Topic Workbook - Corporate Strategy –

Diversification, Integration and Outsourcing

Contents Page

Contents Page ............................................................................................................................................... 1

Chapter Overview ......................................................................................................................................... 2
Learning Outcomes ....................................................................................................................................... 3
Chapter Summary ......................................................................................................................................... 4
Context Section ............................................................................................................................................. 5
Essential Reading .......................................................................................................................................... 6
Corporate level strategy................................................................................................................................ 7
Horizontal integration ................................................................................................................................... 9
Vertical integration, outsourcing and strategic alliances ............................................................................ 13
Diversification: related and unrelated expansion ....................................................................................... 23
The case for diversification and profitability ............................................................................................... 26
Reference List ............................................................................................................................................. 31
Further Study Guidance .............................................................................................................................. 34
Subtopic 1 – Corporate Level Strategy ........................................................................................................ 34
Subtopic 2 - Horizontal Integration ............................................................................................................. 34
Subtopic 3 -Vertical integration, outsourcing and strategic alliances .......................................................... 34
Video........................................................................................................................................................... 35
Index ........................................................................................................................................................... 36

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Chapter Overview

Corporate strategy deals with the firm’s options for expansion. The natural route for expansion is to do it
organically, that is, using the firm’s internal resources and capabilities. However, this is not necessarily the
best way to do it in some cases. Urgency of development, cost of development or simply difficulties to
reproduce competitors’ competitive advantages might push organisations to consider inorganic options for
their business expansion.

Technology firms such as Amazon, Apple, Facebook and Google are good examples of inorganic expansion,
where business growth is fueled by acquisitions. They have acquired hundreds of companies in the last two
decades to propel them to become some of the most powerful tech behemoths in the world (Alcantara
2021).

Source: Alcantara et al. (2021)

The workbook begins with a brief introduction to corporate strategy and the four development directions
available to an organisation. The next sections are devoted to analysing the organisation’s options for
integration across the horizontal and vertical directions. Horizontal integration deals with expansion at the
same level of the supply chain, that is, looking for merger and acquisitions of competitors or complementary
firms. Vertical integration is concerned with expansion within the supply chain, whether it is forward (e.g.,
distributors) or backwards (e.g., suppliers).

Diversification is also explored within two contexts: related diversification, that is, in areas where the
company already operates or into businesses with some commonalities, or unrelated diversification
(including conglomerates) where acquisitions are made in areas with no commonalities.

This workbook is divided into five sub-topics:

• Corporate level strategy
• Horizontal integration
• Vertical integration, outsourcing and strategic alliances
• Diversification: related and unrelated expansion

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 • The case for diversification and profitability

Learning Outcomes
By the end of this topic, you should be able to:

• Evaluate horizontal integration in the context of corporate level strategy

• Evaluate the role of vertical integration, outsourcing and strategic alliances
• Analyse the concepts of related and unrelated diversification
• Construct the case for how diversification can increase profitability

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Chapter Summary

We will discuss the following questions:

• What are the development directions along which a corporate strategy should be based?
• How can companies expand the boundaries of their business by looking at other companies at the
same level of the supply chain?
• To what extent should a firm be involved in the different stages required to provide a
product/service to the final customer?
• What are the issues to consider when dealing with expanding operations in markets adjacent to the
current business or completely unrelated to it?
• What approaches can the parental corporation apply to maximise the value creation of a diversified
business?

In order to develop a corporate strategy, it is necessary to consider the different development directions
available to consolidate the current business or to expand it beyond a firm’s core products and markets.
There are many options for a firm to expand its business, but once the decision is made, a thorough analysis
of the alternative methods of development is crucial to improve the chances of success.

This workbook will focus on the firm’s horizontal and vertical integration options. Cases presented are of
different companies to identify the success factors when dealing with inorganic expansion, that is, through
merges and acquisitions, joint venture, etc.

Diversification, the riskiest option for expansion, is also analysed in the context of related and unrelated
business. The link to corporate or “parental” organisation is also explored with emphasis on the way it can
help to optimise profitability in a conglomerate type of business. Frameworks such as Porter’s essential test,
BCG matrix and GE matrix are introduced with this purpose.

The first two sections of the report, that is corporate level strategy and horizontal integration, cover learning
objective one.

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Context Section

One of the most critical decisions top management usually must make is to define the scope of the firm’s
activities. Think about IKEA for instance. IKEA’s corporate headquarters main strategic issues have to do with
three fundamental questions (Grant 1998):

IKEA’s geographical scope IKEA’s product scope IKEA’s vertical

scope

• Markets/Geographical scope. What is the optimal geographical spread of activities, and within them,
which markets should IKEA activities be targeted towards?
• Product scope. How specialised should IKEA be in terms of the range of products it supplies?
• Vertical scope. What range of activities required to serve customers should IKEA encompass?

The main concern of the corporate strategy is to answer these questions. It finds answers to “where” a firm
should compete. In comparison, business strategy deals with “how” a firm should compete. Corporate
strategy addresses these questions by deciding which strategic directions a firm should take, in terms of
developing products, markets or simply diversifying the firm’s business (Johnson 2017). It also finds answers
to the alternative methods the firm should adopt in order to achieve corporate objectives, whether through
organic or inorganic development.

Therefore, being able to clearly define the corporate strategy is very important for all firms since it provides
the basis for other strategic decisions, including how the organisation is to be run in structural and financial
terms, as well as how resources are to be allocated across the different business units and geographies.

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Essential Reading

To assist with your learning journey, it is important that you read the following to give you knowledge of this
topic:

De Wit, B. (2020) Strategy: an international perspective. 7th ed. Andover: Cengage Learning.

