Vertical integration is Vertical integration is dead, or is it?? dead, or is it?? Group members: Mufakhara Shahid Khan ME-11-11 Syeda Rumaisa Khalil ME-11-24 Khadija Majeed ME-11-36 Syeda Tammat Zahra ME-11-15
Vertical integration The degree to which a firm owns its upstream suppliers and its down stream buyers is referred as vertical integration
Introduction Companies are routinely counseled to “stick to their knitting” and outsource every thing else.
“stick to their knitting” If a person or company sticks to their knitting, they continue to do what they have always done instead of trying to do something they know very little about He believes the key to a companys success is to stick to its knitting rather than trying to diversify or vertical integrate.
Academia has lost interest in VI. The issue is largely regarded as settled in favor of de-integration VI shares the poor track record of conventional diversification, and its presumed deficiency is explained in identical terms
Impact of the differing economic and technological circumstances prevail in the various segments of an industry’s value chain, requiring distinct management styles and cultures. The problems of VI have been thrown into sharp relief by the advent of internet
VI and the Internet Commonly IT technology Information is easily exchanged across companies boundaries Transaction cost are reduced Firm should become smallerand less vertical integrated
According to Evans and Wurster of blown to bits fame(2000) Net is the primary driven behind the de- integration of corporations. it offers new possibilities commercializing the information component of an industry and, correspondingly, has the potential to disrupt existing value chain.
“clicks and bricks” Bricks and clicks is a business model by which a company integrates both offline (bricks ) and online (clicks) presences, A popular example of the bricks and clicks model is when a chain of stores allows the customer to order products either online or physically in one of their stores, also allowing them to either pick-up their order directly at a local branch of the store or get it delivered to their home.
VI is dominant foremost among manufacturers that push downstream, it is also prolific in services, as observed in the converging media/ entertainment sector or in more traditional industries such as engineering and construction
VI strategies in today’s business Environment Current popularity of VI downstream integration of customer interface, marks a departure from traditional motivations base on altering industry structure or minimizing cost VI is driven by learning related motives
Traditional rationales for VI Creating barriers to entry Avoiding exposure to the potential opportunism of others
VI in the academic literature Motives for firm’s VI strategies:1. Strategic considerations, primarily to do with power and positioning2. Efficiency considerations, primarily based on governance and transaction cost arguments
Strategic considerations Positioning via-a-via rivals and potential rivals Strategic approaches aim to change the industry’s power structure, either by building/exploiting the firm’s market power or by attempting to offset the power of others
VI prompted by considerations such as:1. Foreclosing of input and output markets to competitors2. Cross subsidization of one stage of the value chain by another in order to squeeze out more focused competitors3. Increasing barriers to entry4. Retaining control over proprietary knowledge
Efficient governance considerations Governance arguments came to the fore in the 1990’s. Derived from two bodies of theory1. Agency theory2. Transaction cost economies
Both mainly seek to minimize the firm’s exposure to opportunistic action on the part of others Each has a different focus, but both share the premise that the firm governance choice Has a decisive impact on its cost efficiency Both seek to determine the firm’s most efficient (cost minimizing) vertical boundary
Transaction costs Transaction costs are the greatest in instances of “market failure” where a particular transaction cannot be adequately protected by contractual means
VI provides the most economic solution by minimizing technology related transaction costs. In agency theory, the problem of opportunistic action in terms of measurement problems, VI represents the most efficient governance choice
Transaction and agency challenges Through VI a firm can achieve these challenges Uncertainties in demand/price Uncertainties in quality Lack of coordination Market failure in knowledge/technology markets Agency problems of measurement uncertainty
Disadvantages of VI Higher performance risk Technological volitatility Uncertain demand In presence of high exit barriers it turned to be costly Loss of market incentives Higher production cost Loss of focus
Prominent contemporary motives for VI Many of the VI motives identified and studied by academics have become obsolete or diminished in importance. Instead, a number of a new compelling motives for VI seem to have appeared that have yet to b fully explored
Value migration In many industries, particularly in the manufacturing sector, value added has migrated downstream for a host of reasons: High penetration rates and longer product life spans, “the installed base” As a result, a considerable portion of value-added has shift away from manufacturing towards maintaining and servicing existing products
Example of computer manufacturers Most major computer manufacturers have expanded aggressively into downstream services specially consulting IBM was the pioneer, but it was soon emulated by the likes of Compaq Compaq’s acquisition of digital in 1998 was motivated by CEO Pfeiffer’s ambition to move the company into services and consulting
Differentiation Corporations strategy: Corporations differentiate themselves on the basis of product and services. Previously differentiation was on the basis of technical/functional merits of their offerings..
Added offerings : 1. Additional engineering support 2. Performance guarantees 3. Special distribution 4. Delivery arrangements 5. Packaging tailored to the Clients need
A brand for a company is like a reputation for a person. You earn reputation by trying to do hard things well.” – Jeff Bezos
Total brand management Close interaction with the final customer to establish an emotional connection. It creates good image of company in customer mind. Helps to read the customer psyche.
