Operations Strategy - Vertical Integration Strategy

Information about Operations Strategy - Vertical Integration Strategy

Published on July 22, 2014

Author: sujith5989

Source: authorstream.com

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Operations Strategy 4a: Operations Strategy 4a Vertical Integration Strategy PowerPoint Presentation: Questions a company faces to that make up the Vertical Integration or Vertical Disintegration decision : What core capabilities are required to serve target markets? How to get these core capabilities? Should they be developed internally? Or Access them from external sources? What should a company do with the activities it owned that were no longer core to achieving competitive advantage in its target markets? Vertical Integration PowerPoint Presentation: Raw Material Extrac - tion Raw Material Conver - sion Comp. or Part Mfg. Manuf - acturing Distri - butor Retai - lor End User Downstream Upstream Reverse chain Upstream and Downstream processes Activities in the value chain take on different characteristics depending on where they are located Upstream and Downstream processes: 1- 4 Upstream and Downstream processes U pstream activities, those closest to the raw material sources, are typically capital-intensive processes that require long production runs. Products are more standardized Product lines are narrow (less variety) High capital intensity of the upstream processes in many industries result in high break-even points Makes it difficult to respond to high fluctuations in the market Companies in the upstream have to reduce prices in market downturns and suffer relatively high profit variability with market changes Steel Industry is a classic example Downstream activities, those closest to the end user, are labor intensive processes that allow shorter set-up times and short production runs Products are less standardized Product lines are broad (more variety). Low capital intensity results in low break-even point Easier to respond to fluctuations in the market Companies in downstream can reduce output during market downturns and suffer relatively high profit variability Upstream and Downstream processes: 1- 5 Upstream and Downstream processes Companies will Vertically I ntegrate activities, based on what is core to achieving competitive advantage Companies choosing to move upstream and own more of the supply end are said to be backward integrating Companies choosing to move downstream and own more of the customer end are forward integrating Companies may Vertically Disintegrate activities, if it is no longer core to achieving competitive advantage, shedding upstream or downstream operations by outsourcing them Vertical integration decisions shift the boundaries of the organization Deciding the activities that performed internally Deciding the nature of the relationship with the suppliers and customers Historically companies have taken wide ranging vertical integration decisions Complete vertical integration – Ford Full outsourcing – Cisco, IBM Upstream and Downstream processes: 1- 6 Upstream and Downstream processes Companies also make Horizontal Integration decisions Companies continue to perform the same set of activities in a different industry or market Contract manufacturers in the electronics industry - Solectron, Flextronics etc. have both Vertically and Horizontally Integrated. These companies have expanded from their initial focus on printed board assembly and testing to material sourcing and final product assembly, thus vertically integrating They have also expanded to different markets and industry thus horizontally integrating Vertical Integration Decision: 1- 7 Vertical Integration Decision Companies/firms must make Vertical Integration decisions regularly and thoughtfully as industries are dynamic and market places are constantly changing The questions the companies must regularly answer How much of the value chain should the company own Which principal activities will be performed in-house Will the company have sufficient capacity to meet all internal demand or will some work be outsourced Under what conditions should the company change the amount of value chain it owns Answering the above questions constitutes making a Vertical Integration decision Vertical Integration Decision: 1- 8 Vertical Integration Decision There are four different factors to be considered while making a vertical integration decision Strategic factors – whether or not an activity is critical to developing and sustaining the core capabilities of a firm Market factors – the dynamics of the industry in which the firm resides Product, service and technology factors – which relate technology, product, or service architecture and product or service development to operations Economic factors – which balance the costs of owning an activity with the costs of transacting for it. Some researchers think that the market and economic factors are most important since strategic factors are a part of industry dynamics and thus covered by the market factors Strategic Factors: 1- 9 Strategic Factors If supplier markets are reliable and efficient, rationale companies would own only those capabilities that would allow them to achieve a core competitive edge – and outsource all other activities. Understanding a firm’s core capabilities – both existing and needed in future and determining whether or not those core capabilities must be owned (in order to remain core) are the critical first steps in the vertical integration decision making. Core capabilities : sets of activities that the company does at best in the world levels and through which creates uniquely high value for customers today and in the future. Core capabilities are derived from integration of skill sets (and not from individual skill