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Related Diversification:

Market Power

Market Power

-firms abilities to profit through restricting or

controlling supply to a market or coordinating with othersfirms to reduce investment.

Example:

GEs attempt to acquire Honeywell.

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Two principal means by which firms achieve

synergy through Market Power

Pooled Negotiating Power

Vertical Integration

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Pooled Negotiating Power

-Improvement in bargaining position relative to

suppliers and customers.-Similar businesses working together can have

stronger bargaining position relative to

Suppliers

Customers

Competitors

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Vertical Integration

-An expansion or extension of the firm by integratingpreceding or successive production processes.

Example:Vertical Integration at Shaw Industries

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Vertical Integration: BenefitsSecure source of supply of raw materials

Secure distribution channels

Protection and control over assets and services

Access to new business opportunities and technologies

Simplified procurement and administrative procedures

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Vertical Integration: RISKCosts and expenses associated with increased overhead

and capital expenditures

Loss of flexibility resulting from inability to respondquickly to changes in the external environment

Problems associated with unbalanced capacities orunfilled demand along the value chain

Additional administrative costs

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Vertical Integration: ISSUES Are we satisfied with the quality of the value that our

present suppliers and distributors are providing?

Are there activities in our industry value chain presentlybeing outsourced or performed independently by othersthat are a viable source of future profits?

Are there activities in our industry value chain presentlybeing outsourced or performed independently by othersthat are a viable source of future profits?

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Vertical Integration: ISSUES Does the company have the necessary competencies

to execute the vertical integration strategies?

Will the vertical integration initiative have potentialnegative impacts on the firms stakeholders?

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Vertical Integration:

TRANSACTION COST PERSPECTIVETransaction Cost is the sum of:

Search Cost

Negotiation Cost

Contracting Cost

Monitoring Cost

Enforcement Cost

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Comparison: Transaction and Administrative

Cost-If transaction costs are lower than administrativecost, it is best to resort to market transaction andavoid vertical integration.

-if transaction cost are higher than administrativecost, vertical integration becomes an attractive

strategy.