(BQ)Part 2 book Modern competitive strategy has contents: Vertical integration and outsourcing, partnering, global strategy, new business development, managing the multibusiness firm, corporate governance.
CHAPTER Vertical Integration and Outsourcing Chapter Outline Introduction Hybrid Sourcing Arrangements The Employment Relationship Additional Issues Transaction Cost Theory The Property Rights Approach Differences among Types of Uncertainty Strategy and Control The Problem of Consistency Control over the Supplier’s Price Control over the Supplier’s Investment Decisions Industry Dynamics Summary Questions for Practice End Notes Control over Incentives Control over Information Strategy and Relative Capability The Strategic Sourcing Framework Explaining Vertical Integration Explaining Outsourcing Introduction The production and sale of every product requires the output of many activities But in no case does a single firm perform them all This is not a given but a choice firms make For example, when Nike decides how to advertise a new running shoe, it may choose the services of an independent advertising company rather than the creative talent of Nike’s own staff In turn, the advertising company Nike hires may 193 194 Part Four Strategic Boundaries outsource a variety of functions such as media purchasing, website design, direct marketing, and collateral print material The point is that any activity that occurs inside the firm can be also performed by an outside supplier The choice to vertically integrate (perform the activity in-house) or outsource (buy the activity’s output from a company outside the firm) is integral to strategy execution It is guided by the firm’s target market position and related capability planning, just like decisions about organizational practices and policies The key difference is that vertical integration decisions extend execution to the costs and benefits of external markets relative to those of the organization itself (see the sidebar on Coca-Cola and its bottlers) What makes vertical integration more or less attractive than outsourcing? Part of the answer has to with the difference between the firm’s abilities and those of its suppliers When the performance of suppliers is clearly superior to the firm, vertical integration can be hard to justify But another highly important part of the answer has to with the kind and amount of control a firm exercises over its employees compared to suppliers The concept of control is an important element in current theories that explain firm boundaries As described below, control differences between the firm and its suppliers are based to a large extent on the concept of the employment relationship The Employment Relationship1 In many industries the complex relationships within and between firms can make it difficult to separate employees from suppliers, customers, or partners But employees are different, especially when a firm wants extra creativity or effort on a project, special information for planning or decision making, or ongoing access to specific abilities In these kinds of situations, what distinguishes an employee from a market supplier? According to the U.S legal system, employees have three duties to the firms they work in: • • • Duty of obedience: Managers have the right to control both the process and outcomes of work, not just the outcomes alone This often means that the employee must behave in a socially acceptable, respectful way with the employer Duty of loyalty: The employee should act in the interests of his employer and cannot benefit at the employer’s expense Selfdealing is legally unacceptable Duty of disclosure: The employee must disclose information that may benefit the employer In fact, employees may be held legally accountable for losses that result from a failure to disclose critical information Coca-Cola and Its Bottlers A fact not obvious to consumers is that CocaCola has sometimes bottled its soft drinks and sometimes outsourced this function to independent firms Originally (starting in 1899), Coke’s bottlers were independent, governed by an agreement that set the terms for separate ownership and concentrate prices But in 1985, CEO Robert Gouzieta bought two large bottlers and formed Coca-Cola Enterprises (CCE), first as a wholly-owned unit, and then as a Coke minority-controlled entity (49% to Coke; the rest to the public) Over his tenure, he also acquired smaller bottlers and negotiated a Master Bottler Contract to reset concentrate prices with the remaining independents In 2006, Coke formed the bottling investment group (BIG) as a mechanism for buying and turning around underperforming bottlers Then in 2010, it bought CCE’s North American operations What was driving Coke’s in again/out again decisions? One answer is problems of control Each change in the relationship was designed to increase Coke’s control over the bottlers’ investments in marketing, manufacturing and distribution Problems in these areas were exacerbated by soft drink innovations (especially still drinks), difficulty in negotiating concentrate pricing, and bottler management decline With each step, Coke gained more control over bottler policies and thereby improved its ability to compete against the other soft drink majors (Pepsi, DPS), regionals and private labels The key control dimensions were: (1) concentrate pricing; (2) capital expenditures; (3) supply chain coordination; (4) marketing; (5) expansion of points of sale; and (6) strategy execution (marketing, operations, distribution) in still drinks Thus, Coke’s acquisitions of the bottlers followed closely the logic presented in this chapter for vertical integration: Specifically, these decisions were predominantly made to increase the integrator’s control over aspects of the integrated business in order to improve performance A second rationale for Coke’s acquisitions was sheer economic opportunity Coke was in a unique position to improve the performance of its bottlers as a group by acquiring them, turning them around, and then spinning them off with new policies in place that favored Coke’s strategy This was, in part, the motivation first for CCE and then for BIG Is ownership necessary for control? The answer is no—depending on the level of uncertainty surrounding important decisions For Coke, initially, this uncertainty was high (Were still drinks a niche or powerful substitute? How would Pepsi’s vertical integration into bottling work out?), so a dominant equity position was critical Subsequently, as the atmosphere cleared, Coke could reduce its holdings while keeping control through contractual arrangements (franchising) It could also reduce the debt on its balance sheet, which had ballooned as CCE and BIG grew Further, as the opportunity to fix the bottlers in the United