1 on-line seminar series january 18, 2001 lgo-sdm alumni
TRANSCRIPT
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On-Line Seminar SeriesOn-Line Seminar SeriesOn-Line Seminar SeriesOn-Line Seminar Series
January 18, 2001
LGO-SDM ALUMNI
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As You Join the Session. . .As You Join the Session. . .As You Join the Session. . .As You Join the Session. . .
• Please answer the following questions and send your response via the “question” window on your screen.
• What are you hoping to learn from the presenter and your fellow alums about vertical or virtual integration today?
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Vertical or Virtual Vertical or Virtual Integration?Integration?
The Issues and ChallengesThe Issues and Challenges
Vertical or Virtual Vertical or Virtual Integration?Integration?
The Issues and ChallengesThe Issues and Challenges
Sara L. Beckman
Haas School of Business
University of California, [email protected]
http://www.haas.berkeley.edu/faculty/beckman.html
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Objectives:Objectives:Objectives:Objectives:• Provide information on vertical and virtual integration:
– Some definitions– Considerations in making vertical/virtual integration
decisions• Economic• Strategic
– A model for making vertical/virtual integration decisions
• Initiate an ongoing conversation on strategic decision making in operations management and test distance learning software as a means of having that conversation
Poll: How Vertically Integrated Is Your Poll: How Vertically Integrated Is Your Firm?Firm?Poll: How Vertically Integrated Is Your Poll: How Vertically Integrated Is Your Firm?Firm?
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Highly• Moderately• Somewhat• Not much• Not at all
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There Is a Broad Spectrum of There Is a Broad Spectrum of Supplier Relationships; Vertical Supplier Relationships; Vertical Integration Defines One EndpointIntegration Defines One Endpoint
There Is a Broad Spectrum of There Is a Broad Spectrum of Supplier Relationships; Vertical Supplier Relationships; Vertical Integration Defines One EndpointIntegration Defines One Endpoint
Arm’s Length
Linked Agreements
Partnerships Partial Vertical Integration
Full Vertical Integration
Traditional
Cost-based
“Free market”
Short duration
Purchase-order driven
Long-term supply contracts
Value-added services (e.g., supplier managed inventories)
Joint development or optimization of products and/or processes
Equity stake often involved
Firm owns some, but not enough capacity in a given process; outsources the rest
Firm owns all the capacity required to meet its own internal demand
Poll: Where Would You Place VIRTUAL Poll: Where Would You Place VIRTUAL Integration on That Spectrum?Integration on That Spectrum?Poll: Where Would You Place VIRTUAL Poll: Where Would You Place VIRTUAL Integration on That Spectrum?Integration on That Spectrum?
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• A network of arm's length arrangements• A network of linked agreement arrangements • A network of partnership-based arrangements• A network of suppliers supporting a partially vertically
integrated company• A combination of such arrangements
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Where does VIRTUAL integration Where does VIRTUAL integration fall on this spectrum?fall on this spectrum?Where does VIRTUAL integration Where does VIRTUAL integration fall on this spectrum?fall on this spectrum?
Arm’s Length
Linked Agreements
Partnerships Partial Vertical Integration
Full Vertical Integration
Traditional
Cost-based
“Free market”
Short duration
Purchase-order driven
Long-term supply contracts
Value-added services (e.g., supplier managed inventories)
Joint development or optimization of products and/or processes
Equity stake often involved
Firm owns some, but not enough capacity in a given process; outsources the rest
Firm owns all the capacity required to meet its own internal demand
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Virtual Integration Has Become a Real Virtual Integration Has Become a Real Option in Recent Years Due To:Option in Recent Years Due To:Virtual Integration Has Become a Real Virtual Integration Has Become a Real Option in Recent Years Due To:Option in Recent Years Due To:
• The evolution of new forms of contracting with suppliers
• The advent of new service industries that provide specialized intermediate capability
• The development of information technology that supports cross-organizational coordination– 60s/70s mainframe-based MRP– 70s-80s PC-based information access– mid-80s network integration within companies– late 90s Internet integration across firm boundaries
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In essence, the firm has to answer the In essence, the firm has to answer the following questions to develop a “VI” following questions to develop a “VI” strategy:strategy:
In essence, the firm has to answer the In essence, the firm has to answer the following questions to develop a “VI” following questions to develop a “VI” strategy:strategy:
• Breadth: In how much of the supply chain does my firm want to be “heavily” involved?– Direction: Do we want to move upstream (backward) or
downstream (forward) in our supply chain? (Note: From 1899 to 1948, forward integration was three times more common than backward integration.)