Chapter 5: Corporate level strategy:

In particular the following readings:
• Reading: 5.1 Strategy and business portfolio
• Reading: 5.2 The core competence of the Corporation
• Reading: 5.3 Seeking synergies

Chapter 6: Network level strategy

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Corporate level strategy
Corporate strategy is mainly concerned with the scope of the firm’s business areas. This is different from the
business strategy which is concerned with how a firm competes within a particular market. Corporate
strategy covers two main scope of activities (Grant 1998):

• Product scope: it relates to the range of products a firm should specialise in.
• Market scope: it concerns which markets, including different geographies, a firm should focus on.

The combination of these two scopes of activity defines the alternative growth directions available for a
company. Known as Ansoff’s matrix, four different strategy directions are available to companies for
strategic development (Johnson et al. 2017):

This Photo by Unknown Author is licensed under CC BY

Market penetration strategy

Market penetration implies increasing the share of current markets with the current product range. This
strategy builds on established strategic capabilities and does not require the organisation to venture into
uncharted territory. The organisation’s scope is exactly the same. Moreover, greater market share implies
increased power vis-à-vis buyers and suppliers (in terms of Porter’s five forces), greater economies of scale
and experience curve benefits. For instance, Pepsi's increase of bottle size from 500ml to 600ml.

Product development
Product development is where organisations deliver modified or new products (or services) to existing
markets. This can involve varying degrees of diversification along the product axis. The introduction of Pepsi
Cherry shows a new product aimed to an existing market.

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Market development
Market development can be more attractive by being potentially cheaper and quicker to execute than
product development. Market development involves offering existing products to new markets: new users
or new geographies. Again, the degree of diversification varies along market axis and typically entails some
product development as well, if only in terms of packaging or service. International market development
strategies are considered part of this strategy direction. Pepsi introduced Pepsi Max which is the low-calorie
version of Pepsi aimed at the segment of the market concerned with high calorie drinks.

Diversification
Diversification takes the organisation beyond both its existing markets and its existing products. In this
sense, it radically increases the organisation’s scope. Diversification will be developed in more detail in the
next sections of this workbook. The acquisition of Walkers, a chip manufacturer, is an example of
diversification for Pepsi.

Source: The Business Teacher (2018)

Methods of development

Whichever strategic direction an organisation decides to pursue, there are several methods for developing
its strategy (Johnson 2017). Consider for example a firm that wants to strengthen the competitive position in
its core market by gaining market share through cost reduction reflected in more competitive prices (market
penetration strategy). This strategy can be achieved through different methods. Cost reductions could be
done internally by increasing efficiency of current operations, by strategic alliance with distributors or by the
acquisition of a competitor to gain market share and therefore to obtain cost reductions associated to
economies of scale.

Two methods of development are widely implemented by organisations:

• Horizontal integration
• Vertical integration

The relation with regards to the strategy directions will be explored in the rest of this workbook. Horizontal
diversification will be covered in the Diversification section.

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 Corporate growth direction (De Wit, 2020)

Horizontal integration
Horizontal integration is the development or acquisition of a business operating at the same level of the
value chain (offering similar products and services) in the same industry (Investopedia n.d.). This contrasts
with horizontal diversification, where firms expand outside their current industry and vertical integration,
where expansion happens within the value chain.

Source: Adapted from Corporate Finance Institute (n.d.)

Horizontal integration is a competitive strategy that can result in economies of scale, competitive edge,
increased market share and business expansion (Corporate Finance Institute n.d.). The two amalgamated
entities should be better positioned to realise more revenue than they would have when operating
independently.

The basic drivers of horizontal integration are to increase market power and revenue growth. Value creation
in a horizontal integration can be achieved through cost savings, revenue growth and revenue enhancement.

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• Cost savings. Cost savings in horizontal mergers result from combining the functional areas like
production, marketing, sales and distribution or R&D of the acquirer and target firms. The same
activities can be carried out at a lower cost than either firm’s individual costs. This would lead to
reduction in production and fixed costs. The profit margin may be improved and pricing pressure
eased by reducing the supply to match the demand.

A good example of horizontal integration is Marriott's 2016 $13 billion acquisition of Starwood,
becoming the world’s largest hotel chain (CNBC 2016). This acquisition brought brands such as
Sheraton Hotels under the Marriott’s control and created the largest hotel chain in the world with
30 hotel brands, more than 5,800 properties and 1.1 million rooms in more than 110 countries. One
of the objectives behind the acquisition was the economies of scale resulting from the bulk-buying
power Marriott would have over Expedia and Priceline, the two giant online travel agencies that sell
rooms on behalf of hotel companies in exchange for a commission.

• Revenue growth. Revenue growth can be achieved through lowering prices for products that are
highly price sensitive. Successful horizontal integrations can create a large market share for the
integrated company or business units by the expansion of business activities, cost synergies in
marketing, combined product base, and shared technology, among others. Additionally, when two
companies come together, they also bring different consumer bases. As a result, the new firm has
access to a larger customer base. By increasing its market share and consumer base, the new
company has the ability to increase its revenue two-fold or more (Corporate Finance Institute n.d.).

Disney is a good example of using horizontal integration as a business growth strategy. Disney
acquired leading production companies like Pixar, Marvel, Lucasfilm, and 20th Century Fox. Each
brought something different to the table. With Pixar, it acquired the world’s most advanced
animation practices. With Marvel and Lucasfilm, in addition to large movie franchises, it acquired the
merchandise rights to films that it could market through its retail branches. And with 20th Century
Fox, it acquired a hugely valuable back catalogue. For instance, thanks to these acquisitions, Disney
dominated the 2019 income revenue from the USA box office (films) as well as in Return on Invested
Capital for the last decade (Trainer 2019).