States matured, there were fewer bottlers to be turned around Having gone through a reorganization of its bottlers (primarily in the United States), Coke is now de-integrating this business by selling franchises Muhtar Kent, Coke’s CEO, has said that all of U.S bottling will be re-franchised by 2020 One must assume that these agreements will include strict language preserving the kinds of control Coke has spent much time and money trying to achieve, while shifting debt to franchisee balance sheets There are also important benefits of local control in distribution Let us see whether Coke can have its cake (control over bottler investments) without the calories (high debt from acquiring and owning the bottlers) 195 196 Part Four Strategic Boundaries Suppliers have none of these duties, at least as recognized by the courts Correspondingly, employers are not accountable for the actions of their suppliers That is, although an employer is liable for the damage an employee may to a third party in the course of business, it is not liable for the damage a supplier may cause.2 The legal duties of employees highlight two linked aspects of governance that are important for business strategy: (1) legitimate hierarchical authority and (2) the generation and use of strategically important information The hierarchical authority enables managers to align incentives with the firm’s market position, make the firm’s activities more consistent with each other, and develop a culture that supports the firm’s strategy In turn, employees generate useful strategic information, leading to better decision making Given these advantages of the employment relationship, why don’t firms always vertically integrate? The answer is that the administrative costs associated with markets can be much lower than the costs of managerial control Comparing the relative costs and benefits of using the firm versus the market therefore determines the make-or-buy decision Two theories—transaction costs and property rights— have been developed to explain this choice Transaction Cost Theory Transaction cost theory focuses on the problems a firm and a supplier encounter in managing their relationship.3 Under certain conditions, these difficulties can become so frustrating to the firm that the only option is to bring the activity in-house Although in-house production is often more costly than sourcing the input in the market, the lower transaction costs of vertical integration—because of the employment relation—can more than compensate for this disadvantage The theory specifies two basic conditions that in combination lead to vertical integration The first condition is that the transaction between the firm and its supplier is exposed to a significant degree of uncertainty When uncertainty exists, and there is always some, contracts are incomplete Incomplete contracting means that part of the contract between the firm and the supplier remains unspecified That is, the contingencies that impinge on the supply relationship cannot be fully specified, so the firms must leave part of the transaction open for further discussion For example, the firm may not be able to forecast perfectly how much of the supplier’s product it will need in the future Uncertainty increases when there is substantial volatility of some kind For example, the firm may experience heightened demand or volume uncertainty when customers rapidly and unexpectedly shift their buying habits Or perhaps changes in product or process design are more numerous than expected, in which case the firms experience Chapter Vertical Integration and Outsourcing 197 significant technological uncertainty Another type of heightened uncertainty can arise from volatility in input markets, such as labor and materials, which affect the supplier’s costs and therefore future pricing Because the supply relationship’s future states cannot be articulated effectively, the two firms must renegotiate the contract when changes need to be made As uncertainty rises, more discussion is needed The increased frequency of change strains the relationship and makes vertical integration more attractive since, under the employment relationship, employees are more malleable than suppliers But according to transaction cost theory, uncertainty alone is not sufficient to lead to vertical integration; there must also be repeated problems in forming a new contract What might determine such problems? One possibility is that the firm’s costs of switching to another supplier are high High switching costs occur when the supplier has invested in assets or activities that are specific to the firm As the supplier makes these investments and its asset specificity rises, the firm may benefit because inputs are more customized to its requirements But this situation is an opportunity for the supplier to improve its profits, either by decreasing the value it provides the firm or by raising its price In either case, there is potential for increased friction in the relationship as changes need to be made A supplier could become more specialized to the buyer in many ways For example, a supplier may locate its plant next to its customer to reduce transportation and inventory costs When the customer is powerful, as Toyota is over its suppliers, co-location need not induce opportunistic behavior by the supplier But when the power distribution in the supply relationship is more equal, as for instance between a coal mine and an electricity plant, contracting costs may increase when changes in the relationship need to be made.4 Asset specificity may also involve specialized equipment or specialized skills, both of which may raise transaction costs over time For instance, when its own input prices decrease, the specialized supplier may not lower its price to the firm proportionately; or, to take advantage of its importance to the customer, the supplier may cut corners on quality, delivery, or other value drivers Through these actions, the supplier decreases the surplus the customer receives At some point, the customer becomes fed up with the supplier’s uncooperative behavior and decides to perform the activity itself.5 The Property Rights Approach But why does a firm vertically integrate into the activity of its supplier, instead of the supplier vertically integrating into the activity of the firm? For example, in 1999, Viacom, the U.S entertainment 198 Part Four Strategic Boundaries giant, bought CBS, the television network A major argument for the acquisition was that coordinating the production of TV content (Viacom’s Paramount studios produced TV shows) and content distribution (CBS had substantial broadcasting reach) would be more efficient in-house.6 But if this argument is valid, one can ask why CBS didn’t buy Viacom Viacom was not that much bigger, and