Doing Business in Brazil

SEMANA INTERNACIONAL
January 16-20, 2017

Strategies for Growth and Diversification

Jorge Carneiro
FGV Sao Paulo School of Business Administration

Jorge Carneiro & Rosana Codaro

1
 Levels of Strategy

Corporate Business Unit Functional

Level Level Level
In which industries to Choice of customer Production
compete segments Logistics
Degree of vertical Package of attributes to Finance
integration offer to the market and Human Resource Mgt
In which countries or respective level of Research &
regions performance Development
Integrated management Relative price level Marketing
and allocation of Cost structure Sales. . .
resources between the
business units
Alliances, mergers and
acquisitions

2
 Ansoffs matrix
Current products
Market penetration
Increase use of product
Current
Frequence of use / cosnumption
markets /
Quantity used in each occasion
segments
New applciations (or new
occasions of use) for the same
clients
New products
Prodcuct developemnt
New products for the same clients
New attributes and characteristics
Expansion of the product line,
including accessories
New brands, including private
labels for retailers
Packages of offers(bundling),
including added services

Market development Diversification

Geographic expansion Related vs. unrelated
New
New client segments
markets / Vertical integration
New distribution channels
segments New revenue models

3
3
 Ansoffs matrix
Market penetration
Airlines mileage programs
Sale of refill (only content) instead of "packaging + content"
Ades juices (Unilever): new occasions of consumption (lunch
and dinner)
Nespuccino (cappuccino coffee from Nestl): new places of
consumption (ex: at home, instead of only in cafes and
restaurants); New applications (ex: ingredient for cakes)
Ita bank: purchase of other banks access to clients
(including new market segments, such as the state and
municipal governments) via acquisition.
Carpet company that accepts used as part of the payment:
encourages buy back early, reduces manufacturing costs, but
increases reverse logistics costs
Toothbrushes with tape that indicates level of use

4
 Ansoffs matrix
Product development
iPod iPhone iPad (Apple)
Virtua (internet access, offered by Net cable TV)
Added services offered by mobile operators (e.g. text
messages, ringtones, wallpapers, )
Johnson & Johnson: several products for the medical
segment
Oi Paggo, credit card service via mobile phone
Zero Cal: from sweetener to diet desserts and diet
juices
Note: somehow, these new products are targeted at new customer
segments or new occasions of use

5
 Ansoffs matrix
Market development
Spoleto: expansion to various cities
Natura: expansion to other countries
Havaianas: repositioning the product to meet more demanding
customer segments; expansion to other countries
Avon: lines for men
Activia (Danone): besides adult women, appeal also to children
Listerine: from antiseptic in surgical procedures to oral hygiene
New distribution channels: AmBev (kiosks), Nestl (street carts),
Apple and Nike (own stores)
New revenue models: Nestl (sale of automatic coffee machines
with the Nescaf brand and subscription to re-supply service)

6
 Ansoffs matrix
Diversification
H. Stern: from jewelry to household products (H. Stern Home) and
to spa business (H. Stern Spa)
Siemens and Phillips: various technology products, for various
applications and different types of customers
Rede Globo: newspapers, radio, TV, internet, ...
Ambev: popsicle flavored guaran
Votorantim (cement, aluminum, pulp and paper, iron and steel,
mining, chemical specialties, orange concentrate, financial
services)
Aurora fridge (meats and poultry and now also pizzas)
Gerber (infant food and now also cereal bar for adults)
JBS Friboi: vertical forward integration into the production of soaps
(Francis) and hair conditioners (Neutrox) as well as vertical
backward integration into the production of boots for own use.