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 Source: Trainer (2019)

• Revenue enhancement. Acquired firms involved in horizontal mergers with target firms in terms of
network externality can realise revenue enhancement. They reduce competition by removing key
rivals – this increases market share and long-run pricing power. Acquisition can also facilitate
revenue enhancement by acquiring firms whose products are complementary in nature.

An example of horizontal integration of firms whose products are complementary is the acquisition
of NabeWise by Airbnb (Markowitz 2012). NabeWise was a provider of online services for finding
neighbourhoods. The company helps people who are moving and travelling find the right
neighbourhood for them. Its NabeFinder tool uses proprietary data and algorithms to display heat
maps of neighbourhoods based on specific combination of preferences. Airbnb used this acquisition
to launch in 2012 Airbnb Neighbourhoods service, a feature designed to give travellers a more
personalised--and comprehensive--understanding of local neighbourhoods. This service
complements Airbnb core offering which helped the company to go beyond simply helping people
find a good place to sleep and to move into the travel guide business.

Some of the benefits and risk of horizontal integration are:

Benefits Description Example

Cost and financial Cost synergy is the savings in
synergies operating costs expected after
the merger of two companies.
1998 $75.3-billion merger between
Cost synergies are cost Exxon and Mobil, the No. 1 and No. 2 U.S. oil
reductions due to the increased companies. The biggest merger created the
efficiencies in the combined biggest publicly traded oil company and world’s
company. Cost synergy is one of
biggest corporation. It was expected to reduce
three major synergy types, with
about 9,000 of the companies’ 123,000 employees

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 the other two being revenue around the world as part of the planned $2.8
and financial synergies. billion in near-term cost savings (Brooks 1998).
Reduced The result of industry
competition consolidation is fewer
companies operating in the
industry and less intense
competition.
2014, Facebook announced it would pay $19
billion to acquire WhatsApp. This was a preventive
move. Without WhatsApp, Facebook’s
international situation would look a lot more
unpredictable. And if a competitor like Google
acquired it instead, it could have been disastrous.
Instead, Facebook possesses the most popular
messaging app, and has neutralised the biggest
threat to its global domination of social
networking (Constine 2015).
Access to new New markets and distribution
markets channels can be accessed by
integrating with a company that
produces the same goods but 2016 Microsoft’s $26.2-billion acquisition of
operates in a different region or LinkedIn aimed to integrate it with Microsoft’s
serves different market enterprise software, such as Office 365. The move
segments. allowed Microsoft to reach LinkedIn’s massive user
base and put Microsoft’s sales and distribution
heft behind what was already the world’s largest
and most successful social network (Microsoft
n.d.)

Risks Description Examples

Antitrust Issues Horizontal integration can lead
to a monopoly, which is highly
discouraged by many
governments due to lack of
competition. Therefore, 2019. The proposed merger between Sainsbury's
governments usually have to and Asda was blocked by the UK's competition
approve any larger M&A before watchdog over fears it would raise prices for
they can happen. consumers. The Competition and Markets
Authority (CMA) also said it would raise prices at
the supermarkets' petrol stations and lead to
longer checkout queues (BBC 2019).
Integration Issues Significant integration issues
can crop up both operationally
and culturally. A horizontal
integration, and in general, a
merger or acquisition, is a major 1998, Daimler-Benz announced a $36 billion
organisational change with the merger with the Chrysler Corporation, the biggest
potential to alter many of the acquisition by a foreign buyer of any U.S. Company

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 underlying operational in history. In 2006, Chrysler posted a loss of $1.5
processes for both businesses. billion and fell behind Toyota to 4th place in the
U.S. car market. 2007, Daimler Chrysler announced
it was selling 80.1% of Chrysler to a private equity
firm, Cerberus Capital Management, for 7.4 billion
dollars. Reasons for the failure: Cultural
Differences, Lack of Cooperation, Lack of Due
Diligence/ Market Forecast (Mosley 2019).

Vertical integration, outsourcing and strategic alliances

Vertical integration is when a firm enters other businesses upstream or downstream within its own industry
column or supply chain (De Wit 2020). That is, it enters in activities where the organisation is its own
supplier or customer.

Vertical integration is like diversification in increasing corporate scope. The difference is that it brings
together activities up and down the same value network, while diversification typically involves different
value networks. Vertical integration can go in one of two directions (Johnson 2017):
• Backward integration is movement into input activities concerned with the company’s current
business (i.e., further back in the value network). For example, acquiring a component supplier
would be backward integration for a car manufacturer.
• Forward integration is movement into output activities concerned with the company’s current
business (i.e., further forward in the value network). For a car manufacturer, forward integration
would be into car retail, repairs and servicing.

Additionally, there are different levels of integration, from partial to full integration. The following graphic
depicts the types of vertical integration available for a firm.

Source: Copenhagen Economics (2020)

There are four reasons to vertically integrate (Stuckey et al. 1993):

• The market is too risky and unreliable—it "fails"

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 • Companies in adjacent stages of the industry chain have more market power than companies in your
stage
• Integration would create or exploit market power by raising barriers to entry or allowing price
discrimination across customer segments
• The market is young and the company must forward integrate to develop a market, or the market is
declining and independents are pulling out of adjacent stages

The best well-known industry where this “do-it-yourself” approach is widely implemented is the oil & gas
industry. However, there are many other cases where vertical integration is used not just to control costs but
to enhance the competitive advantage of the leading firm.

Oil & gas: BP

The largest oil & gas company implements a business model based on “vertically integrated” oil groups
which combine the upstream activities of finding and developing oilfields with downstream functions such as
refining crude and selling petroleum products. This integration has proven to be a virtue to balance the risk
during the recent oil crises. Since the collapse in crude prices began in mid-2014, the market pressure on big
oil companies such as BP has gone through the roof. Low prices have crushed profits from oil and gas
production, but helped refining and chemicals businesses, supporting integrated groups’ earnings (Stacey
and Crooks 2016).