a benefit from vertical integration would be achieved in any event Why does one firm gain control over the other rather than the reverse? The answer has to with the relative benefit each firm receives from exercising control over the other’s assets The company that has more to profit from controlling investments in the other firm’s assets is the one that vertically integrates The issue of relative gain from control is the foundation of the property rights approach to vertical integration.7 Thus, an organization draws its boundaries around those activities that it can derive a higher value from controlling, compared to the firms that supply it.8 This approach sheds some light on an important aspect of the employment relation Being an employee means giving up control over your work to a firm whose assets contribute more to the value of your work than your work contributes to the value of the assets That is, the firm means more to your productivity than you to the productivity of the firm In many cases, it is quite difficult to identify the contribution of the firm independent of employee activities This is especially true as the firm’s assets shift from being fungible (resources) to nonfungible (capabilities) Employees frequently try to test who is more important by challenging management for control Sometimes, in fact, the employee, not the organization, makes the superior economic contribution There are many examples where the loss of key personnel has caused a firm to suffer a loss in performance In these cases, the employees contributed more to the assets of the firm than the firm’s assets contributed to the employees But there are counterexamples as well, such as the defection of currency traders from Citibank to Deutsche Bank in 1997 Deutsche Bank hired the traders in the belief that their expertise was the primary reason Citibank’s trading revenue had been so high But it turned out that Deutsche Bank was wrong—these revenues were due to Citibank’s large, loyal customer base, not to the traders themselves How we know this? After the traders left, Citibank suffered a small drop in trading volume and then regained its position in the market However, the former Citibank currency traders could not expand the Deutsche Bank business as expected In this case, Citibank owned the critical assets, its customer list Citibank could replace the traders, but the traders could not replace Citibank Chapter Vertical Integration and Outsourcing 199 Strategy and Control It is a small but important shift in emphasis from the ownership of specialized assets to the strategy of the firm Specialization is a necessary but not sufficient condition for an asset to contribute to the firm’s market position relative to competitors It is necessary since a standard asset or activity—for example, a generic database management system—is broadly available to all firms in an industry and so adds no incremental value to any firm in particular However, it is not sufficient since specialization alone does not ensure that the asset will be aligned with the firm’s strategy A unique activity that does not contribute to the firm’s value and cost drivers makes no strategic contribution Ideally, an organization has drawn its boundary around all the activities that are strategically valuable and left those activities that are strategically less important under the control of suppliers If this were always the case, we would never see firms vertically integrating or outsourcing assets or activities since the pattern of ownership would be in equilibrium.9 But since strategies, markets, and capabilities change continually for a host of reasons, there are almost always nonstrategic activities inside the firm and strategic activities outside the firm.10 What types of control problem in a supply relationship might motivate a firm to consider vertically integrating an important activity? We can identify four:11 A problem in distributing the economic gain from the supply relationship, typically focused on price A problem in controlling the quality or quantity of supplier investments in assets, human resources, product design, management processes, and other activities that affect the value or price of what it delivers to the firm A problem in designing incentives within the supplier to be compatible with the buyer’s strategy A problem in the supplier’s handling of information that is strategically sensitive to the buyer Conflict between the firm and the supplier over any of these can be significant and lead the firm to consider vertical integration Control over the Supplier’s Price Conflicts over pricing can emerge in two contexts In one form, the problem appears when the supplier decides that it has sufficient leverage to raise its price without increasing the value it delivers In essence, the supplier is saying, “what we supply to you is important for how much money you make and we want to be paid more for it.” 200 Part Four Strategic Boundaries The second context is a variant of the first In this case, the firm desires a lower price from a supplier that provides a specialized input, but the supplier is unwilling to comply For example, many manufacturing firms, especially those with strategic sourcing relationships, have initiated target pricing programs with their suppliers to reduce purchasing costs As long as the supplier is willing to go along with these programs, there is little reason to integrate vertically However, when (1) a supplier balks at giving up its profits to the firm, (2) there are no alternatives to the supplier (because its product is specialized to the buyer), and (3) the returns from internal operations are worth the firm’s effort to self-manufacture, vertical integration might be considered Control over the Supplier’s Investment Decisions The second type of control problem concerns the supplier’s investments in the assets or activities that produce the input Critical investments might be in manufacturing or operational equipment, the quality and duration of worker and manager training, the qualifications of new workers and managers, and the quality and price of inputs to the supplier’s processes—in short, anything that might affect the supplier’s value or cost drivers In trying to control these decisions, the buying firm wants to make sure that its own value and cost drivers improve as much as possible from its supplier’s investments For an interesting and instructive example of how a firm manages its boundaries to support its market position, see the sidebar on Zara Control over Incentives In addition to investment decisions, a firm may want to control aspects of its supplier’s incentive system The reason is that incentives that are tuned to support the firm’s strategy are more likely to produce superior results.12 However, these