sets) Vertical integration decision must consider current capabilities and future requirements as well Firms may choose to internalize some essential but non-core activities because the customers have asked for them or they are needed to defend the core activities Company may need access to new capability immediately and if the needed capability requires significant time to develop internally it must outsource the activity to a competent supplier in the short term and acquire the capability in the longer term. Market Factors: 1- 10 Market Factors Vertical Integration decisions require an understanding of the industry in which the firm resides and the market structure and dynamics of the industry. The major market factors to be considered are as follows. Market Reliability If the supply base is reliable to perform along cost, quality, availability, innovation, environmental dimensions the firm may operate under vertically disintegrated environment In such cases, the firm may ensure performance through competition among suppliers If supplier markets are not reliable, then the firm may vertically integrate the activity / activities to ensure performance through control V ertically integrated firm may invest in tools and equipment to improve quality The firm may achieve improved availability through better coordination with production The firm may own the design process and by making the link between design and operation efficient, achieve improvement in features/innovation An environmentally concerned firm might choose to own the processes that create the biggest environmental issues. Market Factors: 1- 11 Market Factors Economies of scale Economies of scale are achieved when the unit cost of producing a product or delivering a service decreases as the volume of that product or service increases – spreading of fixed costs over increasing volume Obtaining scale from multiple sources : A supplier providing goods or services to many customers can achieve greater economies of scale than can a customer providing its own goods or services to itself Firms operating at higher volumes had a clear cost advantage over firms operating at lower volumes Obtaining scale by reducing the effects of variability and uncertainty : When a supplier can aggregate demand across customers that experience different demand profiles, that supplier can effectively reduce the effects of variability and uncertainty in demand Working on aggregated volumes, supplier can invest in quality improvement, time reduction, feature development, innovation and environmental improvement efforts that a smaller operation cannot Market Power When most of the competitors in an industry are vertically integrated, it can be difficult for nonintegrated players to enter the market. The vertically integrated player holds the power Product, Service and Technology Factors: 1- 12 Product, Service and Technology Factors Product and service factors have to do with how the firm wants to manage its intellectual property, surrounding core products, services, technologies. Intellectual Property A firm outsourcing an activity associated with critical technologies, products or services, runs the risk of giving intellectual property related to that activity to the competitors - Product secrets could be lost Intellectual property issues must be considered in making a vertical integration (or outsourcing) decision The issue is particularly relevant to growing companies with new products – semiconductor, biotechnology In case of a particular process being proprietary, a company must be careful about licensing the manufacturing process. Product, Service and Technology Factors: 1- 13 Product, Service and Technology Factors Technology Differentiation Vertical integration may be a way to achieve technological differentiation and to rapidly accommodate technological change Conversely, vertical integration can lock a company into a technology base, making it harder to adopt new technologies when needed A particular technology capability may be core to a firm, which it wants to develop and own, but the firm must remain aware that core capability may turn into core rigidity Example : Kodak (highly vertically integrated company) divested its interest in film and paper and acquired company to focus on digital imaging solutions. Kodak’s size made it difficult to react fast to market changes Making vertical integration decisions for the operations function needs understanding the inter-relationships among Research (knowledge of technology), Product or Service Development (application of knowledge of specific outputs) and Operations (produces or delivers the output) Product, Service and Technology Factors: 1- 14 Product, Service and Technology Factors Product Architecture Modular or Integral Make or Buy Dependency on knowledge Dependency on capacity Product Dependency on knowledge and capacity Independent for knowledge, dependent for capacity Independent for knowledge and capacity Modular Outsourcing is risky Outsourcing is an opportunity Opportunity to reduce cost through outsourcing Integral Outsourcing is very risky (May be the company is in wrong business) Outsourcing is an option Keep production in-house (May keep critical parts prodn . Internal - for other parts may outsource to reduce cost) Economic Factors: 1- 15 Economic Factors Economic analysis of a Vertical Integration involves understanding the costs of producing the product or delivering the service - both internally and at supplier site. Understanding the costs of transacting and coordinating with the supplier as well as costs of transporting the goods Understanding the investments required for developing internally Investment costs Costs of acquiring or developing a capability internally – capital costs for equipment and space, people costs, system