BP’s vertically integrated supply chain.

Apparel industry: ZARA

In apparel, a vertical manufacturer is one who produces and sells their own products. From fabric sourcing
and design to manufacturing, distribution and sales, integrated apparel companies gain high levels of
efficiency and responsiveness by controlling their supply chains. This is a critical element in an industry
where fashion trends change very quickly. Companies like GAP, Victoria’s Secret, Old Navy and Zara are
examples of vertical manufacturers. Zara, for instance, is able to deliver a piece of cloth from design to the
shop in just 25 days, all done in-house (CBInsights 2018).

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 Source: CB insights (2018)

Automobile industry: Tesla

Outsourced car manufacturing was a trend driven by the core competence-oriented business strategies
implemented by many car manufacturers during the 1990s. Tesla is rapidly going the other way.

Not only is Tesla Fremont facility a full-service auto plant, but its near-term plans include a supplier park
built in the immediate vicinity with a focus on large, heavy parts with extensive variations. Taking integrated
manufacturing further, Tesla is also building an absolutely giant battery factory in nearby Nevada. This plant
will take in elemental raw materials like copper and aluminium and produce finished battery packs to feed
the car plant (Christianinoa 2016).

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 Source: adapted from Christianinoa (2016) and Vested (n.d.)

It is estimated that Tesla has achieved about 80% vertical integration in its manufacturing supply chain
(Vested n.d.). The company’s innovations range from its supercharger network and custom software, to
novel methods to produce the frame of the car. Tesla is taking it one stage further by expanding the value
chain to the charging stage (car manufacturers do not own gas stations). Tesla is building charging stations
and installing solar panels and energy storage at the houses of its customers.

Competing through vertical integration

Vertical integration is one of the most powerful ways to compete (Lane 2018):
• Vertical integration can lower costs and increase the stability of supply of an important input.
• Products and services can improve as a result of the talent from the different workforces, shared
ideas and closer collaboration. Collaboration can lead to the development of new products and
innovation.
• A merger of companies with different structures can share their strengths and cover each other’s
weaknesses.

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 • Vertical integration can eliminate double marginalisation, which is a harmful situation that occurs
when multiple companies in a supply chain have market power. In this situation, each company
prices too high. Combining these companies actually lowers prices because it reduces the number of
times that a company tries to price above the market along a supply chain.
• Vertical integration provides ways to increase the control on how products are delivered and
increase the overall experience to the final customer.

A good example of vertical competition is the Martech sector. Martech is the blending of marketing and
technology (Martechtoday 2018). Virtually anyone involved with digital marketing is dealing with Martech,
since digital, by its very nature, is technology-based. The term “Martech” especially applies to major
initiatives, efforts and tools that harness technology to achieve marketing goals and objectives.

In the Martech sector, there is a “channel” of multiple different software stages (or layers) that marketers
must work through to engage their audience (Brinker 2016):
• Marketing Software — the on-premise and SaaS (Software as a Service) applications that marketers
buy and use to internally create and manage their campaigns, programmes and capabilities.
• Internet Services — the “destinations” on the web where millions of end-users converge, often as
explicitly identified and authenticated subscribers.
• Client Software — the devices, operating systems, browsers, and apps that end-users use to access
the web and Internet Services.

Source: Brinker (2016)

Interactions between marketers and customers must pass through these stages, creating two kinds of
competition:

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 • Horizontal competition among companies within the same stage of the channel. For instance, Adobe
and Oracle are horizontal competitors in marketing software; Google Search and Bing are
competitors in Internet services; and Google Android and Apple iOS are competitors in client
software.
• Vertical competition between companies at different stages of the channel. In vertical competition,
Adobe competes with Facebook, and Google Search competes with Apple iPhones.

The most powerful companies in marketing’s digital channel are arguably those who are fully vertically
connected: Alphabet, Microsoft, Facebook and Amazon. They have strong positions in all stages: marketing
software, Internet services and client software.
• Marketing software vendors who offer e-commerce platforms, such as Hybris (SAP) and
Demandware (Salesforce), are essentially competing with Amazon to provide merchant marketers
the best solution for selling products online.
• Marketing software vendors who offer products to manage search and social media advertising, like
Marin Software and Wordstream, build on top of Facebook and Google — but they also compete
with the direct advertising products offered by those services, such as Google AdWords and
Facebook Atlas.
• Many Internet services, such as Facebook and LinkedIn, offer native apps as client software to
compete with other client software, especially web browsers like Chrome, Firefox, Internet Explorer,
or Safari. This gives them more control over the experience (including advertising!) and greater
visibility into users’ client-side behaviours.

Integrate or outsource

The opposite of integration is outsourcing. Outsourcing is the process by which activities previously carried
out internally are subcontracted to external suppliers. Where a part of vertically integrated operations is not
adding value to the overall business, it may be replaced through outsourcing or subcontracting (Johnson et
al. 2017).

Outsourcing involves subcontracting parts of a company's value-chain to other companies or contractors

that specialise in those activities. Common outsourcing examples include:

• manufacturing
• distribution
• shipping and logistics
• research and development
• IT services
• bookkeeping or payroll
• marketing
• sales
• administrative tasks
• human resources
• customer service

Outsourcing may be used interchangeably with other terms such as subcontracting or offshoring (Hawrylack
et al. 2020). Outsourcing and subcontracting are different in the level of control held by the company. For
instance, outsourcing delegates an entire project or department’s operations to an unaffiliated individual or

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business. Subcontracting may only assign part of a project temporarily and each task is mutually agreed
upon on a contractual basis. The other term used is offshoring, which refers to outsourcing work to a third-
party in a different geographical area.