incentives may not be consistent with the strategy of the supplier The supplier therefore faces a trade-off: either comply with its buyer and face the possibility that its own strategy execution will suffer or not comply and face the possibility that the buyer will choose another, more compliant supplier or vertically integrate into the business to gain control Here’s a hypothetical example: Imagine that a firm needs to defend its market position by increasing end user retention and the best way to improve retention is through higher service levels But the firm distributes its products through an independent supplier whose incentive system does not support stronger service The reason is that better service would be inconsistent with other elements in the supplier’s activity system The firm and the supplier therefore have a conflict based on their differing strategies If they can’t solve their problem, the firm either lowers its retention goals or forward integrates into distribution to align the incentive system with its strategy.13 Zara Zara, the economy fashion retailer, uses its boundary decisions to tie the its input (supplier) and product (customer) markets together Zara’s key attraction is called “fast—and scarce—fashion.” Zara sells stylish clothes that are on the shelves for not much more than around a month To make this happen, the firm’s activities need to be focused on speed: A large percentage (not all) of Zara’s clothes are designed and delivered to its stores within four to five weeks after the first signal of customer interest is sent from the field The other drivers of demand—store location, layout and atmosphere, and breadth of offering— not have the same kind of impact on control over value chain activities Note that quality is not a focus; although Zara’s clothes are not poorly made, they can only be worn around 10 times before some decline sets in Zara’s emphasis on fast fashion pertains to 40% of its products These are made inhouse The 60% that not require speed are manufactured externally Seventy percent of these are sourced from 20 suppliers that have long-standing, relatively informal relationships with the company Zara’s production value chain for the fast fashion 40% consists of six basic activities: product design, fabric purchasing, fabric-dyeing and cutting, garment sewing, distribution, and logistics First, the company internalizes product design to gain control over its schedule (the faster the better) Second, fabric purchasing is in-house to accelerate the speed of the process and lower costs through buyer power (scale in procurement) Third, fabric cutting is internalized for speed and scale economies But fourth, sewing is outsourced for an interesting reason Zara’s production centers in northern Spain are surrounded by many small job shops in Galicia and northern Portugal that compete heavily for the company’s business Thus, in contrast to the other activities, control is achieved through market competition, not the employment relation, and, given that garments are sewn in small batches, there are no opportunities to lower costs through scale economies The use of these sewing companies reflects Zara’s commitment to and power over its geographical region Last, distribution and logistics are in-house to facilitate fast shipments to the stores and gain efficiency through scale Some transportation may be through (competitive) outside vendors to smooth scheduling This pattern of vertical integration and outsourcing is shown in the following table Thus, to execute “fast fashion” Zara has designed its boundaries to control the speed of response to market trends and to exploit scale economies where possible Activity Type of Control product design fabric purchasing fabric dyeing and cutting sewing distribution and logistics employment relation employment relation employment relation market competition employment relation Economies of Scale? no yes yes no yes 201 202 Part Four Strategic Boundaries Control over Information This kind of control problem involves information that is valuable or sensitive to the firm There are two types First, the firm may gain from having information about a supplier’s business Second, the firm may suffer from the spread of information about its own business from the supplier to the firm’s competitors In the first case, information about the supplier, especially its costs, may give the firm insights that an uninformed competitor would lack This information may refer to valuable technologies, pricing, marketing plans and practices, or key aspects of the company’s future direction The government often recognizes this potential source of advantage as anticompetitive and tries to prevent it through threatening antitrust litigation when the firm controls access to markets For example, in the 1990s the Regional Bell Operating Companies (RBOCs) had to have a lawyer present at most meetings involving the marketing and transmission sides of their businesses to ensure that local resellers were not disadvantaged In the second case, a credible promise of confidentiality can be a key selling point for a supplier For instance, 3M makes the sticky tape on disposable diapers for both Kimberly Clark and Procter & Gamble Needless to say, without the adhesive tape, disposable diapers are not very useful 3M must reassure these two head-to-head competitors that it will not breach the wall of security that separates their individual accounts within its operations Without this reassurance, the threat of having strategic information potentially exposed to a rival might force one or both firms to find another source Or they might bring the technology in-house, if technologically possible Strategy and Relative Capability14 The property rights theory of vertical integration assumes that the organization that benefits the most from performing an activity is also the most competent But, as we have suggested, this is not always the case Even though control over decision making can provide a benefit to the firm, the firm may lack the ability to perform the activity capably In the 3M example above, Procter & Gamble benefits when 3M protects its strategic information from Kimberly-Clark But it is unlikely that Procter & Gamble could replicate 3M’s production processes successfully Thus, in analyzing make-or-buy decisions, we need to compare the relative competence or production costs of the firm and its supplier in addition to looking at problems of control in the supply 384 Subject Index Cultural differences in drug purchasing patterns, 261 in partnerships, 240 Culture national, and global strategy, 259–261 organizational, effect of corporate leadership on, 331–332 weak, 158 of workers, as critical strategy execution, 155, 158 Customer-based organizations, 152 Customer-based