firm

©McGraw-Hill Education.
 Exhibit 8.2 Transaction Cost Economies

• Helps explain & predict boundaries of the firm

• Helps managers decide
– Which activities to perform in-house
– Services & products to obtain from the external market

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description

©McGraw-Hill Education.
 Transaction Costs

• Costs associated with an economic exchange

• Can be within or external to a firm
• External transaction costs
– Searching for a firm individual to contract with
– Negotiating, monitoring, and enforcing the contract
• Internal transaction costs
– Recruiting and retaining employees
– Paying salaries and benefits
– Setting up a shop floor
– Providing office space and computers, etc.

©McGraw-Hill Education.
 Firms Vs. Markets: Make Or Buy?

• If Cin-house < Cmarket, vertically integrate

– Own production of the inputs or
– Own output distribution channels
• When firms are more efficient than the market,
vertically integrate
• Example: Google in-house programmers

©McGraw-Hill Education.
 Exhibit 8.3 Organizing Economic Activity:
Firms vs. Markets

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description

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 Alternatives on the Make-or-buy Continuum (1 of 2)

• Short Term Contracts

• Strategic Alliances
– Long term contracts
• Licensing
• Franchising

– Equity alliances
– Joint Ventures
• Parent-Subsidiary Relationships

©McGraw-Hill Education.
 Exhibit 8.4 Alternatives on the Make-or-buy Continuum (2 of 2)

©McGraw-Hill Education.
 Strategy Highlight 8.1

Is Coke Becoming a Monster?

• The demand for Coke / Pepsi is falling.
– Replaced by water & energy drinks
• Coca Cola formed an alliance with Monster.
– $2B for a 16.7% stake in the company
• Why not an acquisition?
– Several wrongful death suits
– They can benefit from explosive growth.
– They can protect their wholesome image & brand.
©McGraw-Hill Education.
 Vertical Integration along the
Industry Value Chain

©McGraw-Hill Education.
 Exhibit 8.5 A Vertical Value Chain

The transformation of raw materials into finished goods and

services along distinct vertical stages

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description
©McGraw-Hill Education.
 The Vertical Value Chain of Your Cell Phone

• Raw materials
– Chemicals, ceramics, metals, oil for plastic
• Intermediate goods and components
– Integrated circuits, displays, touchscreens, cameras, and
batteries
• Original equipment manufacturing firms
– Assembly of cell phones under contract
• Service provider
– AT&T, Sprint, T-Mobile, Verizon, etc.

©McGraw-Hill Education.
 Types of Vertical Integration

• Backward Vertical Integration

– Moving ownership of activities upstream to the originating
inputs of the value chain
• Forward Vertical Integration
– Moving ownership of activities closer to the end customer

©McGraw-Hill Education.
 Exhibit 8.6 Forward and Backward Integration:
The Smartphone Industry

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description

©McGraw-Hill Education.
 Benefits of Vertical Integration

• Lowers costs
• Improves quality
• Facilitates scheduling and planning
• Facilitates investments in specialized assets
– Reference the next slide for more information
• Secures critical supplies and distribution channels

©McGraw-Hill Education.
 Specialized Assets

• Unique assets with high opportunity cost:

– They have significantly more value in their intended use
than in their next-best use.
• 3 Types:
– Site specificity
• Co-location requirements (Machine collaboration)
– Physical asset specificity
• Unique physical & engineering properties (Coca-Cola Bottle)
– Human asset specificity
• Investments made in human capital (knowledge & skills for a
specific process)

©McGraw-Hill Education.
 Risks of Vertical Integration

• Increase in costs
• Reduction in quality
• Reduction in flexibility
• Increase in the potential for legal repercussions

©McGraw-Hill Education.
 When Does Vertical Integration Make Sense?

