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Essay Questions: CHAPTER 5 (DAVID: 2009): Strategies in Action
Question 1: Define and give an example of three integrative strategies.
Answer:
Integration Strategies
Integration strategies or vertical integration is the extent to which an organization controls its
inputs and the distribution of its products and services. Vertical strategy or integration
strategy means the process in which several steps in the production and/or distribution of a
product or service are controlled by a single company or entity, in order to increase that
company's or entity's power in the marketplace. Vertical integration strategies allow a firm to
gain control over distributors, suppliers, and/or competitors. It is typified by one firm
engaged in different parts of production (e.g. growing raw materials, manufacturing,
transporting, marketing, and/or retailing).
There are three types of integration strategies: Forward Integration, Backward Integration,
and Horizontal Integration.
1. Forward Integration
Forward integration means, gaining ownership or increased control over distributer or
retailers. Forward integration means, gaining ownership or increased control over distributer
or retailers. An effective means of implementing forward integration is franchising. The
advantages of forward integration include excluding competing suppliers, greater ability to
reach end customers and better access to information about end customers.
For example, the textbook (David: 2009) explains this through the example of Boise
Cascade who owns 2.3 million acres of timberlands and more than two dozen paper and
building-products mills continue to pursue forward integration, as evidenced by its recent
acquisition of OfficeMax. OfficeMax is the third largest retail office product after Staples
and Office Depot. OfficeMax has more than 1000 superstores and they have focused on
boosting domestic sales and on remodeling stores, rather than expanding internationally.
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Staples and Office Depot can drop the Boise Cascade line of product because the company
has more competitor than a supplier.
Another example of forward integration is American Apparel, a fashion retailer and
manufacturer. American Apparel controls the dyeing, finishing, designing, sewing, cutting,
marketing and distribution of the company's product. The company shoots and distributes its
own advertisements, often using its own employees as subjects. It also owns and operates
each of its retail locations.
2. Backward Integration
Backward integration is a company’s expansion into the production of inputs
previously purchased. When a company chooses to buy a corporation that has been a steady
supplier or vendor, this is referred to as backward integration. From the textbook (David:
2009), backward integration is defined as a strategy of seeking ownership or increased
control of a firm’s suppliers.
A very simple example would be if a bakery business bought a wheat farm in order to
reduce the risk associated with the dependency on flour. Another example of backward
integration would be a computer company that purchases all its components, such as boards
and processors that begins manufacturing its own processors, or purchases a processor
manufacturing company.
The backward integration strategy can be especially appropriate when a firm’s current
suppliers are unreliable, too costly, or cannot meet the firm’s needs. The textbook (David:
2009) explains this through the example of how in most hospitals, the reordering supplies
was a logistical nightmare. However, through effective backward integration, the U.S
Defense Department and Columbia/HCA Healthcare Corporation was able to eliminate $11
billion from the estimated $83 billion spent annually on hospital supplies by requiring
electronic bar codes on every supply item purchased. This allows instant tracking and
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recording without invoices and paperwork which solved the inefficiency caused by lack of
control of suppliers in the health care industry before.
McDonald's has practiced a backward vertical integration, by replacing most of its
suppliers. It has done so for two reasons, 1) To reduce costs, and 2) To ensure that its
products are of top quality. These supplies include beef and milk to be used in its products,
which it gets from its farms. Other suppliers include local grocery stores that supply
McDonald's with fresh vegetables. Soft drinks are supplied exclusively by Coca-Cola, which
is also its ally. McDonald's supplies also include raw material such as flour, sugar, yeast, etc.
3. Horizontal Integration
Horizontal integration refer to a strategy of seeking ownership of or increased control
over a firm’s competitors and the merger of firms at the same stage of production in the same
or different industries. When the products of both firms are similar, it is a merger of
competitors. When all producers of good or service in a market merge, it is the creation of a
monopoly. If only a few competitors remain, it is termed an oligopoly. Also called lateral
integration.
From the textbook (David: 2009), the Chicago Mercantile Exchange (CME) acquired
the CBOT Holding exchange in mid-2007 for about $8 billion, creating the world’s largest
derivatives exchanges, with dominant positions in several futures markets from soybeans to
Eurodollars. There is rapid consolidation among exchanges worldwide. For example the
New York Stock Exchange recently acquired the pan- European exchange Euro next NV.
The GAP Inc. retail clothing corporation is a good example of a business that
practices horizontal integration. GAP Inc. controls three distinct companies, Banana
Republic, Old Navy, and the GAP brand itself. Each company has stores that market clothes
tailored to appeal the needs of a different group. Banana Republic sells more expensive
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clothes with a more "upscale" image, the GAP sells moderately priced clothes that appeal to
middle-aged men and women, and Old Navy sells inexpensive clothes geared towards
children and teenagers. By using these three different companies, GAP Inc. has been very
successful at controlling a large segment of the retail clothing industry and in the late
nineties the finance industry experienced much horizontal integration, with numerous
mergers between companies in the retail banking, investment and insurance industries.