The argument for outsourcing to specialist suppliers or service providers is often based on strategic
capabilities. Specialists in a particular activity are likely to have superior capabilities than an organisation for
which that particular activity is not a central part of its business and therefore it costs less than performing it
in-house. A specialist IT contractor is usually better at IT than the IT department of a steel company.

The reasons for outsourcing could be various, however, cost reduction is increasingly critical and is a primary
reason for outsourcing. The impact of COVID-19 plays a key role here: the uncertain economic environment
is switching the focus back to the numbers (Deloitte 2020). Other reasons are enabling speed to market,
scaling faster, enhancing user experience and achieving competitive advantage. Agility is also important as
changing business scenarios, heightened visa restrictions and increasing customer expectations are all
creating a need for the service providers to become more agile. Firms will now accelerate overall
outsourcing as they learn to collaborate in a world where speed, quality, flexibility and cost are more
important than physical location.

Source: Deloitte (2020)

There are many benefits for a company to outsource (Hawrylack et al. 2020), including:

• Reduced costs such as overhead, staff, equipment and technology

• Work may be less expensive than hiring staff members
• May have greater access to experts in the field
• Tasks may reach completion more quickly
• Companies can focus on revenue-driving work
• Assistance in planning and mitigating against potential risks
• Ability to take on more projects that work towards the company’s mission and goals

However, there are also risks associated to outsourcing, such as:

• Complex contracts between companies with possible hidden costs

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 • Access to confidential data can cause security threats or data breaches
• Communication challenges that cause project delays and slower turnaround time
• Language and cultural barriers
• Little control over quality from the originating company
• Less knowledge of the industry or domain
• Public backlash or moral dilemmas

The following table present some examples of successful outsourcing.

Area of Case Description

outsourcing
R&D In 2001, P&G radically changed its approach to
Research & Development. Instead of relying solely
on its own R&D resources, P&G welcomed ideas
from individual entrepreneurs and scientists from
other companies and universities. The goal was to
gain half the ideas from inside and half from outside
the company.
Software Alibaba used outsourcing of development to the US.
development This is because the skills and experience required to
build the world’s largest online marketplace were
scarce in China but available in North America.
Service support In 2011, Google AdWords offered coverage of about
90% Internet users across the world and was used
by many marketers. Around a thousand outsourced
reps were entrusted with providing client support
via phone and email, all of them scattered around
the globe.
Software In 2003, the founders of Skype outsourced the
development actual back-end development of the platform to
Estonian professionals, who created what we now
know and use. The features like video chat, instant
messaging and file transmission have made it
indispensable.
Software Most of the in-house employees were focused on
development customer support and operations, while
development was handled offshore. WhatsApp
turned to Eastern Europe, in particular Russia, in an
attempt to source the required tech/developer
talent.
Manufacturing Nike has no manufacturing plants of its own but
chooses to outsource the work to contractors in the
Philippines, Vietnam, China, Indonesia, and Taiwan.
There are 500,000 people worldwide involved in the
production of Nike footwear.

Strategic alliances as an alternative to M&A

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M&A bring together companies through complete changes in ownership. However, companies also often
work together in strategic alliances that involve collaboration with only partial changes in ownership, or no
ownership changes at all as the parent companies remain distinct. Thus, a strategic alliance is where two or
more organisations share resources and activities to pursue a common strategy (Johnson et al. 2017).

There are two types of strategic alliances:

• Equity alliances involve the creation of a new entity that is owned separately by the partners
involved. The most common form of equity alliance is the joint venture, where two organisations
remain independent but set up a new organisation jointly owned by the parents.

Tesla and Panasonic equity alliance shows the importance of this kind of agreement for business
collaboration. In 2009, Panasonic and Tesla initially entered into an Electric Vehicles batteries supply
agreement. In 2010, Panasonic invested $30 million (equity) in Tesla to deepen the partnership and
foster the growth of the electric vehicle industry. The agreement supplies Tesla with Panasonic’s
lithium-ion battery cells to build more than 80,000 vehicles over the next four years. In June 2014,
Panasonic and Tesla announced their initial agreement to build (equity) the Nevada Gigafactory. At
35 gigawatt-hours of capacity, this factory alone would have more than double the entire world’s
lithium-ion battery supply. Tesla will continue buying batteries from Panasonic until at least 2022
despite the US electric vehicle maker's plans to produce its own cheaper alternative (Aregay 2020,
Yu 2021).

This Photo by Unknown Author is

• Non-equity alliances are typically looser, without the commitment implied by ownership. Non-equity
alliances are often based on contracts. One common form of contractual alliance is franchising,
where one organisation (the franchisor) gives another organisation (the franchisee) the right to sell
the franchisor’s products or services in a particular location in return for a fee or royalty. Licensing is
a similar kind of contractual alliance, allowing partners to use intellectual property such as patents
or brands in return for a fee. Long-term subcontracting agreements are another form of loose non-
equity alliance, common in automobile supply.

A good example of non-equity alliances is Apple and Mastercard (Hunh 2021). When Apple released
the Apple Pay system for contactless transactions, it was poised to change the way people used their
credit cards forever. But first, Apple needed credit card companies to partner with them and support
the technology. MasterCard was the first company to partner with Apple. This means that, when
Apple Pay launched, only MasterCard customers could pair their card with an iPhone and use their
credit card without carrying their physical card with them. By entering into a strategic alliance with
Apple early, MasterCard connected itself with a company known to be on the cutting edge. This
strategic alliance also paid off later, when Apple partnered with Mastercard again for support in
launching the Apple Card credit card.

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The benefits of strategic alliances are (Stenzel n.d.):

Benefit Example
Market entry British Airways, American Airlines, Finnair and Iberia have teamed up
across USA, Canada, Mexico and Europe (fares across all four airlines,
mixing and matching flights to suit schedule, smoother connections for
onward flights, use any of the airlines’ websites for booking flights, online
check-in and to get your boarding pass for any eligible flight across the 4
airlines, integrated customer support.