• When there are shortages of raw materials

– Ex. Henry Ford ran mining operations
• To enhance the customer’s experience
– Eliminate annoyances & poor interfaces

©McGraw-Hill Education.
 Exhibit 8.7 Tapering Integration

• An alternative to
vertical integration
• Involves either:
– Backward
integration &
relying on others
for supplies
– Forward
integration &
relying on others
for distribution

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description

©McGraw-Hill Education.
 Strategic Outsourcing

• Moving one or more internal value chain activities

outside the firm’s boundaries to other firms in the
industry value chain
• Example: Off-shoring
• Most active sectors of off-shoring:
– Banking & financial services
– IT
– Health Care

©McGraw-Hill Education.
 Corporate Diversification: Expanding
Beyond a Single Market

©McGraw-Hill Education.
 Diversification

• Increase in:
– The variety of products / services a firm offers, or
– The markets / geographic regions in which it competes
• Can be targeted towards:
– Products
– Geography
– Product-Market

©McGraw-Hill Education.
 Four Main Types of Business Diversification

1. Single business
– Single business leverages its competencies
2. Dominant business
– Dominant & minor businesses share competencies
3. Related diversification
A. Related Constrained: all businesses share competencies
B. Related Linked: some businesses share competencies
4. Unrelated diversification (conglomerate)
– No businesses share competencies
©McGraw-Hill Education.
 Examples of the Four Main Types of Business Diversification

1. Single business
– Coca-Cola, Google, Facebook
2. Dominant business
– Harley Davidson, Nestle, UPS
3. Related diversification
A. Related Constrained: ExxonMobile, Nike
B. Related Linked: Amazon, Disney
4. Unrelated diversification: (conglomerate)
– Berkshire Hathaway
©McGraw-Hill Education.
 Strategy Highlight 8.2

The Tata Group: Integration at the Corporate Level

• A multinational conglomerate in Mumbai, India
– Activities: tea, hospitality, steel, IT, communications,
power, and automobiles
• Tata Motors
– Bought Jaguar and Range Rover from Ford (2008)
– Created the Tata Nano a small, no-frills car
• 50% cheaper than their next-lowest cost car

– Pursue differentiation & low cost strategies simultaneously

©McGraw-Hill Education.
 Exhibit 8.9 Leveraging Core Competencies
For Corporate Diversification

SOURCE: Adapted from G. Hamel and C.K. Prahalad

Jump to Appendix 8 long image (1994), Competing for the Future (Boston, MA: Harvard
description Business School Press).

©McGraw-Hill Education.
 Exhibit 8.10 Corporate Diversification and Firm
Performance

• Does corporate diversification indeed lead to superior

performance?
– High and low levels of diversification = lower performance
– Moderate levels of diversification = higher firm performance

SOURCE: Adapted from L.E. Palich, L.B. Cardinal, and C.C.

Jump to Appendix 9 long image Miller (2000), “Curvilinearity in the diversification-performance
description linkage: An examination of over three decades of research,”
Strategic Management Journal 21: 155–174.
©McGraw-Hill Education.
 How Diversification Can Enhance Firm Performance

• Provide economies of scale: reduces costs

• Exploit economies of scope: increases value
• Reduce costs and increase value

©McGraw-Hill Education.
Exhibit 8.11 Vertical Integration and Diversification: Sources
of Value Creation and Costs

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description

©McGraw-Hill Education.
 Financial Economies of Scale Can Be Achieved Through
Restructuring

• Restructuring:
– Reorganizing & divesting business units & activities
– Refocuses a company on its core competencies
• Executives can restructure the business portfolio.
• Boston Consulting Group (BCG) growth-share matrix:
– Helps guide portfolio planning
– Each category warrants a different investment strategy.

©McGraw-Hill Education.
 Exhibit 8.12 Boston Consulting Group (BCG)
Growth-share Matrix

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description

©McGraw-Hill Education.
 Implications for the Strategist

©McGraw-Hill Education.
 Executives Make Important Choices Along Three Dimensions

• Degree of vertical integration: the stages of the

industry value chain to participate in
• Type of diversification: the range of products and
services to offer
• The geographic scope: where to compete

©McGraw-Hill Education.
 Exhibit 8.13 Dynamic Corporate Strategy:
Nike vs. Adidas

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description

©McGraw-Hill Education.
 Chapter 8 Summary

©McGraw-Hill Education.
 Take Away Concepts (1 of 9)

LO 8-1 Define corporate strategy and describe the three dimensions along
which it is assessed.
• Corporate strategy addresses “where to compete.” Business strategy
addresses “how to compete.”
• Corporate strategy concerns the boundaries of the firm along three
dimensions: (1) industry value chain, (2) products and services, and (3)
geography (regional, national, or global markets).
• To gain and sustain competitive advantage, any corporate strategy must
support and strengthen a firm’s strategic position, regardless of whether it
is a differentiation, cost-leadership, or blue ocean strategy.