7
 Potential new revenue models
Dental floss
Usual model: little box for personal use, sold at
drugstores and supermarkets
New model: use in companies or restaurants
bathrooms
New dispenser
New type of relationship (re-supply contract loyalty)
Amusement parks
Usual model: payment for entry + payment for
each toy / equipment
New model: plans for members with free access to
toys / equipment
Is there any conflict of interest between the two customer
segments?
8
 Potential new revenue models
Information guides
Usual model: sales at bookstores and newsstands
New model #1: new channels
New model #2: souvenir, as a relationship
instrument between firms and their clients
Personal sales force, several substitutes
Dehydrated food
Usual model: sale at supermarkets and
convenience stores
New model #1: sales to airline companies
New model #2: food supply for armed forces
Substantial modification in the 4Ps

9
 Potential new revenue models
Nescaf (Nestl)
Usual model: sale at supermarkets and
convenience stores
New model: Sale of automatic coffee machines
with the Nescaf brand and respective
subscription of a re-supply service
Brastemp
Usual model: Sale of electrical home appliances to
wholesalers and large retailers; on-demand
maintenance service
New model: "Sale" of water purifier with
subscription service (right of use and maintenance
service)
10
10
 Diversification
Each segment selected must be large enough or have growth
prospects to be potentially profitable
The number of segments selected will depend on the company's
capacity to serve them and the coherence between the business
strategies adopted for each one
It is also necessary to evaluate the degree of competition and
the costs to serve the target segments

External coherence:
Internal consistency:
Needs and types of
Sharing of resources
buyers served
and activities
11
11
 The Strategic Management Process
Business Unit Level
Strategy
External
Analysis

Strategic Strategy Competitive

Mission Objectives
Choice Implementation Advantage

Which Businesses
Internal to Enter?
Analysis
Diversification
Corporate Level Vertical Integration
Strategy

Note: slides adapted from material gently made available by Pearson Education / Prentice Hall 12
Logic of Corporate Level Strategy
Corporate level strategy should create value:
1) such that the value of the corporate whole increases

2) such that businesses forming the corporate whole

are worth more than they would be under
independent ownership

3) that equity holders cannot create through

portfolio investing
a corporate level strategy should create
synergies that are not available in equity
markets
vertical integration = value chain economies
13
Logic of Corporate Level Strategy
Corporate level strategy should create value:
1) such that businesses forming the corporate whole
are worth more than they would be under
independent ownership

2) that equity holders cannot create through

portfolio investing

Therefore,
a corporate level strategy must create
synergies
economies of scope - diversification
14
Vertical Integration and Diversification
Vertical Integration

Backward Forward

Diversification
Other Current Other
Businesses Businesses Businesses

No Unrelated Related Many

Links Links
15
Types of Corporate Diversification
At a general level
Product Diversification:
(operating with multiple products / client segments)
operating in multiple industries

Geographic Market Diversification:

operating in multiple geographic markets

Product-Market Diversification
operating in multiple industries in multiple
geographic markets
16
 17

Related-constrained Related-linked Unrelated

diversification diversification diversification
C
C
C

A
A

A
B
B

B
A
A

B
business business
Single Dominant
Competitive Advantage

If a diversification strategy meets the

VRIO criteria
Is it Valuable?

Is it Rare?
Is it costly to Imitate?

Is the firm Organized to exploit it?

it may create competitive advantage.

18
 lower costs
Is Diversification Valuable? higher revenues

Two Criteria

1) There must be some economy of scope (synergy),

so that the value of the set of businesses is higher if
managed by the same firm than the sum of the value
of the businesses when managed by independent
firms

2) The focal firm must have a cost advantage over

outside equity holders in exploiting any
economies of scope

19
 Value of Diversification

Business X + Business Y + Business Z Value

Independent: equity holder could buy shares of each firm

Focal Firm

Business X
Economies
Of Business Y Value
Scope
Business Z

Combined: equity holder buys shares in one firm

20
The Corporate Strategy is composed of the
decisions made and actions taken by the
company in order to develop a competitive
advantage based on the selection and
administration of a portfolio of businesses

Products / Services and respective buyer

segments

Countries and geographic regions

21
The company should check whether two
potential benefits of diversification have
been (will be) attained:
Reduction in risk (i.e., volatility of returns)
Increase in net present value (NPV)