structure, 149–150 Customer retention, geographical scope and, 49 increasing, 48–49 customization, 48 learning costs, 48 network externalities, 49 reputation and brand, 49 search costs, 48 switching costs, 48 transition costs, 48 sample program template for strategic (table), 182 Customers competitive positioning with, 24 and purchasing decisions, retention of, 6; see also Customer retention transaction with, willingness to pay, 25–30 Customization and customer retention, 48 increasing, 180 as value driver, 38 D DaimlerChrysler, 38 Dannon Yogurt, DCF analysis; see Discounted cash flow (DCF) analysis Debt ratings, S & P, 177 for industrial firms (table), 178 Dedicated assets, 50 Delivery, as value driver, 36 Dell Computer, 110 and dominant design, 113 as Lenovo and Hewlett Packard competitor, 64 and scale-driven value drivers, 107–108 Delta Airlines and global market, 230 scalable practices and, 109 Demand, 196 Deming Award, 263 Deregulation, industry, 125 Deutsche Bank, 198 and corporate governance, 357 global operations of, 274 Development stages for selected industries (table), 101 Differentiator, 28, 33 Digital Equipment, 110 Dillard’s, 29 Discounted cash flow (DCF) analysis, 180 Diseconomies, 52 Disney, 290 Disruption; see Industry disruption Disruptive innovation, 121 Disruptive technology, 123–124 Distortion, and alignment problem, 154 Diversification in different nations, 302, 304 and economies of scope, 291–292 and making the new business successful, 290–301 and managing internal capital market, 312–315 motivations for, 289 and new business acquisitions, 297–298 new concepts for, 286–288 process of, in new business development, (figure), 287 Diversification discount, 313 Diversification premium, 314 Documentum, 300 Dogs, 315 Dominant design, 112–113 Double-loop learning, 161 Dow Chemical, 228 Dr Pepper, 117, 152 Drug purchasing patterns, in global pharmaceutical industry, 261 Dual pricing, 322 Duopoly, 78 Dupont, 291–292 Duties of employees, legal, 194 Duty of care, 343–344, 347 Subject Index Duty of loyalty, 194, 344 Duty of obedience, 194 Dynamic capability, 103–106 key concepts in developing and maintaining (table), 106 E Early mover advantage, 109–110 Economic contribution, 26–27 Economic sociology, 11 Economics, three traditions of, 10–11 Economies of scale alliances to achieve, 238–239, 241 concentration ratio and, 117 as cost driver, 35 in demand, 38 and dominant cost position, 267 and efficient boundaries model, 203–205 and functional organization, 151 and global firms, 274 minimum efficient size for, 43 in operations, 73 of rival firm, 109 and vertical and horizontal integration, 272 Zara, 201 Economies of scope, 44, 291–292 Efficiency differences, among firms, 77–78 Efficient boundaries model, 203 Eli Lilly, 143 EMC, 300 Emerging markets, 264–266 Emerson Electric, 295 Employment relationship duty of disclosure, 194 duty of loyalty, 194 duty of obedience, 194 Enron and Arthur Andersen, 349 bankruptcy of, 18 failure of board of directors of, 348–349 fall of, 348–349 origins of, 345–347 response to collapse of, 349–351 Entrepreneurial capabilities, leveraging, 293–294 Entry barriers buyer power, 66 limit pricing, 72 Entry opportunities, 274 Environmental policies, as value driver, 40 Esprit, 139 Evolutionary economics, 11 Exchange autonomy, 322–323 Experience good, 48, 49 Explicit collusion cartels, 85 defined, 82 F FedEx, 77, 226 Fidelity, 75 Financial goals and related metrics performance metrics, 177–179 and strategic planning, 175–176 Finnair, 229 Five forces framework, 12, 65–88 buyers, 66–67 competition, 74–88 entrants and entry barriers, 71–72 substitutes, 70–71 suppliers, 68–69 Fixed costs, 43 Foley’s, 29 Ford-Ferguson, 114 Ford Motor Company, 38 assembly line of, 43, 105 and partnership with Xerox, 225 and path of innovation, 105 scale of economies of, 109 and strategic sourcing framework, 206 and vertical integration into component supply, 206 Forecasting ability, 138 Foreign markets, modes of entering, 275–277 Formal collusion; see Explicit collusion Formulation, as stage of strategy, 14 Fox Media, 50, 290 France, and corporate governance, 358 Franchising, as hybrid sourcing, 210–211 Fuji, 148, 225 Functional organizations, 151 385 386 Subject Index Functional structure, 149–150 Fuyo, 225 G Game theory, 10 Gap, the, 147, 325 General Electric (GE), 14 and centralized process innovation at, 325–328 corporate mandates of CEO Jack Welch, 326 and diversification premium, 314 as multibusiness firm, 18 and quality matrix, 326–327 and shared resources, 292 and strategic business units, 328–329 and top-down initiatives, 325 General Motors (GM) and alliance with Toyota, 228 innovations of, 105 as large durable goods assembler, 38 productivity of, 16–17 as vertically integrated U.S company, 323 Geographical location, 136 Geographic market, gaining access to, 229–230 Geographic organizations, 152 Geographic structure, 149–150 Geography and natural resources, in global strategy, 261–262 as value driver, 35, 38 Germany, and corporate governance, 357–358 Global alliance networks, 229 Global competition, framework for, 266–267 Global configuration of firms, 272–275 Global industry, corporate governance in, 356–358 Global integration, and partnering, 224–225 Global markets; see Global strategy Global multibusiness firms, and competition, 329 Global pharmaceutical industry drug purchasing patterns in, 261 price controls in, 258 Global strategy, 17 diversification in different nations, 302, 304 framework for global competition, 266–275 changes in configuration of firms, 275 global configuration of firms, 272–275 horizontally integrated industries, 272 modes of entering foreign markets, 275–277 nationally segmented industries, 269–271 organizing for global competition in a single business, 277–280 table, 269 vertically and horizontally integrated, 271–272 vertically integrated across countries, 271 Porter’s Diamond Model, 262–264 why countries matter?, 257–262 laws and regulations, 257–259 national cultures, 259–261 natural resources and geography, 261–262 why regions matter?, 254–272 Golden parachutes, 352 Google as single business firm, 17–18 strategy, 41–42 two-sided platform, 42 Great Britain, and corporate governance, 356 Greenmail, 352 Growth in corporate earnings, 289–290 and innovation, 13 stage of industry evolution, 102–110 and developing scalable value and cost drivers, 106–109 dynamic capabilities and firm growth, 103–106 and early mover advantage, 109–110 strategic pricing, 110 Growth rate, decline in market, 116–117 Growth-share matrix, 315, 317 H Haier, 266 Hanson Trust, 314 Hasbro, 209 Health insurance industry, CEO compensation in, 354–356 HeidelbergCement, 314 Hewlett Packard acquisition of Compaq, 113 as Dell and Lenovo competitor, 64 as Lenovo competitor, 64 Hierarchical referral, 