– Extent: How far?• Form: What form of relationship do we want to have with our
outside resources/suppliers? i.e., How “heavily” will we be involved?
• Change: What will trigger us to consider a change in our vertical integration strategy?
Poll: Is Your Firm Thinking About:Poll: Is Your Firm Thinking About:Poll: Is Your Firm Thinking About:Poll: Is Your Firm Thinking About:
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Becoming more forward integrated (moving towards the marketplace)?
• Becoming more backward integrated (moving towards the supply base)?
• Maintaining current levels of integration?• Becoming less forward integrated?• Becoming less backward integrated?
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Typical Considerations in Making Typical Considerations in Making a Vertical Integration Decision:a Vertical Integration Decision:Typical Considerations in Making Typical Considerations in Making a Vertical Integration Decision:a Vertical Integration Decision:
• Setup costs• Transaction costs• Risk• Coordination effectiveness
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Setup CostsSetup CostsSetup CostsSetup Costs
VERTICAL INTEGRATION• Capital (e.g., equipment,
acquisitions)• Systems development• Training
VIRTUAL INTEGRATION• Relationship negotiation• Contract
COST
Arm’sLength
Full VerticalIntegration
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Transaction CostsTransaction CostsTransaction CostsTransaction Costs
• Information collection and processing
• Legal• Sales and purchasing• Physical handling costs
C
O
S
T
Arm’sLength
Full VerticalIntegration
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RisksRisksRisksRisks
• Possibility for unreasonable price changes
• Supply or outlet foreclosure• Insulation from market• Insulation from technology
sources
C
O
S
T
Arm’sLength
Full VerticalIntegration
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Coordination EffectivenessCoordination EffectivenessCoordination EffectivenessCoordination Effectiveness
• Run lengths, inventory levels• Capacity utilization• Delivery performance• Quality
C
O
S
T
Arm’sLength
Full VerticalIntegration
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So, What’s Better?So, What’s Better?So, What’s Better?So, What’s Better?
Virtual Integration Vertical Integration
Setup Costs
Transaction Costs
Risk
Coordination Effectiveness
Poll: What's better if you want to be an Poll: What's better if you want to be an innovative organization?innovative organization?Poll: What's better if you want to be an Poll: What's better if you want to be an innovative organization?innovative organization?
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Arm’s length arrangements• Linked agreements• Partnerships (virtual organization)• Vertical integration
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What’s Better If You Want to What’s Better If You Want to Innovate?Innovate?What’s Better If You Want to What’s Better If You Want to Innovate?Innovate?
• It depends.– Autonomous innovations can be handled in virtual
– even arm’s length -- environments– Systemic innovation (e.g., lean manufacturing) is
harder– Lack of industry standards favors vertically
integrated firms that have the clout to advance new standards
• “Virtuous virtuals” are at the center of a network they use to leverage their own capabilities; their unique competencies drive the network’s success
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Some rough rules of thumb:Some rough rules of thumb:Some rough rules of thumb:Some rough rules of thumb:
Autonomous Innovation
Systemic Innovation
Capabilities exist outside
Go virtual Ally with caution, probably tighter
alliances
Capabilities must be created
Ally or bring in house
Bring in house
Poll: What's Better If You Want to Provide a Poll: What's Better If You Want to Provide a High Degree of Customization?High Degree of Customization?Poll: What's Better If You Want to Provide a Poll: What's Better If You Want to Provide a High Degree of Customization?High Degree of Customization?