©McGraw-Hill Education.
 Take Away Concepts (2 of 9)

LO 8-2 Explain why firms need to grow, and evaluate different growth
motives.
• Firm growth is motivated by the following:
– increasing profits,
– lowering costs,
– increasing market power,
– reducing risk, and
– managerial motives
• Not all growth motives are equally valuable. Increasing profits and lowering expenses are
clearly related to enhancing a firm’s competitive advantage.
• Increasing market power can also contribute to a greater competitive advantage, but can also
result in legal repercussions such as anti-trust law suits.
• Growing to reduced risk has fallen out of favor with investors, who argue that they are in a
better position to diversify their stock portfolio in comparison to a corporation with a number
of unrelated strategic business units.
• Managerial motives such as increasing company perks and job security are not legitimate
reasons why a firm needs to grow.

©McGraw-Hill Education.
 Take Away Concepts (3 of 9)

LO 8-3 Describe and evaluate different options firms have to organize

economic activity.
• Transaction cost economics help managers decide what activities to do in-house (“make”)
versus what services and products to obtain from the external market (“buy”).
• When the costs to pursue an activity in-house are less than the costs of transacting in the
market (Cin-house < Cmarket), then the firm should vertically integrate.
• Principal–agent problems and information asymmetries can lead to market failures, and thus
situations where internalizing the activity is preferred.
• A principal–agent problem arises when an agent, performing activities on behalf of a principal,
pursues his or her own interests.
• Information asymmetries arise when one party is more informed than another because of the
possession of private information.
• Moving from less integrated to more fully integrated forms of transacting, alternatives include
short-term contracts, strategic alliances (including long-term contracts, equity alliances, and
joint ventures), and parent–subsidiary relationships.

©McGraw-Hill Education.
 Take Away Concepts (4 of 9)

LO 8-4 Describe the two types of vertical integration along the industry
value chain: backward and forward vertical integration.
• Vertical integration denotes a firm’s addition of value—what percentage of
a firm’s sales is generated by the firm within its boundaries.
• Industry value chains (vertical value chains) depict the transformation of
raw materials into finished goods and services. Each stage typically
represents a distinct industry in which a number of different firms
compete.
• Backward vertical integration involves moving ownership of activities
upstream nearer to the originating (inputs) point of the industry value
chain.
• Forward vertical integration involves moving ownership of activities closer
to the end (customer) point of the value chain.

©McGraw-Hill Education.
 Take Away Concepts (5 of 9)

LO 8-5 Identify and evaluate benefits and risks of vertical

integration.
• Benefits of vertical integration include securing critical supplies and
distribution channels, lowering costs, improving quality, facilitating
scheduling and planning, and facilitating investments in specialized
assets.
• Risks of vertical integration include increasing costs, reducing quality,
reducing flexibility, and increasing the potential for legal
repercussions.

©McGraw-Hill Education.
 Take Away Concepts (6 of 9)

LO 8-6 Describe and examine alternatives to vertical integration.

• Taper integration is a strategy in which a firm is backwardly integrated but
also relies on outside-market firms for some of its supplies, and/or is
forwardly integrated but also relies on outside-market firms for some if its
distribution.
• Strategic outsourcing involves moving one or more value chain activities
outside the firm’s boundaries to other firms in the industry value chain.
Off-shoring is the outsourcing of activities outside the home country.

©McGraw-Hill Education.
 Take Away Concepts (7 of 9)

LO 8-7 Describe and evaluate different types of corporate diversification.

