As we look across the business landscape of 2016, we see many companies with multiple business units in operation, often running in different profit markets.
Why do they compete in multiple markets? Is the whole worth more than the sum of the parts? Let’s discuss.
Let’s talk about two major strategies through which companies & their business units can operate in different markets. Horizontal integration and vertical integration.
Horizontal integration is where a company chooses to compete in multiple product markets. Creating integration and synergy across those business units to deliver lower costs for the business and higher willingness to pay for the customer.
This can be done in two ways, the first, is ‘related diversification’, as successfully executed by Disney and Proctor and Gamble. It’s defined as a process that takes place when a business expands its activities into product lines that are similar to those it currently offers.
Related diversification aims to share resources and capabilities across multiple business units. This can include the sharing of factories and expertise. We call this ‘economies of scope’ as the costs of the two business units working together, lowers the costs for both units.
We then have ‘unrelated diversification’, where companies launch into very different markets, that seem to have little-to-no connection with one another. This has been successful for companies like GE or Virgin.
Vertical integration is where a company launches into one product market, but competes along multiple pieces of the supply chain. They can do this through backward integration and forward integration.
Backward integration is where a company chooses to make its own components. For example, Amazon sold books and ebooks in their online store. To extend their control across the supply chain, they became a book publisher in their own right.
Forward integration is where a company chooses to own its own distribution and store networks. Apple is an example of this.
A good corporate strategy is about strengthening the business units to be more than they would be alone. When there is synergy between operations, the sum of the parts (business units) really can be worth more than business units in isolation. In other words, 1+1 can equal 3 when corporate strategy is executed correctly.
So, let’s look at an example of good corporate strategy, let’s look at Disney.
Disney own theme parks, animation studios, hotels, retail stores, TV channels, record labels and plenty more incredible business units.
The key skill that Disney has is character development. Once the characters are created, they’re very durable – that is to say, they last forever, with multiple generations enjoying the same characters.
Disney create synergy, in part, by tieing all their business units together with the use of their durable characters. For example, they create a greater willingness to pay for their hotels as customers will pay for the experience of interacting with the characters – having breakfast with Mickey for example.
So Disney leverages the value of their characters to create a greater willingness to pay from their customers. This is a good corporate strategy.
Companies can leverage generic capabilities or specialised capabilities.
Generic capabilities are those that can be applied across multiple businesses. For example, marketing skills, production or graphic design.
Specialised capabilities are patented or very unique capabilities. These add much more value to the other business units. These capabilities are narrower in their application applicability than generic capabilities.
Steve jobs bought Pixar with the dream of releasing feature films from the studio. He realised quite quickly that he needed a big brand like Disney to help distribute those films.
So, Disney agreed and they drew up a contract / partnership. Due to their favourable position, Disney were able to negotiate that they owned the characters, even if the contract was terminated. This is what we refer to as opportunistic behaviour, as they took advantage of their strong negotiating position.
At this point Steve Jobs needed Disney more than Disney needed Pixar.
That changed when Disney animation had less success than Pixar. Jobs threatened to go into partnership with Universal, but ultimately these were empty threats as the codependency of the two companies meant they couldn’t go their separate ways. Why? because Disney needed Pixar to create synergy in their theme parks and Pixar needed Disney as Disney owned their characters.
Ultimately, it made business sense for Disney to buy Pixar to ensure continued success and synergy, which could be used across their other business units.
When businesses can create synergies and economies of scope, it makes sense to manage multiple business units.
Vertical integration gives the company more control over the end to end supply chain, while horizontal integration gives them the ability to ‘dip their toes’ into new markets, taking advantage of those synergies to compete with incumbents.
Sometimes outsourcing makes more sense than running multiple business units. Ultimately, it depends on the business model you’re running & with which option the cost per transaction is lower.
Solid analysis in this area, will lead to solid results.