22
What is the difference between diversification of
a portfolio of financial assets vs. diversification of
a portfolio of businesses?
In a portfolio of financial assets, the investor does not
act actively in the management of the underlying
financial securities (he acts actively only in asset
selection and investment / divestment timing)
combination (but not modification) of financial flows
In a portfolio of businesses, the investor performs the
role of manager (directly or through hired executives),
playing an active role in strategic and operational
decisions regarding asset management
modification of financial flows

23
Economies of Scope
Four Types
1) Operational

2) Financial

3) Anticompetitive

4) Managerialism

24
Economies of Scope
1) Operational Economies of Scope
a) Sharing Activities
exploiting efficiencies of sharing business
activities

b) Leveraging / Sharing Core Competencies

exploiting core competencies in other businesses

25
Economies of Scope
1) Operational Economies of Scope
a) Sharing Activities
Cost reduction
Economies of scale by
sharing activities of
procurement, production,
distribution, advertising,
etc.
Economies of experience
and of learning
Sharing R&D results
across SBUs
Increase of differentiation
Offer of complementary
products
Better integration and
compatibility
Less search costs for
the client
Full solution (product +
services)
Use of the brand image
of some products (or the
reputation of the firm) to
boost others
26
 Economies of Scope
1) Operational Economies of Scope
a) Sharing Activities
Inbound logistics Marketing & Sales
Procurement of raw materials Advertisment (instituional / brand)
Inventory management Promotions
Warehousing facilities Linked sales
Qualtity control Integrated sales (pacages))
Sales force
Operations
Distribution channels
Standardiztion of compontnes and
interfaces Price management
Production facilities After-sales
Quality control Techinacal assistance network
maitenance Call centers
Oubbound logistics
Salespersons training
Invesntory management
Receivvables management
Order processing
Delivery systems
Warehousing facilites 27
Economies of Scope
1) Operational Economies of Scope
a) Sharing Activities

Problems of organization and management

Difficulties for executives to keep adequately informed about the
intricacies of each SBU
Bureaucratic costs of integration, coordination and control
Activity sharing can limit meeting specific needs of buyer
segments
Overly standardized offers
Locked distribution
Inflexible sales and after-sales forces
Sharing of brands and reputation can harm the entire
portfolio if one of the items faces problems
28
Economies of Scope
1) Operational Economies of Scope
b) Leveraging / Sharing Core Competencies
Use of technical or managerial know-how through:
Exploitation of similar technologies
Honda in the manufacture of engines (automobiles, motorcycles, lawn
mowers, small electric generators)
3M in substrates and adhesives
Exploitation of similar managerial principles
DuPont in operational safety
Exploration of marketing expertise
Philip Morris (cigarettes) by buying Miller (beers) to leverage their
knowledge of brand positioning regarding the consumer products
market
Leveraging managerial capacity to restructure businesses
GP Investimentos (ABInBev, Heinz, KFC, Lojas Americanas, ...)
29
Economies of Scope
1) Operational Economies of Scope
b) Leveraging / Sharing Core Competencies
Do such central competencies actually exist and can be transferred
well across other industries or are they merely an illusion and wishful
thinking of company managers?
A company that diversifies to exploit its core competencies in new
markets tends to have lower costs or higher revenues (or both) than
companies entering those markets without such competencies or
without the possibility to share them across businesses.
However, one should note that:
The company needs to have organizational structure and processes
that allow it to exploit such skills in new markets (VRIO)
Even if other companies (new entrants in this market) have higher
costs or lower revenues, they can still decide to enter as long as
they think they will recover their cost of capital 30
Economies of Scope

2) Financial Economies of Scope

a) Internal Capital Market
premise: insiders can allocate capital across
divisions more efficiently than the external capital
market
works only if managers have better information
have less incentive to lie to their peers and
superiors than to the financial market
may protect proprietary information
but may suffer from escalating commitment

31
Economies of Scope

2) Financial Economies of Scope

b) Risk Reduction
counter cyclical businesses may provide
decreased overall risk
however,
individual investors can usually do this more
efficiently than a firm (except for the risk of bankruptcy)
- Broker fees and commissions are lower than
executive salaries and bonuses
- Costs of entry, exit and switching are lower for
investors than for a firm
- does the company have the competencies to be
competitive (cost and quality) in new businesses?32
Economies of Scope