• A single-business firm derives 95 percent or more of its revenues from one
business.
• A dominant-business firm derives between 70 and 95 percent of its revenues from a
single business, but pursues at least one other business activity.
• A firm follows a related diversification strategy when it derives less than 70 percent
of its revenues from a single business activity, but obtains revenues from other lines
of business that are linked to the primary business activity. Choices within a related
diversification strategy can be related-constrained or related-linked.
• A firm follows an unrelated diversification strategy when less than 70 percent of its
revenues come from a single business, and there are few, if any, linkages among its
businesses.

©McGraw-Hill Education.
 Take Away Concepts (8 of 9)

LO 8-8 Apply the core competence–market matrix to derive different

diversification strategies.
• When applying an existing/new dimension to core competencies and markets, four quadrants
emerge, as depicted in Exhibit 8.9.
• The lower-left quadrant combines existing core competencies with existing markets. Here,
managers need to come up with ideas of how to leverage existing core competencies to
improve their current market position.
• The lower-right quadrant combines existing core competencies with new market
opportunities. Here, managers need to think about how to redeploy and recombine existing
core competencies to compete in future markets.
• The upper-left quadrant combines new core competencies with existing market opportunities.
Here, managers must come up with strategic initiatives of how to build new core
competencies to protect and extend the firm’s current market position.
• The upper-right quadrant combines new core competencies with new market opportunities.
This is likely the most challenging diversification strategy because it requires building new core
competencies to create and compete in future markets.

©McGraw-Hill Education.
 Take Away Concepts (9 of 9)

LO 8-9 Explain when a diversification strategy creates a competitive

advantage and when it does not.
• The diversification-performance relationship is a function of the underlying type of diversification.
• The relationship between the type of diversification and overall firm performance takes on the shape
of an inverted U (see Exhibit 8.10).
• Unrelated diversification often results in a diversification discount: The stock price of such highly
diversified firms is valued at less than the sum of their individual business units.
• Related diversification often results in a diversification premium: The stock price of related-
diversification firms is valued at greater than the sum of their individual business units.
• In the BCG matrix, the corporation is viewed as a portfolio of businesses, much like a portfolio of
stocks in finance (see Exhibit 8.12). The individual SBUs are evaluated according to relative market
share and the speed of market growth, and are plotted using one of four categories: dog, cash cow,
star, and question mark. Each category warrants a different investment strategy.
• Both low levels and high levels of diversification are generally associated with lower overall
performance, while moderate levels of diversification are associated with higher firm performance.

©McGraw-Hill Education.
 Key Terms
• Backward vertical integration • Licensing
• Boston Consulting Group (BCG) growth-share • Principal–agent problem
matrix • Product diversification strategy
• Conglomerate • Product–market diversification strategy
• Core competence–market matrix • Related diversification strategy
• Corporate strategy • Related-constrained diversification strategy
• Credible commitment • Related diversification strategy
• Diversification • Related-linked diversification strategy
• Diversification discount • Specialized assets
• Diversification premium • Strategic alliances
• External transaction costs • Strategic outsourcing
• Forward vertical integration • Taper integration
• Franchising • Transaction cost economics
• Geographic diversification strategy • Transaction costs
• Industry value chain • Unrelated diversification strategy
• Information asymmetries • Vertical integration
• Internal transaction costs • Vertical market failure
• Joint venture

©McGraw-Hill Education.
 Chapter 8 Cases & Exercises

©McGraw-Hill Education.
 Chapter Case 8: Consider This… (1 of 2)

• Amazon.com continues to diversify.

– Is positioning to capture a piece of the $10B college
bookstore market
• Goals of “Amazon Campus”
– To offer textbooks, clothing, food
– Offer prime membership at a discount
– Guarantees next-day delivery
– Estimated to save students $200-$400 per year
• This binds a new generation of users early.

©McGraw-Hill Education.
 Chapter Case 8: Consider This… (2 of 2)

• Do you believe this diversification will contribute to

Amazon gaining / sustaining a competitive
advantage?
• Amazon is 20 years old. As an investor, would you be
concerned that they haven't yet returned a profit?
• What is Amazon’s core business?
– Is its cloud services offering (AWS) related?
– Do you think AWS should be spun out?

©McGraw-Hill Education.
 My Strategy Exercise: How Diversified Are You?