Customer demand integrated solutions Many companies are compelled by their clients to offer an ever greater range of products and services Clients increasingly rely on their suppliers to provide them with “integrated solutions”.
VI “push” in represents differentiation while the integrated solutions motive represents a VI “pull” by the customer
OEM Companies had to expand their activities into product innovation and assembly to gain the ability to provide their clients with advanced subassemblies OEMs are not the original manufacturers; they are the customizers.
Clients increasingly charge engineering contractors with holistic business problem. Engineering and construction companies such as Bechtel and Fluor Daniel have expanded their range of activities to offer full project services
What is synergy? synergy means that teamwork will produce an overall better result than if each person within the group were working toward the same goal individually.
Synergies One of the principal arguments against VI is that combining fundamentally different segments of the value chain within firm reduces efficiency and raises bureaucratic costs.
Counterargument is that combining the different stages offer more transaction opportunities . Close and ongoing relations between, say, sales and manufacturing may lead to significant synergies.
“Powerful synergies can also b realized by suppliers that are allowed to penetrate deep into their clients decision making processes.”
“Make for stock” to “make to order” By integrating forward into their customers inventory planning they typically obtain more timely information about demand.
Firms that involve in Integration Contractors & Engineers/Architects “Design builders” “Constructability
VI benefits In-house operating expertise Maximum operability Minimizing total spending Maximizing its return
Emerging Industries VI is popular in mature industries but it is often imperative for emerging industries for two reasons:1. Credibility2. System compatability / technological standard
Credibility Credibility = trust. Credibility = someone worth the time. A new industry may lack the credibility to attract the suppliers and distributors.
Ford motor company The emerging car industry by Henry Fords operation. Company used to own the railways, locomotives, power plants, ore-carrying ships, blast furnaces and foundries necessary to transform the inputs from the firms iron ore and coal mines
The company initially was forced to own and operate every stage of the industry value chain because suppliers were reluctant to share Henry ford’s bold vision" horseless carriage” So VI may be necessary to educate customers and convince them of the merits of the new products.
System Compatibility/Technology Standards Emerging industries frequently rely on a set of highly coordinated components, which may be difficult to achieve among independent parties Coordination is required to lift performance
Attractive content was the key to getting people to subscribe to the emerging cable TV “Time Warner” was able to enhance the value proposition of its cable service
Services of “Time Warner” are: Feature films would no longer appears last on cable, but immediately after their release in theater Higher subscription revenue Cable advertising allowed the firms to buy more attractive contents
Assessment and implications The majority of the firms moving downstream and a casual survey of the business press confirms that forward integration is far more prevalent Controlling down stream stages grown importance over the years Production paradigm has shifted from push to pull in many industries
Move toward mass customization New communication technologies have allowed for un precedent direct contact with customers, enabling the creation of enduring relationships for manual benefit
Traditional VI motives are outdated Significant numbers of traditional VI motives have become obsolete or have at least been severely weakened Many governance arguments have been cast aside by technological and other innovations Upstream VI benefits for superior production and inventory scheduling
Spatial integration in place of ownership- based VI Attributed to technology have been successfully migrated through the use of technology brokers and consultants Transaction cost motives for VI have been weakened through the advent of the internet
Barriers to entry have been eroded by such events as converging industries and abundant availability of global investment capital Liberalization of trade and investment around the world attempt to foreclose supply and distribution channels have been shown to be futile in many industries
Why we need VI? Downstream VI has remained popular in many industries For customer interface we use forward integration Upstream VI accessioned with independent , closely aligned suppliers
Downstream VI based on learning motives Recent VI decisions can best be explained in terms of learning arguments Most motives for contemporary VI are value migration, differentiation, integrated solutions, and synergy motives. Downstream VI facilitates access to both information and knowledge about customers.
Such knowledge extends beyond insight into what customers want today, how best to provide them, and what future offerings might look like. Such knowledge can be generated only through intimate learning relationships with customers.
Upstream benefits Upstream VI benefits can be replicated with independent, closely aligned suppliers, learning benefits can only be realized fully by firms that own the customer interface Learning depends on the suspension, at least temporarily, of the market logic, which is the most easily accomplished within the company
Importance of learning The learning argument emphasizes the need for more creative Entrepreneurship. Entrepreneurial “alertness” through the identification, acquisition, and adoption of economically meaningful information and knowledge is an essential component for the company success
Challenges for VI Challenges associated with VI are inside put-able Firms must find ways of retaining strong market incentives and flexibility, where they pursue a form of tapered VI Make sure to keep their existing buyers/suppliers on the side
Conclusion Large scale empirical studies suggest that VI has not been diminished by the popularity of new organizational forms. The anecdotal evidence presented that vertically integrated firms compete successfully in a wide range of industries