development costs and inventory costs (initial inventory) Firm choosing to vertically disintegrate may have to invest in layoff, facility shutdown Economic Factors: Economic Factors Design, Production and Delivery Costs In vertical disintegration the firm substitutes the direct cost of designing, making/delivering the product or service – material, labor and overhead costs, for the costs of procuring the design, product or service from a vendor Vendor may achieve economies of scale by aggregating demand Labor cost advantages may be there owing to vendor’s location – low wage countries Overhead costs are difficult to calculate - decisions have to be made as to what costs to include and what costs would go away Transportation costs must be considered Varies depending on the location of the buyer and the supplier Transaction costs Depends on the type of contract Economic Factors: 1- 17 Economic Factors Type of cost Cost of owning an activity Cost of outsourcing an activity Design, production or service delivery costs Materials Labour (Direct) Overhead : Production, Procurement, Engineering Purchase cost includes : Labour (Direct) Materials Overhead Vendor profit Transportation & Logistics Costs Cost of moving output from site of creation to site of use Cost of moving output from vendor’s location to buyer’s site of use Investment costs Capital (equipment and space) People resources (hiring, training) System development Inventory Transaction costs Contracting costs including purchasing, sales, marketing, taxes, legal Coordination costs including engineering, production scheduling PowerPoint Presentation: Vertically integrate to Vertically disintegrate to Strategic Factors Develop and retain core and essential capabilities Access a core or essential capability externally while working on its development internally Market Factors Control cost, quality, availability, features and environmental performance in unreliable markets Reduce dependency on suppliers Leverage competition among suppliers to access best-in-class performance Aggregate demand at suppliers thus generating economies of scale and improved responsiveness to variability in demand Product and Technology Factors Control integral or critical technologies Integrate design and production or service delivery Access current technologies not available internally Obtain leverage available from modular product architectures Economic Factors Minimize transportation and logistics costs Minimize transaction (contracting and coordination) costs Access lower production or service delivery costs Minimize investment costs Factors for and against Vertical Integration PowerPoint Presentation: Making a vertical integration decision entails industry analysis and a clear understanding of the company’s strategy. There are a spectrum of options to choose from. The following process are suggested for making vertical integration or disintegration decision. Apply the core capabilities screen Assess the industry context and identify opportunities Identify alternative value chain structures Assess alternatives and choose one Implement Making a Vertical Integration Decision PowerPoint Presentation: Step 1 : Apply core capabilities screen From the firm’s core and essential capabilities identify which activities to own and which to outsource Identifying what is core and what is non-core is a difficult task in dynamic scenario, with rapidly changing industry structure Companies today should constantly review what is core and non-core for them and accordingly decide which to own and which to outsource Making a Vertical Integration Decision PowerPoint Presentation: Step 2 : Assess industry context and identify opportunities Prepare a flow-chart of the company’s value chain showing the flow of materials and/or services from raw material sources to delivery to the end users. Disaggregate the activities to natural business or work units. The flow-chart should have information about Number of players at each stage of the value chain Size of each player (annual sales volume) Types of transactions between players (spot buying or long-tem contracts) and frequency of transactions Ownership connections (joint venture relationships) Making a Vertical Integration Decision PowerPoint Presentation: Step 3 : Identify alternatives From an understanding of where the firm wants to focus its resources (on its core capabilities) and of where the opportunities lie in the industry value chain structure, Identify options for making vertical integration moves . Identify practical options for acquiring or shedding capabilities The options may be Full outsourcing Sale of business Partial outsourcing and consolidation Partial ownership Making a Vertical Integration Decision PowerPoint Presentation: Step 4 : Assess the alternatives and select one Assess each of the alternatives - if the firm vertically integrates or if the firm vertically disintegrates against each of the following criteria Cost Quality Availability Features / Innovation Environmental performance Making a Vertical Integration Decision PowerPoint Presentation: Step 5 : Implement It is helpful for a firm, managing vertical integration strategy, to build different knowledge centres Highlight the role of knowledge and intellectual property Explicitly and actively manage the critical assets There are risks in outsourcing Loss of skills that can be very difficult to rebuild Loss of intellectual property which are sold or illegally transferred from the firm’s new suppliers to competitors Firm may face employee resentment – security There are risks in bringing an activity in house May become too inwardly focussed Missing innovation, that would obsolete own technology Making a Vertical Integration Decision

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