Gain PepsiCo formed a joint venture in 1991 with the Thomas J. Lipton Co. to
competitive market ready to-drink teas throughout the United States. Lipton
advantage contributed brand recognition in teas and manufacturing expertise.
PepsiCo, as the world's second-largest soft-drink manufacturer, shared its
extensive distribution network. Then in 2003 a second joint venture,
(PepsiCo and Unilever), Pepsi Lipton International (PLI), was setup,
centrally operating from Geneva. In January 2014 whilst remaining legally
separate, these two joint ventures formed a new leadership team under
the rebranded name of Pepsi Lipton.

Synergistic Renault and Nissan became strategic partners in 1999, with Mitsubishi
effects of joining later. The three companies are joined together through a cross-
shared sharing agreement. In 2019, the 3 companies presented a new business
knowledge and model which will enable the Alliance to bring out the most of each
expertise company’s assets and performing capabilities, while building on their
respective cultures and legacies. The three companies of the Alliance will
cover all vehicle segments and technologies, across all geographies, for the
benefit of every customer, while increasing their respective
competitiveness, sustainable profitability and social and environmental
responsibility.

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 Sharing risks Chevron and Toyota announced in April 2021 the first step towards a
and expenses strategic alliance to commercialise hydrogen. The alliance, which is
centered on the United States, is expected to focus on three areas:
collaborating on public policy to promote hydrogen infrastructure,
assessing the market for fuel cell electric vehicles and the hydrogen supply
that will be needed, and exploring opportunities to jointly research and
develop hydrogen powered transportation and storage. The memorandum
of understanding is non-binding but lays out the path to a formalised
strategic alliance by the early third quarter of 2021.

Diversification: related and unrelated expansion

When a corporation enters yet another line of business, either by starting up new activities (internal growth)
or by buying another firm (acquisition), this is called diversification. Diversification occurs when an
organisation moves into areas that are clearly differentiated from its current businesses.

Diversification growth strategies may be appropriate for firms that cannot achieve their growth objectives in
their current industry, with their current products and markets. Other reasons for a firm to diversify include
the following (Barnat, 2014):

• Markets of current business(es) are approaching the point of saturation or decline of the product life
cycle.
• Current business(es) are generating excess cash that can be invested elsewhere more profitably.
• Synergy is possible from new business (for example, because of common component part, costs can
be spread among more units).
• Antitrust regulations prohibit expansion in present industry.
• A tax loss can be acquired.
• The international sector can be entered into quickly.
• Technical expertise can be gained quickly.
• New and experienced executives can be attracted or current executives can be held (for example, if
they are productive but bored).

But, whatever the reason for diversification, the firm must define the role of each business within the
enterprise - successful diversification is not mere aggregation.

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Most diversification strategies can be classified as related diversification and unrelated or conglomerate
diversification (Corporate Finance Institute n.d.).

• Related Diversification
Related diversification involves diversifying into products or services where a company already
operates or into businesses with some commonalities. Examples of related diversification include
horizontal and concentric diversification strategies. Horizontal diversification occurs when a
company creates a new product for its existing customers. It allows the company to stick to its
original customer base and try to increase its revenue per customer. Concentric diversification
occurs when a company introduces new and correlated products in a new market. An example
would be a television cable company acquiring an internet company (both are related services).

A good example of related diversification is Walt Disney Company. Walt Disney Company is a leading
diversified international family entertainment and media enterprise with four business segments:
media networks and interactive media, parks and resorts, studio entertainment, consumer products.

Source: Williams (2019) and Line (n.d.)

The Walt Disney Company’s organisational structure facilitates the achievement and maintenance of
synergy through the related operations of various business segments (Williams 2019).

The Walt Disney Company has a cooperative multidivisional (M-form) organisational structure that
focuses on business type. The cooperative M-form involves related constrained diversification. Also,
the company has strong centralisation involving functional groups in its corporate headquarters.
Such centralisation is a structural aspect that ensures strong managerial control on diversified
growth in the global mass media, entertainment and amusement park industries. The divisions’
operations are related through shared competitive advantages, such as the company’s strong brand.
Through centralised control, Disney’s corporate headquarters prioritise strategies that benefit
multiple divisions. For example, characters from new movies (Studio Entertainment segment) are
used in the company’s Disneyland amusement parks (Parks and Resorts segment) and merchandise

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 (Consumer Products & Interactive Media segment). Such cooperation is possible through the
functional groups in this corporate structure.

• Unrelated Diversification
Unrelated diversification occurs when a company merges or acquires another company without any
commonalities. In such a situation, there is no overlap in markets, distribution channels, or
production technology. Typically, companies with extremely high cash flows go for unrelated
diversification, and it is used to hedge the risk of the industry the company operates in.
Conglomerates are good examples of unrelated diversification.

A typical example of an unrelated conglomerate is 3M. Founded in 1902, 3M is an industrial

conglomerate that markets over 60,000 products used in homes, businesses, schools and hospitals in
more than 200 countries around the world. Revenue in 2019 was $32 billion. 3M is a highly
diversified company with five main business segments that cover over 45 technology platforms,
ranging from adhesives and abrasives to ceramics and nanotechnology (Simply Safe Dividends 2019).

Source: Simply Safe Dividends (2019)

3M is notable among diversified American corporations for its growth by largely internal means
rather than by means of large-scale acquisitions. R&D is considered to be 3M’s strongest unit
because it leads to the development of new products, improves existing products and aids in the
development of new methods to improve the manufacturing and production process. 3M has
innovated from one industry into another over time, having developed products including visual
graphics, highway road signs, liquid crystal display screens, adhesive tape, note paper, electronic
communications, and surgical tape.