149 Subject Index Hierarchies, management, 149–150 Home Depot, 36, 292 Honda, 266 Horizontally integrated industries, 271–272 Hostile bidders, tactics for delaying, 351 HSBC, global operations of, 274 Hybrid sourcing arrangements, 210–213 four insights into, 210–213 franchising as type of, 210–211 single source partner as type of, 211 supplier with creative input, as type of, 211 table, 211 Hybrid structures, use of in global organization, 279–280 Hypercompetition, 118 Hyundai, 28, 38 I Iberian Air, 229 IBM, 49, 110 acquisition of, 300 and dominant design, 113 and joint ventures, 230–231 portfolio of businesses from 1994–2007, 318–319 Imitation, 6, 49–50 Implementation, as stage of strategy, 14 Incentives, control over, 200 Incentive systems; see Compensation Incomplete contracting, 196 Industrial economics, 10 Industry analysis, 61–91 defining industry boundaries, 62–64 and five forces framework, 12–13 forces influencing profitability, 64 forces that drive profits down, 68–88 forces that drive profits up, 88–90 Industry concentration, three factors of, 117–118 Industry deregulation, 125 Industry disruption defined, 99 major types of, 121 by regulatory change, 125–126 Industry dynamics, and vertical integration, 215 Industry forces driving profits down buyers, 66–68 387 competition, 74–88 entrants and entry barriers, 71–72 substitutes, 70–71 suppliers, 68–70 driving profits up complementors, 88–89 cooperation with buyers and suppliers, 89–90 coordination among competitors, 90–91 value net, 88 effect on value, cost, and price, 91 and firm performance, 62 and profit, Industry structure influence on, alliances and, 232 and trends, analysis of, 173–175 Information anchoring, 171–172 Information availability, 171 Information, control over, 202 Information sharing, between buyers and suppliers, 89–90 Information signaling, 84 Infrastructure, developing corporate, 328–332 In-house production, 196, 203–215 Initiatives, strategic development of, 179–180 programs to implement, 180 three categories of, GE and, 326 Innovation cycle, 103–106 Innovation sharing, at General Electric, 325–328 Insourcing, 15 Institutional economics, 11–12 Institutional Shareholder Services, 204 Integration success of administrative, 300 and turnaround of acquired business, 299–301 Intel, 44 and CopyExactly policy, 44 and dominant design, 112 as early computer innovator, 105 as IBM supplier, 105 innovations of, 137 internal venture capital unit of, 88 and scale-driven value drivers, 107 standard in microprocessors, 53 technological innovation of, 317 and technology transfer, 228 Intel Pentium, 42 388 Subject Index Interbusiness relationships, 186 Interdependency problem, 153 Interface with partners design of, 241–242 management of, 239, 241–242 Internal creative unit, 213 Internal engineering, 25 Internalization, theory of, 276 International Harvester, 114 Internet, and Cisco Systems, 37 Internet start-ups, 147 Interunit coordination, 149, 297 Interunit pricing, 321–323 Interunit transfers of goods and services, 320–323 Investment decisions, control over supplier’s, 200 Isolating mechanisms, 47 causal ambiguity as, 51–52 dedicated assets as, 50 development costs as, 52–53 and industry disruptions, 120 property rights and, 47 iTunes, J Japan and corporate governance, 357 and rise in world manufactured goods, 274 Japan Airlines, 229 Japanese industry, and Deming Award, 263–264 Japanese partnership practices, diffusion of, 225 JCPenny and channel complementarity, 147 as Target competitor, 29 JetBlue, 147 Jidoka, 16 John Deere, 114 Johnson & Johnson, 148 leveraging capabilities, 295 market positions of, 317 mission statement of, 173 Joint venture and cost reduction, 230–231 in global extractive industries, 224, 238 as type of partnership, 238 JPMorganChase, 116 Just-in-time logistics, 36, 116 K Keiretsu, 357 Kodak, 148 Komatsu, 139, 273 Korea First Bank, 302–304 L Labor market flexibility and depth, 265 Labor pooling, 255 Land’s End, 147 Laws and regulations, in global strategy, 257–259 Learning double-loop, 161 from failure, 161 as part of firm’s culture, 159 single-loop, 161 Learning costs, 49 Learning curves and causal ambiguity, 44–45 as cost drivers, 44–45 Lenovo, 64, 110, 113; see also IBM Leveraging capabilities, 292–293 entrepreneurial capabilities, 293–294 License, 238 Life cycle, stages of, 11 Limit pricing, 72 Lincoln Electric, 52 company profile, 157–158 piece rate, 154–155 Lotus Notes, and IBM, 318 Low input costs, as cost driver, 45 Luen Thai, Chinese manufacturer, 209 Lufthansa, 230 M 3M, 202, 294 Macroeconomic forces, and profit, Macro Environment Openness, 265 Macy’s, 29 as Target competitor, 31–33 Madok’s Model, 140–141 Make-or-buy decisions, 202–205 Subject Index Managerial incentives, in new ventures, 296 Mandated full cost, 321–322 Mandated market price, 321 Marakon profitability matrix, 185 Market access, 229–230 Market characteristics, new, 295–296 Market, emerging, 264–266 Market forces, in alliance dynamics, 242–243 Market growth rate, and buyer power, 67 Market interdependence, 62 Market position, 23 Market segmentation, 64 Market to book ratios, 298 Massey-Harris, 114 Mass merchandising marketers, Matrix form, 153 Matsushita, 275, 279 Maturity stage of industry evolution concentration of market share among similar firms, 117–118 decline in the market growth rate, 116–117 disruption by regulatory change, 125–126 increase in buyer experience and, 116 and industry disruption, 120–121 persistence of niche markets, 119 sustaining and disruptive technologies and, 123–124 technological substitution and, 121–123 Mazda, 225 McKinsey management consulting, 270 Mercedes-Benz, 38, 146 Merck, 143 Mergers and acquisitions, 298–301 acquisition performance, 298–299 merger waves, 298 ongoing operations, 301 transaction, 299 turnaround or integration, 299–301 Merger waves, 298 Microsoft and antitrust suits, 49 and dominant design, 112 as example of preempting competition, 5–6 as example of supplier power, 69 and market power over software firms, 67 Windows, 42 Word, 40 Mission statement, 173 Mitsubishi, 225 as global competitor, 266 and technology transfer, 228 Mitsui, 225 Money market fund industry, 75 Monopoly, 74 Motorola, 228 MTV, 276 Multibusiness firms managing developing corporate infrastructure, 328–332 internal capital market and, 312–315 portfolio of businesses and, 315–320 top-down initiatives and, 325–328 transfers and centralization, 320–323 planning in, 182, 184, 185 Multipoint competition, 118 Mutual Fund Industry, 204 shareholder services, 204 Myopia, as decision-making bias, 171 N Nationally segmented industries, 269–271 Nationsbank, 116 Natural resources and geography, 261 NEC, 325 Net discounted cash flow, 181 Net present value, 181 Network externalities and customer retention, 49 as value driver, 38 New