2) Financial Economies of Scope

c) Tax Advantages

transfer pricing across countries

if corporate tax rates are different across countries in
which the firm has businesses
but, it may not work if suspicion of tax evasion and
there bi-taxation agreement between countries
possibility to use losses in one business as a tax
shield to pay less corporate income tax in a
profitable operation in another business
smoothing of cash flows can allow for greater
capacity of indebtedness
33
Economies of Scope
3) Anticompetitive Economies of Scope
a) Multipoint Competition
mutual forbearance
a firm chooses not to compete aggressively in one
market to avoid competition in another market
Example: Coca-Cola vs. ABInBev (soft drinks and beers), Dell and HP
(computers and printers), Michelin and Goodyear (Europe and USA)

b) Market Power
using profits from one business to compete in
another business (but investors may be able to replicate)
using buying power in one business
to obtain advantage in another business
34
Economies of Scope
4) Managerialism
does a diversified firm attract better managers?
career development opportunities
an economy of scope that accrues to managers
at the expense of equity holders
managers of larger firms receive more compensation
(larger scope = more compensation)
therefore, managers have an incentive to
acquire other firms and become ever larger
even though the incentive is there, it is difficult
to know if managerialism is the reason for an
acquisition
35
Other motives for diversification

Dissatisfaction with the Uncertainty about future

company's performance cash flows (eg in
in current businesses + mature or declining
a risk-taking posture industries, attack by
competitors)
Increased executive
prestige, power and
compensation

Antitrust laws that may

limit company growth in a
business

36
Equity Holders and Economies of Scope
Most economies of scope cannot be captured
by equity holders
risk reduction can be captured by equity holders

Managers should consider whether corporate

diversification will generate economies of scope
that equity holders can capture
if a corporate diversification move is unlikely
to generate valuable economies of scope,
managers should avoid it

37
Rareness of Diversification
Diversification per se is not rare

Underlying economies of scope may be rare

relationships that allow an economy of scope
to be exploited may be rare
an economy of scope may be rare because
it is naturally or economically limited
a soft drink bottler buys the only source of
spring water available
a hotel in a resort town creates a large water park,
there are only enough customers to support one park
38
Imitability of Diversification
Duplication of Economies of Scope

Less Costly-to-Duplicate Costly-to-Duplicate

Employee Compensation Core Competencies
Tax Advantages Internal Capital Allocation

Risk Reduction Multipoint Competition

Shared Activities* Exploiting Market Power
(codified/tangible) (tacit/intangible)

*may be costly depending on relationships

39
Imitability of Diversification
Substitution of Economies of Scope

Internal Development Strategic Alliances

start a new business under
the corporate whole
avoids potential cross-
firm integration issues
find a partner with the
desired complementary
assets
less costly than
acquiring a firm

Competitors may use these strategies to arrive at a

position of diversification without buying another firm

40
The O of VRIO: organizaing to exploit diversification

Organizational structure and organization and management

model: multidivisional form (M-form)
Synergies vs. conflicts of interest between businesses
Corporate Capital Allocation and Base-zero Budget
Cost Centers, Profit Centers, and Transfer Pricing
Evaluating the performance of each business
How to take into account the role of other businesses in the
performance of each business?
Economies of scope and ambiguity in assessing the
performance of SBUs
Governance mechanisms and incentives to executive
Role of the Board of Directors
Role of institutional investors

41
 Related diversification: strategic vs. operational

Grant (1988) argues that the degree of relationship (between business) at

the strategic level would be more important than the relationship at the
operational level
Corporate management
Resource allocation
Strategy formulation
Performance monitoring
of the business units
Determinants of strategic similarity
Projects of similar capital needs
Projects of similar time horizons
Similar sources of risk
Similar management skills requirements
Similar key success factors
Same stage of the industry life cycle
Similar competitive positioning
Similar performance metrics for objectives
Similar temporal horizons regarding goals

42
Summary
Corporate Strategy: In what businesses should
the firm operate?
an understanding of diversification helps managers
answer that question

Two Criteria:
1) economies of scope must exist

2) must create value that outside equity holders

cannot create on their own

43
Summary

Economies of Scope
a case of synergycombined activities generate
greater value than independent activities

may generate competitive advantage if they

meet the VRIO criteria

Firms should pursue diversification only if careful

analysis shows that competitive advantage is likely!