It is important to recognise that the distinction between related and unrelated diversification is in many
cases a matter of degree. Relationships that might have seemed valuable in related diversification may not
turn out to be as valuable as expected (Johnson et al. 2017). If relativeness between companies is based on
products/services, technologies and markets, then the difference between related and unrelated
diversification is easy to quantify. However, relativeness refers to other levels more difficult to identify.

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 The Determinants of Strategic Relatedness between Businesses. Source Grant (2007)

Similarities between industries in technologies and markets emphasise relatedness at the operational level –
in manufacturing, marketing, and distribution – typically activities where economies from resource sharing
are small and achieving them is costly in management terms (Grant 2007). Conversely, some of the most
important sources of value creation within the diversified firm are the ability to apply common general
management capabilities, strategic management systems and resource allocation processes to different
businesses. Such economies depend on the existence of strategic rather than operational commonalities
among the different businesses within the diversified corporation.

The case for diversification and profitability

Porter’s diversification test

If we return to the assumption that corporate strategy should be directed toward the interests of
shareholders, what are the implications for diversification strategy? For focused firms the two sources of
superior profitability are industry attractiveness and competitive advantage. For firms contemplating
diversification, Michael Porter proposes three “essential tests” to be applied in deciding whether
diversification will truly create shareholder value (Grant 2007):

• The attractiveness test: The industries chosen for diversification must be structurally attractive or
capable of being made attractive.
• The cost-of-entry test: The cost of entry must not capitalise (exceed) all the future profits.
• The better-off test: Either the new unit must gain competitive advantage from its link with the
corporation, or vice versa. That is, is there any reason why the combined company should become
any more profitable that the two companies separately?

Yet, although Porter’s test could point to the potential for value creation from exploiting linkages between
the different businesses, the practical difficulties faced by “parental” management of exploiting such
opportunities have made diversification a corporate minefield. Portfolio management is one approach used
by many corporate managements to determine the best configuration that optimise the multi-business
organisation’s chance to succeed.
The portfolio management approach is similar to that of shareholders in the stock market. The idea is to
identify and acquire under-valued assets or businesses and improve them through, for example, acquiring
another corporation, divesting low-performing businesses within it and intervening to improve the
performance of those with potential. Portfolio management is suitable for corporations with little concern

26
for the relatedness of the business units in their portfolio, typically adopting a conglomerate strategy.
Blackstone and Berkshire Hathaway are an example of this kind of organisation.

The following section introduces models by which managers can determine financial investment and
divestment within their portfolios of business (Johnson et al. 2017).

Boston Consulting Group (BCG) Growth/share matrix

The BCG matrix uses market share and market growth criteria for determining the attractiveness and
balance of a business portfolio. High market share and high growth are, of course, attractive. However, the
BCG matrix also warns that high growth demands heavy investment, for instance to expand capacity or
develop brands.

This Photo by Unknown Author is licensed

Boston Consulting Group matrix

The growth/share axes of the BCG matrix define four sorts of business:

• A star is a business unit within a portfolio that has a high market share in a growing market. The
business unit may be spending heavily to keep up with growth but high market share should yield
sufficient profits to make it more or less self-sufficient in terms of investment needs.
• A question mark (or problem child) is a business unit within a portfolio that is in a growing market
but does not yet have a high market share. It is important to make sure that some question marks
develop into stars, as existing stars eventually become cash cows and cash cows may decline into
dogs.
• A cash cow is a business unit within a portfolio that has a high market share in a mature market.
However, because growth is low, investment needs are less, while a high market share means that
the business unit should be profitable. The cash cow should then be a cash provider, helping to fund
investments in question marks.
• Dogs are business units within a portfolio that has a low share in static or declining markets and are
thus the worst of all combinations. They may be a cash drain and use up a disproportionate amount
of managerial time and company resources. The BCG usually recommends divestment or closure.

Unilever's top brands is a good case to explain BCG matrix application (Oakley 2014).

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 Source: Oakley (2014)

• Lipton is a Star. Despite its existing stature, continued investment in the patented TESS technology
(which uses the natural essence pressed from freshly picked leaves) enabled a global re-launch of
Lipton Yellow Label that fuelled growth of 5.6% between 2012 and 2014.
• Marmite is a key Cash Cow for Unilever with sales just about holding their own in the spreads
industry that is slowly beginning to decline in Europe and North America. Investment in Marmite has
been largely limited to advertising campaigns.
• The excess profit from brands like Marmite has been reinvested into new innovative brands like T2,
the fast-growing premium tea brand in Australia, and new products like Small & Mighty liquid
detergent, under the Omo brand (Persil in the UK), which concentrates the same number of washes
into a bottle one third of the size.
• Unilever sold its Slim-Fast brand in July 2014 to private-equity firm, Kainos Capital, to focus on other
brands with greater appeal and growth potential.

The directional policy (GE– McKinsey) matrix

The directional policy matrix categorises business units into those with good prospects and those with less
good prospects. Specifically, the directional policy matrix positions business units according to:

(i) how attractive the relevant market is in which they are operating and
(ii) the competitive strength of the SBU in that market

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 This Photo by Unknown Author is licensed under
GE– McKinsey matrix
The matrix offers strategy guidelines given the positioning of the business units. It suggests that the
businesses with the highest growth potential and the greatest strength are those in which to invest for
growth. Those that are the weakest and in the least attractive markets should be divested or ‘harvested’
(i.e., used to yield as much cash as possible before divesting).

Conclusion: M&A, alliances or organic, which one is the best?