business development, 286–288 Niche markets, persistence of, 119 Nickelodeon, 276 Nike, 137 Nippon Airways, 230 Nissan, 38 Noise, and controllability problem, 153–154 Nokia, 99 Noncooperative game theory, 78–79 Noncooperative strategic interaction, 78–82 Nordstrom, 158 NPV; see Net present value Nucor, 5, 44 389 390 Subject Index O OODA loop, Oligopoly, 76–83 and collusion, 82 competing in, 76–78 and efficiency differences among firms, 77–78 and noncooperative strategic interaction, 78–82 summary of competition in, 87–88 OPEC; see Organization of Petroleum Exporting Countries Operational control processes, 148–149 Operations, ongoing, 301 Options strategy, 237 Organizational identity, as problem in partnerships, 233–234 Organizational learning, 159 Organizational practices and causal ambiguity, 45–47 as cost driver, 47 Organizational structures of global firms (table), 279 types of (figure), 150 Organization by function, 151 Organization of Petroleum Exporting Countries (OPEC), 233 Outside supply, as type of vertical arrangement, 210 Outsourcing, 15–17; see also Vertical integration and outsourcing to China, 209–210 explaining, 207–208, 210 patterns in, 207 wave in services, 225–226 P Paramount, 276 Partnering alliance dynamics, 242–243 disadvantages of, 232–234 formation of, 225–227 form of, 237–239 managing alliances, 239–242 motivations behind, 227–232 recent trends in, 224 selection of, 234–236 Partners, alternative, 235–236 Partner selection, 234–236 Partnership major focus of, 231 as type of vertical arrangement, 210 Partnership form, 237–239 Patents, 49, 137 Path dependence, 105 Pay-for-performance systems, 156 Pepsi-Cola, 48, 117 Perfect competition, 74–76 Performance metrics debt ratings, 177 for divisional reporting in multibusiness firms, 329–331 return on investment (ROI) as, 330–331 for single business planning, 177 Performance task measures, 154 Pfizer, 143 Philippe Patek, 28 Piece rate, 154–155 Planning, strategic; see Strategic planning Poison pill, 352 Political risk, to firms, 277 Polo, 139, 209 Porter’s Five Forces Framework (table), 65 Portfolio, diversified, 178 Portfolio management, 186 of businesses, 315–320 dimensions that complicate assessment of, 317, 320 portfolio analysis tool, 320 Posco, 52 Positioning strategy, 237 PPG and outsourcing, 208, 210 and technology transfer, 228 Preventing imitation, Price competition, 86 Price controls, in global pharmaceutical industry, 258 Price leader, 84 Price makers, 78 Price sensitivity, 33 Price, supplier’s, control over, 199–200 Price takers, 78 Pricing, strategic, 110 Prisoner’s Dilemma Game, 83 Process innovation, achieving low costs through, 231 Subject Index Procter & Gamble, 288 alliance with Walmart, 45, 226, 231 delivery time, 90 top-down initiatives, 325 Product life cycle, 99 Product Market Efficiency, 265 Product value, customer perceptions of, 25–26 Profit, 27 Profitability, how industry forces influence, 64 industry forces and, macroeconomic forces and, Profit center, and hybrid sourcing arrangements, 211 Program accountability and schedule, 180 to implement strategic initiatives, 180 valuation of, 180–181 Project, life of, in alliance dynamics, 242 Property rights as isolating mechanism, 47 and vertical integration, 197–198 Prospect theory, 171 Public Company Accounting Oversight Board, 349 PUK, 239 Q Qantas Airlines, 229 Quality, as value driver, 36 Quality Matrix, 326–327 Quantitative analysis, 26–27 Quantity competition, 80–81 Question marks, 316 R Rabbi trusts, 351 Radical institutional change, 121 Radio Shack, 110 R&D grant, 238 Real options analysis, 181 and net present value, 183–184 Recency bias, 171 Recurring fixed costs, 43 Reebok, 137 Regional Bell, 202 Regions, importance in global strategy, 254–257 391 Regulations, taxes, limit profit, Relational capability, 90 Repositioning, 290 Research grant, 238 Residual income, 178, 330–331 Resource defined, 47, 136–137 shared, 291 Resource allocation goals of, 185–186 of new ventures, 296 Resource complementarity, 139, 141 Resources leveraging, 291–292 natural, 261–262 sharing, 90 Return on equity, 186 Return on investment, as performance metric, 330–331 Risk assumption, as value driver, 38–39 Risk reduction, 232, 289 ROE; see Return on equity Rolex, 28, 39 Royal Dutch Shell, 175 Rule 404, 350–351 Ryobi, 36 S Saatchi brothers, 270 Samsung and competition, 99 and technology transfer, 228 virtuous cycle of, 106 Sarbanes-Oxley Act, 349–351 SAS Air, 230 SBUs; see Strategic business units (SBUs) Scale-driven cost drivers, 108–109 Scale-driven value drivers, 107–108 Scale economies as cost drivers, 43–45 and technology centralization, 324 Scale efficiencies, 43 Scope economies as cost drivers, 44 and technology centralization, 324–325 Search costs, 48 Security and Exchange Commission (SEC), 18 Segmentation, international, reasons for, 270 392 Subject Index Sematech, 232, 234 Semiconductor industry and cost reduction, 230–231 and partnering, 229 Service, as value driver, 37–38 Shakeout stage of industry evolution duration and severity of, 112–115 emergence of a dominant design, 112–113 maturation of product life cycle, 111–112 Shareholder services, and vertical integration, 203–204 Shareholders, role in firm’s decision making, 341 Siemens, 228, 230 Siemens Medical Solutions, 317 Single business organizing global competition for, 277–280 performance metrics for planning, 177–179 Single-loop learning, 161 Size of firm, and global configuration, 274 Social capital, 236 Social networks, 160 Sony Corporate Social Responsibility initiatives, 325 as global competitor, 266 global presence of, 275 and scale-drive value drivers, 107 and technology transfer, 228 Sourcing arrangements, hybrid, 210–213 Sourcing framework, strategic, 206–207 Southwest Airlines, 136 and cost leaders, 146 and cost reduction, 47 and organizational learning, 159 and organizational specific practices, 51 scalable practices of, 109 and scale-driven cost drivers, 108 SOX; see Sarbanes-Oxley Act Specialization and firm’s market position, 198 and relative capability, 202–205 Spirit, 147 Staff unit, and hybrid sourcing arrangements, 212 Stages of industry evolution, 98–102 growth, 102–110 maturity, 115–126 shakeout, 111–115 Staggered board, 351 Starbucks, 325 Stars, 316 Strategic alliances, 15–17 Strategic business units (SBUs), 328–329 Strategic initiatives, 179–180 Strategic plan elements of, at business level, 170, 172 statement of intent and business scope, 172–173 Strategic planning, 10 and analysis of industry structure and trends, 173–175 and decision making, 169–190 centralization of activities, 186 corporate infrastructure and, 187 development of strategic initiatives, 179–180 interbusiness relationships and, 186 in multibusiness firms, 182, 184, 185 net present value and real options, 183–184 portfolio management, 