44
 Why do so many Brazilian
companies, particularly family
companies, have a high
degree of diversification?

What about Peruvian firms?

45
Why so many Brazilian companies are diversified?

Internal capital allocation at a time when capital markets were

insufficient or too expensive to finance companies
Market failures in the past: lack of suppliers, lack of channels,
etc. vertical integration decisions
Family culture: a business for each child in order to avoid
conflicts in inheritance sharing
Managers without proper knowledge

46
 Portfolio Models

Two-dimension matrix:
Market attractiveness
Firms strength (competitive positioning)

Most well-known portfolio models:

Boston Consulting Group (BCG)
General Electric / McKinsey
Arthur D. Little

47
 Portfolio Models
BCG (Boston Consulting Group)
growth X market share matrix

market attractivenss represented by:

Growth rate

competive positioning represented by:

Relative market share

48
 Portfolio Models
BCG (Boston Consulting Group)
growth X market share matrix
Star Question mark

?
Market growth rate

Cash flow Cash flow

high

+ or - modest negative

Cash cow Dog

Cash flow Cash flow
low

positive + or - modest

high low
Relative market share
49
49
 Portfolio Models
Dynamics of the BCG mztrix

?
Successful
sequence ?

Disastrous
sequence $ x
$ X

50
50
 Example of the product portfolio matrix of a
diversified firm
20%

market growth rate

10%

4.0 2.0 1.0 0.5 0,25

relative market share 51
51
 Portfolio Models
General Electric and McKinsey
market attractiveness X Business strngth matrix
Market attractivenss represented by:
Market size
Historical market growth
Competition characteristics
Price levels
Degree of government intervention
Demographic, social, legal variables, etc..
...
Competitive positioning represented by:
Relative market share
Customer loyalty
Control over the distribution channels
flexibility
Patents / technological capability
Marketing training
52
 Portfolio Models
General Electric and McKinsey
market attractiveness X Business strength matrix
Market attractiveness
high medium low

investment and crescimento

high selectivity
Business strngth

growth seletivo

medium selective growth selectivity harvest / exit

low selectivity harvest / exit harvest / exit

53
53
 Portfolio Models
Arthur D. Littles model:
market attractiveness represented by:
Stage of industry development (introduction, growth, maturity,
decline). . .
Competitive positioning represented by:
Relative market share
Customer loyalty
Control over the distribution channels
flexibility
Patents
...

54
 The Strategic Management Process
Business Unit Level
Strategy
External
Analysis

Strategic Strategy Competitive

Mission Objectives
Choice Implementation Advantage

Which Businesses
Internal to Enter?
Analysis
Diversification
Corporate Level Vertical Integration
Strategy

55
What is Vertical Integration?
Where your pizza comes from

Dairy Farmers
(milk)

Seed Companies Pizza Chains

(Alfalfa & Corn)

Leprino Foods
(Mozzarella Cheese)

Crop Farmers
(Alfalfa & Corn) End Consumer

Food Distributors

56
What is Vertical Integration?

Backward
Vertical
Dairy Farmers Integration
(milk)

Seed Companies Pizza Chains

(Alfalfa & Corn)

Leprino Foods
(Mozzarella Cheese)

Crop Farmers
(Alfalfa & Corn) End Consumer

Food Distributors Forward

Vertical
Integration
57
Value Chain Economies
The Logic of Value Chain Economies
Backward
Vertical
the focal firm is able to Dairy Farmers Integration
(milk)
create synergy with the
other firm(s)?
cost reduction
Leprino Foods
revenue enhancement (Mozzarella Cheese)

the focal firm is able to

capture above normal
economic returns Forward
Food Distributors
(avoid perfect competition)? Vertical
Integration
58
 Is it worth to integrate vertically?