• We choose how we spend our time & energy

– Example: school, work, family, sleep, and play
– Can be thought of as personal diversification
• Using Exhibit 8.8 as a guide:
– List your major activity areas
– List the percentage of time you spend doing them
– Assess your degree of related and unrelatedness
• What conclusions do you derive?
• Should you make adjustments?
• Has / should this change over time?

©McGraw-Hill Education.
 Small Group Exercise #1 (1 of 2)

• Agriculture: one of the largest / oldest industries in

the world
– They often struggle for profit.
– Some are turning to tourism.
– Complimentary revenue source
• Fair Oaks Farms
– Dairy farm in Indiana
– Home to 30,000 cows
– Initiated several attractions: play area, cheese area, cow
viewing
– Hosts 500,000 tourists / year

©McGraw-Hill Education.
 Small Group Exercise #1 (2 of 2)

• What industrial / commercial industries could benefit

from such potential tourist or recreational revenues?
– What new / complementary capabilities need to be
developed to succeed?
• List other industry combinations you have seen be
successful.
– Why do you think the combination has been a success?

©McGraw-Hill Education.
 Small Group Exercise #2 (1 of 2)

• Consider the rollout of “Amazon Campus”

– Competes with university bookstores
– Gives insight into shopping trends of college students
– Large competitive threat to Barnes & Noble
• To make it beneficial for universities…
– Amazon gives the school between .5 and 2.5% of sales
– Purdue expects to earn $1.7M over 4 years
• Barnes & Noble split off it’s education division
– To ensure greater focus
©McGraw-Hill Education.
 Small Group Exercise #2 (2 of 2)

• What are the ethical issues with Amazon paying the

university for access into the campus’s course
textbook system?
• While Amazon diversifies its products, services, and
markets under one corporate umbrella, why do firms
such as Barnes & Noble choose to split into separate
firms for greater focus on each piece of the business?
– Do these different strategies align with the core
competencies of each?

©McGraw-Hill Education.
 End of Chapter 8

©McGraw-Hill Education.
 Strategy Smart Videos

©McGraw-Hill Education.
 Strategy Smart Videos (1 of 6)

• Jay Leno
• 2012 Tata Nano: From Bollywood to Hollywood - Jay
Leno's Garage
– Related to Strategy Highlight 8.2
• Link:
– https://www.youtube.com/watch?v=NGEwG62Q1UQ
• 9:51 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (2 of 6)

• Fair Oaks Farms Adventure Center - America's

Heartland
– Related to Small Group Exercise #1
• Link:
– https://www.youtube.com/watch?v=JJRy82i8e5Q
• 5:02 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (3 of 6)

• Delta Dental Commercial

• Humorous example of inefficient diversification
• Link:
– https://www.youtube.com/watch?v=8JSLsztzeJs&feature=
player_embedded
• 0:33 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (4 of 6)

• Practical example explaining vertical integration

• Link:
– https://www.youtube.com/watch?v=X4G4yUYqEVU
• 8:14 Minutes
– This video is ~15 minutes, but only the first 8 minutes or so
is about vertical integration

©McGraw-Hill Education.
 Strategy Smart Videos (5 of 6)

• Principal-Agent problem overview

• “The Busy Secretary”
• Link:
– https://www.youtube.com/watch?v=ydh_TXrkj54
• 4:17 Minutes

©McGraw-Hill Education.
 Strategy Smart Videos (6 of 6)

• HP and Microsoft’s Global Strategic Alliance

• An interview with
– Tarun Gulati, Microsoft's Global Alliance Lead, and
– Mike Crowsen, HP's VP of Microsoft Alliance Enterprise
Group
• Links:
– https://www.youtube.com/watch?v=loKBNPdQ_vM
• 7:59 Minutes

©McGraw-Hill Education.
 Chapter Case 8

©McGraw-Hill Education.
 Chapter Case 8: Amazon.com (1 of 2)

• Originally was an online book seller

– Started in a garage in a Seattle suburb
• Amazon now:
– Sells 30x the number of items sold by Walmart
– A widely diversified technology company
– Holds 2/3 market share in e-books
• Sells more e-books than print books
– Streams music, movies, TV shows
– Largest cloud computing service provider globally
– Is establishing country-specific sites

©McGraw-Hill Education.
 Chapter Case 8: Amazon.com (2 of 2)

• Amazon is engaged in a competitive battle.