186 program accountability and schedule, 180 program valuation, 180–181 resource allocation, 185–186 setting goals, 179 top-down initiatives, 186 financial and operating metrics and, 177 performance metrics, 177–179 the planning period, 176–177 in a single business, 170, 172–182 and statement of financial goals and related metrics, 175–176 what is?, 169–170 Strategic positions, 273–274 Strategic pricing, 110 Strategic sourcing arrangements, 231 Strategic sourcing framework, 206–210 Strategy contributions of economic and organizational sociology to, 11 options, 237 positioning, 237 and relative capability, 202–205 two stages of, 14 what is? corporate governance, 18 global, 17 how important is strategy?, 8–9 industry analysis, 12–13 origins of, 10–12 outsourcing, vertical integration, and strategic alliances, 15 Subject Index in single and multibusiness firms, 17–18 strategic planning and execution, 14–15 strategy over time: growth and innovation, 13 what defines successful?, 5–8 why study business strategy?, 3–5 window, 237 Strategy analysis, building blocks of, 10–11 Strategy execution basic elements of capabilities, 137–139 resources, 136–137 building capabilities, 141–142 activities systems, 143–145 value chain and, 142–143 compensation and incentive systems, 153–154 culture and learning, 155, 158, 159, 161, 162 piece rate, 154–155 organizational dimensions of capability development, 145–153 outsourcing, vertical integration, and strategic alliances, 15–17 relating resources and capabilities, 139–141 Structure-conduct-performance paradigm, 10 Student health insurance industry, 39 Substitutes, 70–71 Substitution, 48 Sumitomo, 225 Sunk costs, 52–53 as decision-making bias, 171 as impediment, 52 Supplier partnerships, diffusion of, 225 Supplier power, 68–70 Suppliers control over investment decisions of, 200 control over price of, 199–200 specialized, and transaction cost theory, 196–197 specialized local, 255 Supply chain management practices, 226 Sustainable competitive advantage, 5, 23–24 Sustaining and disruptive technologies, 123–124 Sustaining technology, 123–124 Switching costs, 6, 48 System-level effect, social capital as, 236 T Tacit collusion, 83–85 Target company profile, 31–33 as mass merchandising marketer, as mid-cost marketer, 29–30 Technological similarity, 62 Technological substitution, 121–123 Technological uncertainty, 196–197, 213–214 Technology centralizing development of, 324–325 spillovers, between firms, 255–257 transfer and development, 227–229, 237–238 as value driver, 36 Technology-intensive industries, growth of, 226–227 Technology partnerships joint venture, 238 license, 238 R&D grant, 238 Tiffany, 31 brand/reputation of, 38 and value leaders, 146–147 Time-compression diseconomy, 52 Tobin’s Q, 178 Top-down initiatives, 186, 325–328 Toshiba and alliance with Motorola, 228 and joint ventures, 230–231 and technology transfer, 228 Total quality management (TQM), 116 Toyota, 135 and alliance with General Motors, 228 business model, 225 and causal ambiguity, 52 and cost reduction, 47 as de-integrated Japanese company, 323 growth and innovation of, 16–17 increasing dominance in auto industry as large durable goods assembler, 38 supplier management practices of, 236 TQM; see Total quality management (TQM) Trademarks, 49 Trade policy, in global strategy, 259 Transaction cost theory, 196–197 Transaction with customer, two-parts of, 393 394 Subject Index Transfer pricing practices, 321–323 dual pricing, 322 exchange autonomy, 322–323 mandated full cost, 321–322 mandated market price, 321 Transfers and centralization, 320–325 centralization of activities, 323–324 centralizing technology development, 324–325 interunit transfer of goods and services, 320–323 and portfolio management, 320 Transition costs, 48 Transnational form of business, 279 Turnaround and integration of acquired business, 297–298 post acquisition, 300 TWA, 140–141 Two-sided platform, 40–42, 54, 58 U Uncertainties differences among types of, 213–214 in partnerships, 239–240 technological, 197 volume, 196 United Airlines, 136 as competitor of American Airlines, 229 scalable practices and, 109 United States and corporate governance, 358 trade relations with China and, 209–210 UPS, 77, 226 V Valuation methods and goals, 296 Value advantage, 146 Value chain and building capabilities, 142–143 Value-cost framework, 24 Value drivers, 35–40 brand/reputation as, 38 breadth of line as, 36–37 complements as, 40–42 customization as, 38 delivery as, 36 environmental policies as, 40 geography as, 38 network externalities as, 40 quality as, 36 risk assumption as, 38–39 service as, 37–38 technology as, 36 Value, investing in higher, 33 Value minus cost (figure), 28 Value net, 88 Vanguard Group activity system of, 143–145 and cost leaders, 146 low costs at, 45, 108 Venture, new, governance of, 296–297 Vertical arrangements, 210 Vertical integration, 15–17 buyer threat of, 68 as cost driver, 45 industries across countries, 271 Vertical integration and outsourcing consistency problem, 214 explaining outsourcing, 207–208, 210 explaining vertical integration, 207 hybrid sourcing arrangements, 210–213 industry dynamics and, 216 property rights approach, 197–198 strategic sourcing framework, 206–207 strategy and control, 199 strategy and relative capability, 202–205 transaction cost theory, 196–197 types of uncertainty, 213–214 Viacom, 197, 198 global changes, company profile, 276 as global media company, 290 Virtuous cycle, 106 Vision statement, 173 Vivendi, 275 Vividness bias, 171 Volume uncertainty, 196, 213–214 W WACC; see Weighted average cost of capital (WACC) Walmart alliance with Procter & Gamble, 45, 90, 226, 231 brand/reputation of, 38 founded by Sam Walton, 31 and logistics, 52 Subject Index as low-cost giant, 29 as mass merchandising marketer, 4, and new geographical markets, 44 value to customer, 33 Weak cultures, 158 Weighted average cost of capital (WACC), 330 Whole Foods, 40 Willingness to pay, 24 Window strategy, 237 WorldCom, bankruptcy of, 18 World Trade Organization, 50 X Xerox partnership with Ford, 225 partnership with Fuji and Mazda, 225 as vertically integrated U.S Company, 323 Z Zara fast fashion, 201 production value chain, 201 395 ... Systems 9 (19 92) , pp 7 24 22 See Richard Makadok and Russ Coff, “Both Market and Hierarchy: An Incentive-system Theory of Hybrid Governance Forms.” Academy of management Review 34 (20 09), pp 29 7–319... of the Firm,” Quarterly Journal of Economics 120 (20 05), pp 729 –61; and Daniel Drezner, “The Outsourcing Bogeyman,” Foreign Affairs, May–June 20 04 20 For an important study showing how the decision... 62 (19 72) , pp 7 72 95; Benjamin Klein, Robert G. Crawford, and Armen Alchian, “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process,” Journal of Law and Economics 21 ,