Assumptions (generally incorrect) that managers often use to

justify vertical integration:
Increase control over the value chain (quality, quantity, deadlines)
Reduce costs (keep the margin/profit of suppliers)

59
 Is it worth to integrate vertically?
Flaw in the previous reasoning: exception X general rule
Quality does not improve (suppliers tend to be more specialized)
Costs do not fall (suppliers tend to have larger scale and more
accumulated experience, and there would still be a need for capital
cost investments, generally ignored in a simplistic analysis)
Some costs increase (e.g., overhead, operational inefficiency due
to accommodation, implicit subsidies, suboptimal scale of
production)
Commitment of resources that may be scarce
Risks increase (operational leverage, loss of flexibility, barriers to
exit, reduction of information exchange with the market, dilution of
managerial focus; if forward integration, possible relationship
problem with channels)

60
 Is it worth to integrate vertically?
What are the real intentions of the manager who choose to
integrate vertcially?
Agency problem?
Increase company size
Increase executive power and salaries
Opportunity to disguise inefficiencies in part of the company
...

61
 Reasons for vertical integration
Which circumstances would justify backward vertical
integration?
Incompetent or unreliable suppliers (on quality, quantity, deadlines)

opportunism
and absence of alternative suppliers
Very powerful suppliers
Lack of interested suppliers (why?)
Risk of commitment of investment in specific transaction with
supplier (ex .: refinery vs. pipeline) vs. Cost of reversing investment
in vertical integration
Preservation of industrial secrets
Reduction of the tax burden (if cumulative taxation)

What are the Does the firm have What are the
costs of the competencies to alternatives to
vertical participate in these vertcial
integration? other stages of the integration?
system of activities?
62
 Reasons for vertical integration
Which circumstances would justify forward vertical integration?
Very powerful distribution channels (but would the buyer accept a mono-
brand channel?)
Risk of commitment of investment in specific transaction with buyer (ex .:
refinery vs. pipeline) vs. Cost of the reversal of vertical integration
Importance of direct contact with the customer or technical requirements,
in cases where they are not well served by the existing "channels"
Importance of brand management with final consumers
Preservation of industrial secrets
Increased barriers to entry of potential competitors
Reduction of the tax burden (if cumulative taxation)

What are the Does the firm have What are the
costs of the competencies to alternatives to
vertical participate in these vertcial
integration? other stages of the integration?
system of activities?
63
 Reasons for vertical integration

Backward vertical integration

Marcopolo, a multinational company of Brazilian origin,
manufacturer of bus bodies, has backward vertically integrated in
the production of:
Chairs, doors, foam, ...
The executives directors argue:
Lack of responsiveness from suppliers
Flexibility and speed of response
Blocking competitors

Discuss the advantages / disadvantages of vertical integration

compared to other ways the company can reap the same
benefits

64
 Reasons for vertical integration

Backward and forward vertical integration

Kopenhagen, a company of the CRM Group, a manufacturer of fine
chocolates, has forward vertically integrated:
Operation of retail stores
From the point of view of the operation of retail stores, one can
say that the company has backward vertically integrated:
Production of quality chocolates

Discuss the advantages / disadvantages of vertical integration

from the point of view of each of these stages of the value
system compared to other ways for the company to reap the
same benefits

65
 Reasons for vertical integration

Virtual vertical integration

From the corporate and financial point of view, BRF - leader in the
processed food industry - were not backward vertically integrated
companies, that is, it did not act directly with assets in the
industries that supply it the inputs
However, the company exercises "virtual" control over its suppliers
Discuss these organizational and contractual agreements

66
Competitive Advantage

If a vertical integration strategy meets the

VRIO criteria
Is it Valuable?

Is it Rare?
Is it costly to Imitate?

Is the firm Organized to exploit it?

it may create competitive advantage.

