Exam 9: Corporate-Level Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing

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Compared to vertical integration,strategic alliances allow the firm to reduce its bureaucratic costs because the firm no longer has to manage the entire set of complex activities.Also,strategic alliances enable the firm to remain flexible?for example,by renegotiating the contract terms.This means the firm is not locked into choices about technology,capacity,and so on.Thus,strategic alliances provide the advantages of vertical integration?closer coordination,investment in specialized assets,and so on?but with lower costs and increased flexibility.The major disadvantages of strategic alliances are the potentially higher costs of allowing the partner to profit and the possibility of losing control over scheduling,proprietary know-how,and other items. Outsourcing will reduce costs when the price paid to a specialist company is less than performing the function internally.Specialists can control their cost structure (and therefore offer their services at attractive prices)because of economies of scale,learning effects,location scale,and other efficiencies not available to the client company.Secondly,outsourcing will afford the client company greater ability to differentiate its final products if the quality of the activity is greater than the quality that could be achieved internally.Higher quality products with lower defect rates,for example,translate into reliability,a key factor in differentiation.Thirdly,outsourcing allows managers to focus their energies and the company's resources on core activities.The pitfalls to outsourcing include the risk of overdependence on the specialist (sometimes leading to holdup,an extreme effect of bargaining power),and the loss of critical information (such as customer complaints).Compared to vertical integration,outsourcing requires much less outlay of resources,affords greater flexibility and less complexity,and keeps an organization on track with its core business. To reduce or eliminate risks,managers considering the use of strategic alliances or outsourcing can take actions that align the interests of the parties more closely.For example,the parties can exchange hostages by the use of mutual investments in specialized assets,also called credible commitments.This will ensure that each party can inflict some costs on the other,lessening the chance that either will do so.Market discipline,in the form of a willingness to renegotiate contractual agreements or switch to a different partner altogether,also reduces the chances of one firm taking advantage of the other.Another way to accomplish market discipline is through the use of parallel sourcing so that the firm uses two or more partners,signaling its independence from both.Finally,any action that serves to build trust,encourage cooperation,improve communication,support personal friendships,and so on,will increase the chances that the firms will act in a way that enhances the benefits for both.