– For control of the emerging digital ecosystem
– Competes with Apple, Google, Facebook, Walmart,
Microsoft, and IBM
• Amazon is one of the five largest technology
companies.
– Annual sales = $100 billion
– Struggles to obtain profitability
• In 2014, it lost $250 million
– It continues to diversify.

©McGraw-Hill Education.
 Appendix 1 The AFI Strategy Framework
The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with
five different circles on on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The
five outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4)
Formulation, Corporate Strategy, and (5) Implementation.

Each of these outer five circles have a brief description beside them to explain what the circle means:

Under the first outer circle titled "Getting Started", it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic
Leadership: Managing the Strategy Process (Chapter 2)".

Under the second outer circle titled "External and Internal Analysis", it says: Part 1, Strategy Analysis, "External Analysis: Industry
Structure, Competitive Forces and Strategic Groups (Chapter 3)", "Internal Analysis: Resources, Capabilities and Core
Competencies (Chapter 4)", and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)".

Under the third outer circle titled "Formulation: Business Strategy", it says: Part 2, Strategy Formulation, "Business Strategy:
Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter
7)".

Under the fourth outer circle titled "Formulation: Corporate Strategy", it says: Part 2, Strategy Formulation, "Corporate Strategy:
Vertical Integration and Diversification (Chapter 8)", "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter
9)", and "Global Strategy: Competing Around the World (Chapter 10)".

Under the fifth outer circle titled "Implementation", it says: Part 3, Strategy Implementation, "Organizational Design: Structure,
Culture and Control (Chapter 11)", and "Corporate Governance and Business Ethics (Chapter 12)".

Return to slide

©McGraw-Hill Education.
 Appendix 2 Exhibit 8.2 Transaction Cost Economies

It has two circles, Firm A and Firm B, and shows the respective
internal transactions costs within Firm A and Firm B via an arrow
inside the circle. This image also shows the external transactions
that occur when Firm A and Firm B do business with one
another, with an arrow pointing externally from the circles under
a title called "Market."

Return to slide

©McGraw-Hill Education.
 Appendix 3 Exhibit 8.3 Organizing Economic Activity:
Firms vs. Markets
Firm Advantages:

Command and control (flat & hierarchical)

Coordination

Transaction specific investments

Community of knowledge

Firm Disadvantages:

Administrative costs

Low powered incentives

Principle agent problem

Market Advantages:

High powered incentives

Flexibility

Market Disadvantages:

Search costs

Opportunism (hold up)

Incomplete contracting (specifying and measuring performance, and information asymmetries)

Enforcement of contracts

Return to slide

©McGraw-Hill Education.
 Appendix 4 Exhibit 8.4 Alternatives on the Make-or-buy
Continuum (2 of 2)

Several alternative hybrid arrangements are available between

these two extremes. Moving from transacting in the market
(“buy”) to full integration (“make”), alternatives include short-
term contracts as well as various forms of strategic alliances
(long-term contracts, equity alliances, and joint ventures) and
parent–subsidiary relationships.

Return to slide

©McGraw-Hill Education.
 Appendix 5 Exhibit 8.5 A Vertical Value Chain

This image shows a downward facing series of arrows that moves from
upstream activities (backward integration) toward upstream activities
(forward integration).
The arrows move along the following sequence:
Stage 1 - Raw Materials
Stage 2 - Components & Intermediate Goods
Stage 3 - Final Assembly & Marketing
Stage 4 - Marketing & Sales
Stage 5 - After-Sales Service & Support

Return to slide

©McGraw-Hill Education.
 Appendix 6 Exhibit 8.6 Forward and Backward Integration:
The Smartphone Industry

Backward Vertical Integration achieved through:

Stage 1, Design: Apple, Blackberty, Google, HTC, Microsoft, LG, Samsung,
Xiaomi
Stage 2, Manufacturing: flextronics, Foxconn, HTC, Inventec, other OEMs

Forward Vertical Integration achieved through:

Stage 3, Marketing and Sales: Apple, BlackBerry, Google, HTC, Microsoft, LG,
Samsung, Xiaomi
Stage 4, After-Sales Service & Support: AT&T, Google (Project Fi), Sprint, T-
Mobile, Verizon

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 Appendix 7 Exhibit 8.7 Tapering Integration

In tapering integration, the firm sources intermediate goods and

components from in-house suppliers as well as outside suppliers.
In a similar fashion, a firm sells its products through company-
owned retail outlets and through independent retailers.