67
Value of Vertical Integration
Market vs. Integrated Economic Exchange
markets and integrated hierarchies are forms in which
economic exchange can take place

economic exchange should be conducted in the form

that maximizes value for the focal firm

thus, firms assess which form is likely to generate

more value

Integration makes sense when the focal firm can

capture more value than a market exchange provides
68
Value of Vertical Integration
Three Value Considerations

Leverage Manage Exploit

Capabilities Opportunism Flexibility

firm capabilities opportunism internalizing is

may be sources may be checked usually less
of competitive by internalizing flexible
advantage in (TSI)
other businesses flexibility is
internalizing must prized when
if not, then dont be less costly than uncertainty is
integrate exchange opportunism high
69
Rarity of Vertical Integration
Integration vs. Non-Integration
a firms integration strategy may be rare because
the firm integrates or because the firm does not
integrate
thus, the question of rareness does not
depend on the number of forms observed

a firms integration strategy is rare or common with

respect to the value created by the strategy

Example: Toyotas Choice Not to Integrate Suppliers

70
Imitability of Vertical Integration
Form vs. Function
the form, per se, is usually not costly to imitate

the value-producing function of integration may

be costly to imitate, if:
the integrated firm possesses resource
combinations that are the result of:
historical uniqueness
causal ambiguity
social complexity
small numbers prevent further integration
capital requirements are prohibitive
71
Imitability of Vertical Integration
Modes of Entry

acquisition and internal development are alternative

modes of entry into vertical integration
thus, one firm may acquire a supplier while a
competitor could imitate that strategy through
internal development
in both cases, the boundaries of the firm would
encompass the new business

strategic alliances can be viewed as a substitute for

vertical integrationwithout the costs of ownership

72
 Organizing Vertical Integration
Functional Structure (U-Form)
CEOs Role
Cooperation
Accounting Finance Marketing HR Engineering

Cooperation
Conflict

Original Original Original Original Original

Business Business Business Business Business

New New New New New

Business Business Business Business Business

Conflict
73
Organizing Vertical Integration
Management Controls
What needs to be controlled in a vertically integrated
firm?

managers efforts to achieve the desired value

chain economies
cooperation and competition among and between
functions
the integration of new businesses into the
existing business
time horizon of managers

74
Organizing Vertical Integration
Management Controls
Board
Budgets
Committees
separating strategic and provide oversight and
operational budgets direction to managers
strategic: inputs help ensure that strategic
& outputs direction is maintained
operational: outputs

These mechanisms focus management attention

on achieving value chain economies
75
Organizing Vertical Integration
Compensation
Salary
Integration
Opportunism Cash Bonus: Individual

Stock Grants: Individual

Leveraging Cash Bonus: Group Cooperation

Capabilities
Stock Grants: Group

Stock Options: Individual

Exploiting Time Horizon
Flexibility Stock Options: Group

76
Summary
Vertical Integration

makes sense when value chain economies

can be created and captured

may allow a firm to leverage capabilities

may be a response to the threat of opportunism

and uncertainty

as a form of exchange per se, is not rare nor

costly to imitate
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 The Strategic Management Process
Business Unit Level
Strategy
External
Analysis

Strategic Strategy Competitive

Mission Objectives
Choice Implementation Advantage

In which Countries
Internal to Compete?
Analysis
Diversification
Corporate Level
Internationalization
Strategy
Vertical Integration

Note: slides adapted from material gently made available by Pearson Education / Prentice Hall 78
 International Strategies as a Special Case of
Corporate Strategies

Firms can
Vertically integrate
Diversify
Form strategic alliances
Implement mergers and acquisitions
all across national borders

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 Main motives for internationalization
Market Seeking Resource Seeking Strategic-Asset Efficiency Seeking
Sales growth Raw materials Seeking Economies of
Protection against Labor Brand image scale or scope (in
reduction of sales in the Capital development production,
domestic market Access to logistics, marketing,
Exploitation of technology or R&D, procurement)
comparative advantages knowledge Flexibility of
Use of distinctive Development of
production
competences technical, market,
Location of
Follow the client management skills
Reduce market risk production near
buyers
Use of idle
capacity
Overcome
commercial
barriers