It is clear that all three methods of M&A, strategic alliances and organic development can be used in
horizontal/vertical integration and diversification strategies. Depending on the circumstances, one method
could be better than the others. Four factors can help in choosing between acquisitions, alliances and
organic development (Johnson et al. 2017):

Source: Johnson (2017)

• Urgency. Acquisitions are a rapid method for pursuing a strategy. Alliances too may accelerate
strategy delivery by accessing additional resources or skills, though usually less quickly than a simple
acquisition. Typically, organic development (DIY) is slowest: everything has to be made from scratch.

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 • Uncertainty. It is often better to choose the alliance route where there is high uncertainty in terms
of the markets or technologies involved. If the venture turns out to be a failure, then at least the loss
is shared with the alliance partner. Acquisitions may also be resold if they fail but often at a much
lower price than the original purchase. On the other hand, a failed organic development might have
to be written off entirely, with no sale value.

• Type of capabilities. Acquisitions work best when the desired capabilities (resources or
competences) are ‘hard’, for example physical investments in manufacturing facilities. However,
greater ‘soft’ integration might pose the risk of significant cultural problems. The DIY organic
method is typically the most effective with sensitive soft capabilities such as people. Internal
ventures are likely to be culturally consistent at least.

• Modularity of capabilities. If the sought-after capabilities are highly modular, in other words they are
distributed in clearly distinct sections or divisions of the proposed partners, then an alliance tends to
make sense. A joint venture linking just the relevant sections of each partner can be formed, leaving
each to run the rest of its businesses independently. An acquisition can be problematic if it means
buying the whole company, not just the modules that the acquirer is interested in. The DIY organic
method can also be effective under conditions of modularity, as the new business can be developed
under the umbrella of a distinct ‘new venture division’.

After this analysis, the key message is simple: it is important to weigh up the available options systematically
and to avoid favouring one or the other without careful analysis.

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Further Study Guidance

You need to do your own research to apply the concepts presented above to the assessment task for this
topic.

In addition, see below further readings, case studies and articles which will help you to have a deeper
knowledge of this topic.

List of Additional Resources (also detailed in the Additional Reading and

Videos):
Subtopic 1 – Corporate Level Strategy

Li B, Chou S (2018) Corporate-level strategy and firm performance: evidence from China; Chinese
Management Studies, 2019, Vol. 14, Issue 1, pp. 1-14.

Meyer K, Tran Thu Y (2006) Market Penetration and Acquisition Strategies for Emerging Economies; Long
Range Planning. 2006 39(2):177-197

Yang C-L, Hsu H-K (2019) Optimized New Product Development Strategy; International Journal of
Organizational Innovation. Jul2019, Vol. 12 Issue 1, p110-121

Subtopic 2 - Horizontal Integration

Alvarez-SanJaime O, Cantos-Sanchez P, Moner-Colonques R, Sempere-Monerris J (2013) Competition and

horizontal integration in maritime freight transport; Transportation Research Part E May 2013 51:67-81

Kim H; Park, M, Lee, S (2017); Do vertically and horizontally integrated firms survive longer? The case of
cable networks in Korea. Information Economics & Policy. Jun2017, Vol. 39, p84-93

Subtopic 3 -Vertical integration, outsourcing and strategic alliances

Lei, D, Slocum Jr. J W (1991). Global Strategic Alliances: Payoffs and Pitfalls; Organizational Dynamics.
Winter91, Vol. 19 Issue 3, p44-62

Sherman L (2020) What Makes Peloton, Apple, Netflix, and Tesla Successful? Entrepreneur Dec 2020, Vol.
48, Issue 7 p28-29

Triance C (2020) Outsourcing and collaboration: What to expect now? Journal of Securities Operations &
Custody. Winter2020/2021, Vol. 13 Issue 1, p82-87

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Subtopic 4 - Diversification: related and unrelated expansion

Hauser P (2021) Does ‘more’ equal better? – Analyzing the impact of diversification strategies on
infrastructure in the European gas market; Energy Policy June 2021 153

Zabala-Iturriagagoitia J M, Porto G I, Aguirre L U (2020) Technological diversification: a matter of related or

unrelated varieties? Technological Forecasting & Social Change. June 2020

Sub- Topic 5 - The case for diversification and profitability

Wagner J (2014) Is export diversification good for profitability? First evidence for manufacturing enterprises
in Germany; Applied Economics. 46(33):4083-4090

Westerman W, De Ridder A, Achtereekte M (2020) Firm performance and diversification in the energy
sector; Managerial Finance, 2020, Vol. 46, Issue 11, pp. 1373-1390

Case Studies
Hall B (2021) Luxembourg finance minister: ‘Diversification is crucial’ ; Financial Times – available online at
https://www.ft.com/content/2b40ecee-b174-4173-b3a4-bb0205606b0b - accessed 28/4/21

Hammond G (2021) British Land buys up retail parks and warehouses in diversification push; Financial Times
– available online at https://www.ft.com/content/5326db8f-c2d2-43dc-8baf-a426b390e810 - accessed
28/4/21

Financial Times (2021) Foxconn/electric vehicles: Apple car inspires supplier’s new business model available
online at https://www.ft.com/content/4f400b42-1159-4fe8-a30f-ea4c59579fd4 - accessed 28/4/21

Video

McGannon B (2021) Outsourcing Critical Success Factors – available online at

https://www.linkedin.com/learning/outsourcing-critical-success-factors/successful-
outsourcing?u=56741521 – accessed 28/4/21 (Approx. 34 minutes)

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Index

A N

Ansoff matrix, 7 Non-equity alliances, 21

B O

BGC matrix, 27 Outsourcing, 18

D P

Diversification, 23 Porter’s essential test, 26

E R

Equity alliances, 21 Related diversification, 23

G S

GE matrix, 28 Strategic alliances, 20

H V

Horizontal integration, 9 Vertical integration, 13

M U

Methods of development, 8 Unrelated diversification, 24

Martech, 17

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