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Arm's length arrangements• Linked agreements• Partnerships (virtual)• Vertical integration
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Pure Customization
Design
Fabrication
Distribution
Assembly
Tailored Customization
Fabrication
Distribution
Design
Assembly
Customized Standardization
Design
Fabrication
Distribution
Assembly
Segmented Standardization
Design
Fabrication
Assembly
Distribution
Pure Standardization
Design
Fabrication
Distribution
Assembly
Custom
Standard
Customization StrategiesCustomization StrategiesCustomization StrategiesCustomization Strategies
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Market Structure May Also Market Structure May Also Suggest Vertical IntegrationSuggest Vertical IntegrationMarket Structure May Also Market Structure May Also Suggest Vertical IntegrationSuggest Vertical Integration
One Buyer Few Buyers Many Buyers
One Seller Sellers dominate
Few Sellers Sellers dominate
Many Sellers Buyers dominate
Buyers dominate
No one dominates
High TradingRisk
A firm may want to vertically integrate to defend against market power or to create and exploit it
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As May Asset SpecificityAs May Asset SpecificityAs May Asset SpecificityAs May Asset Specificity
Low Asset Specificity, Durability and Intensity
High Asset Specificity, Durability and Intensity
Low Transaction Frequency
Detailed, standardized contracts (e.g., office lease, credit sale arrangements)
Detailed, probably unique contract (e.g., major public construction projects)
High Transaction Frequency
Standardized transactions (e.g., groceries)
Vertical integration (e.g., bauxite, specialized auto components)
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Or, Perhaps It Is Just the Right Or, Perhaps It Is Just the Right Time in the Industry Life CycleTime in the Industry Life Cycle
Pressure todisintegrate
Pressure to integrate
Integralproduct,verticalindustry
Modularproduct,
horizontalindustry
Nichecompetitors
High-dimensionalcomplexity
Technicaladvances
Organizationalrigidities
Suppliermarket power
Proprietarysystem
profitability
Charles Fine, Clockspeed: Winning Industry Control in the Age of Temporary Advantage
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To develop your own “VI” To develop your own “VI” strategy:strategy:To develop your own “VI” To develop your own “VI” strategy:strategy:
• Step 1: Characterize your present supply chain– Identify all “natural” business units that could not
be further disaggregated from an ownership perspective
– Assess number and sizes of all participants at each stage
– Determine the types of transactions that currently take place among the various members of the chain
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To develop your own “VI” To develop your own “VI” strategy:strategy:To develop your own “VI” To develop your own “VI” strategy:strategy:
• Step 2: Perform a “static” analysis of the chain– Assess degree of asset specificity at each stage– Measure transaction frequency– Estimate economics at each stage– Assess effects if weak and powerful players were
to change their position– Identify key sources of technological innovation– Identify key loci for customization
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To develop your own “VI” To develop your own “VI” strategy:strategy:To develop your own “VI” To develop your own “VI” strategy:strategy:
• Step 3: Perform a “dynamic analysis” of the chain– Predict future changes in industry structure– Predict changes in integration strategy by other
players– Predict strategic needs for supply chain
performance • Technological advancement• Customization
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To develop your own “VI” To develop your own “VI” strategy:strategy:To develop your own “VI” To develop your own “VI” strategy:strategy:
• Step 4: Identify, assess and choose from a set of alternative strategies– Quantify and weigh the setup costs, transaction
costs, risks and coordination effectiveness of each option
– Assess the strategic implications of each option– Choose one– Develop a (staged) implementation plan
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Questions?Questions?Questions?Questions?
Poll: Would you be interested in an ongoing Poll: Would you be interested in an ongoing discussion of this or other operations strategy topics?discussion of this or other operations strategy topics?Poll: Would you be interested in an ongoing Poll: Would you be interested in an ongoing discussion of this or other operations strategy topics?discussion of this or other operations strategy topics?
• [PlaceWare Yes/No Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Yes• No
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Poll: If so, would you want to talk:Poll: If so, would you want to talk:Poll: If so, would you want to talk:Poll: If so, would you want to talk:
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Once/year• Once/quarter• Once/every other month• Once/month
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Poll: What Format Appeals Most?Poll: What Format Appeals Most?Poll: What Format Appeals Most?Poll: What Format Appeals Most?
• [PlaceWare Multiple Choice Poll. Use PlaceWare > Edit Slide Properties... to edit.]
• Discuss problem company is solving• Discuss new research paper on topic• Have presentation from professor
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Further InformationFurther InformationFurther InformationFurther Information
• Papers and theses: http://lfmsdm.mit.edu (password for theses needed: contact [email protected] if you don’t have it)
• [email protected] [email protected]
• (415) 464-0517
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ReferencesReferencesReferencesReferences
• Chesbrough, Henry W. and David J. Teece, “When is Virtual Virtuous? Organizing for Innovation,” Harvard Business Review, January-February, 1996.
• Stuckey, John and David White, “When and When Not to Vertically Integrate,” Sloan Management Review, Spring 1993.
• Hill, Terry, Manufacturing Strategy: Text and Cases, 2000