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 However, internationalization entails costs:
Marketing costs to win customers
Costs to analyze and learn about new markets
Possibly lower prices in order to attract customers (at
least initially)
Adaptation to local needs, tastes or rules
Additional administrative and functional structures
Dispersion of managers' attention
Legal costs and transport costs, in the case of exports
Cost of capital, in the case of construction of facilities
abroad
+ Errors (at the beginning) due to lack of experience
+ Possible future costs for de-internationalization, if
necessary
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 Risks of internationalization
Commercial /
Market

Operational Finance

Risks
Political-Legal Cultural

Social

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 Managing Financial Risks
Currency hedging
Geographic diversification
Spreading risk across several countries

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 Managing Political Risks
Find a local partner
Political neutrality
Negotiation with governments
Foreign governments often have an interest in
direct investment

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 Potential Sources of Economies of Scope in
International Markets

1. To gain access to new customers for

current products or services
2. To gain access to low-cost factors of
production
3. To develop new core competencies
4. To leverage current core competencies in
new ways
5. To manage corporate risk

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 Learning from International Operations

As a firm enters a new market:

A disciplined learning mentality is
imperative for success
what resources and capabilities meet the
VRIO criteria in the new market?
what can the firm learn from partners in the
new market?

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 The Local Responsiveness vs. International
Integration Trade-off

Local Responsiveness International Integration

Non-standard product Standardized product
High variance in tastes & Little variance in tastes &
preferences preferences
Decentralized control Centralized control
Focused on satisfying Focused on efficiency
tastes & preferences

Example: Siemens Example: Sony

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 Integrated management of
international operations
When competing in more than one country, the firm needs to decide
which value chain activities will be carried out in which countries

Infra-structure
Human Resource Management
Technology Development
Procurement

Inbound Operations Outbound Marketing After-Sales

Logisitics Logistics & Sales

Upstream activities Downstream activities

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 Integrated management of
international operations
The location of downstream activities is usually close to
the buyer.
On the other hand, upstream activities and support
activities need not, in principle, be located close to the
buyer.
This means that, in general, the competitive advantages
provided by the operation of downstream activities are
often country-specific.
The competitive advantage derived from the operation
of upstream activities and support activities, however,
usually depends on how the company manages these
activities in the set of countries.
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 Integrated management of
international operations
A consequence of this distinction between
downstream vs. upstream is that in those
industries where competitive advantage is
linked to downstream activities, a pattern of
multidomestic performance and competition is
usually observed.
Already in those industries where upstream or
support activities are crucial to the development
of competitive advantage, a global pattern of
performance and competition is often observed.

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 Integrated management of
international operations
In terms of the configuration dimension, the
following factors would tend to suggest that the
company concentrate certain activities in one or
a few countries:
Economies of scale in the execution of the activity
Learning Economies
Comparative advantage of any particular location
Coordination advantages when closely related
activities (e.g., R&D and production) are carried out in
close proximity to one another

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 Integrated management of
international operations
On the other hand, the following circumstances
would tend to suggest the dispersion of
activities by several countries:
Differences in buyers' needs or preferences
Need for local responsiveness
Signaling of commitment with each country
Transportation costs
Pressure from governments
Reduction of exposure to risks (foreign exchange,
political, etc.)

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 Integrated management of
international operations
In terms of the coordination dimension, the coordinated
implementation of activities that are dispersed across
countries tends to be recommended for:
Sharing experiences and acquired knowledge
Exploitation of opportunities for arbitration (due to imbalances
across countries)
exchange rates
Interest rates
factor costs
prices and volumes of products and inputs
transfer prices
Consistent image or reputation development
Multi-point competititon
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 Integrated management of
international operations
What advantages can the multinational have in competing
with an articulated strategy in several countries?
Configuration Coordenation
Concetration of activites Information sharing
Scale economies Alocation of resposibilities
Learning economies Alignment of efforts
Dispersion of activities Global optimum vs. local optima
Transportation costs
Specifiic needs of local clients
Risk dillution
Location of activities
Factor costs (labor, materials, Very difficult to
...)
Access to local resources be attained

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Thank you for your attention!

Jorge Carneiro (jtcarneiro@gmail.com)

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