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 Appendix 8 Exhibit 8.9 Leveraging Core Competencies
For Corporate Diversification

The first task for managers is to identify their existing core competencies and understand the firm’s current
market situation. When applying an existing or new dimension to core competencies and markets, four
quadrants emerge, each with distinct strategic implications.

The lower-left quadrant combines existing core competencies with existing markets. Here, managers must
come up with ideas of how to leverage existing core competencies to improve the firm’s current market
position.

The lower-right quadrant combines existing core competencies with new market opportunities. Here,
managers must strategize about how to redeploy and recombine existing core competencies to compete in
future markets.
The upper-left quadrant combines new core competencies with existing market opportunities. Here, managers
must come up with strategic initiatives to build new core competencies to protect and extend the company’s
current market position.

Finally, the upper-right quadrant combines new core competencies with new market opportunities. Hamel and
Prahalad call this combination “mega- opportunities”—those that hold significant future-growth opportunities.

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 Appendix 9 Exhibit 8.10 Corporate Diversification
and Firm Performance

This image shows an inverted U-shaped relationship between

the type of diversification and overall firm performance. High
and low levels of diversification are generally associated with
lower overall performance, while moderate levels of
diversification are associated with higher firm performance.

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©McGraw-Hill Education.
 Appendix 10 Exhibit 8.11 Vertical Integration and
Diversification: Sources of Value Creation and Costs
This image shows a table with three rows, titled Vertical Integration, Related Diversification, and Unrelated Diversification. Two columns are named Sources of Value Creation (V) and Sources of Costs (C).

Vertical Integration Sources of Value Creation:

-Can lower costs (but can go other way too)

-Can improve quality (but can go other way too)

-Can facilitate scheduling and planning (but can go other way -too)

-Facilitating investments in speciialized assets

-Securing critical supplies and distribution channels

Vertical Integration Sources of Costs:

-Can increase costs (but can go other way too)

-Can reduce quality (but can go other way too)

-Can reduce flexibility (but can go other way too)

-Increasing potential for legal repercussions

Related Diversification Sources of Value Creation:

-Economies of scope

-Economies of scale

-Financial economies: Restructuring & Internal capital markets

Related Diversification Sources of Costs:

-Coordination costs

-Influence costs

Unrelated Diversification Sources of Value Creation:

-Financial economies

-Restructuring

-Internal capital markets

Unrelated Diversification Sources of Costs:

-Influence Costs

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©McGraw-Hill Education.
 Appendix 11 Exhibit 8.12 Boston Consulting Group (BCG)
Growth-share Matrix

This image shows the BCG corporate planning tool in which the corporation is
viewed as a portfolio of business units, which are represented graphically
along relative market share (horizontal axis) and speed of market growth
(vertical axis). SBUs are plotted into four categories (dog, cash cow, star, and
question mark), each of which warrants a different investment strategy.

High market growth and high market share = star

High market growth and low market share = question mark
Low market growth and high market share = cash cow
Low market growth and low market share = dog

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©McGraw-Hill Education.
 Appendix 12 Exhibit 8.13 Dynamic Corporate Strategy:
Nike vs. Adidas

There are two axes on this graph: Vertical Integration (along stages of the
industry value chain) is on the Y axis, and Diversification (in products and
services) is on the X axis.
This image shows how Adidas' corporate strategy has changed from a small,
highly integrated single business to a disintegrated and diversified global
company.
This image also shows how Nike was vertically disintegrated from the
beginning. Over time, this graph shows how Nike has diversified into different
lines of business, and also how it has stayed true to its vertical disintegration
by focusing on only a few activities.

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