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Vertical Integration and Retailing June 6, 2006 Slide 2 Overview Successive monopolies analysis Make or buy analysis, markets versus hierarchies Unbalanced throughput Monitoring problems Strategic perspectives Slide 3 Vertical Integration Single firm, or unified ownership, of both sides of an exchange relationship. Individuals employed by separate firms are now employed by a single firm. Examples: Manufacturer owned outlets Retailer owned warehouse and distribution True private labels Slide 4 Slide 5 20 2.00 5.25 6.35 (6.35-5.25)20=$22 (5.25-2.00)20=$65 Successive markup, independent profit maximization Slide 6 20 2.00 5.25 6.40 4.70 47 (4.70-2.00)47=$126.9 All margin is retail, supplier delivers at cost Slide 7 20 2.00 6.40 4.50 (4.50-2.00)42=$105.0 5.00 (5.00-4.50)42=$21.0 Retailer accepts unit markup 42 Slide 8 Allure of Vertical Integration One profit-maximizing markup in the channel yields superior channel profits. Achieving this is difficult without control of pricing of the suppliers price by the retailer or retailers price by the supplier. Analysis is based strictly on gross margins. Slide 9 Make or Buy Oliver Williamson Makevertical integration Buyusing the market, outsourcing Asset specificity, transaction specific assets Transaction frequency Bounded rationality and uncertainty Slide 10 Transaction Specific Assets The assets required of a retailer specific to conducting business with a single supplier. Signage, store appearance, manufacturer marks Equipment Training and skills required of employees The more transaction specific assets required of the retailer, the greater the likelihood of vertical integration Slide 11 Transaction Frequency Repetitive transactions, dealings, with a supplier versus One-time, idiosyncratic negotiations The greater the transaction frequency, the greater Slide 12 Monitoring Problems Agency problem: Providing proper incentive structure for employees to discourage theft from owners. Dulled incentives--having one arm operate only to reduce costs rather than profit maximization Slide 13 Unbalanced Throughput One side of the exchange relationship cannot produce/consume the volume required to keep the other side operating at an efficient scale. Car dealerships desiring to sell a broader/deeper line than that provided by a single supplier. Retailers cannot sell the volume of a dedicated warehouse. Slide 14 Fords Dealer Network 1998 Obtains a controlling level of ownership within a market Implemented one-price, no haggling approach to reduce intrabrand competition Plan included: Consolidation of selling locations, Increased number of service locations Slide 15 UnitedAuto, which has pursued a strategy based on internal growth from its existing dealerships, as well as from strategic acquisitions, operates 150 franchises in the United States and 96 franchises internationally, primarily in the United Kingdom. UnitedAuto dealerships sell new and used vehicles, and market a complete line of after- market automotive products and services.automotive products Slide 16 Life cycle issues Specialization is limited by the extend of the market Economics dictate forward integration into retailing early and late in a product life cycle Kathryn Harrigan, looks at strategic integration in mid-levels of market development, Bailing out in the end-game Slide 17 Outsourcing versus vertical integration Motivation Specialization Survival of the economically fittest Economies of scale Heavier market coverage Independence from any single manufacturer Slide 18 Uncertainty Absent significant specificity, uncertainty favors outsourcing. In the presence of significant specificity, uncertainty favors vertical integration forward. Slide 19 Bridgestone/Firestone Leading Bridgestone Firestone's sales recovery in North America are its almost 2,300 company- owned stores--the world's largest tire and automotive service network--and thousands of independent retailers. In support of their efforts, Bridgestone Firestone North American Tire, LLC is promoting all our main tire brands aggressively through stepped-up advertising and PR events. Slide 20 Firestone Complete Auto Care With nearly 1,500 Firestone Complete Auto Care stores nationwide, finding a store that is convenient to your home or business is easy. Slide 21 Sherwin William Williams Company (NYSE: SHW)SHW 101 Prospect Ave. NW Cleveland, OH 44115-1075 (Map)Map Phone: 216-566-2000 Fax: 216-566-2947 No matter how you coat it, Sherwin-Williams is the largest paint manufacturer in the US and #2 worldwide, after Akzo Nobel. Sherwin- Williams' products include a variety of paints, finishes, coatings, applicators, and varnishes sold under the names Dutch Boy, Krylon, Martin-Senour, Red Devil, Sherwin-Williams, Thompson's, and Minwax. The company operates 2,700 paint stores throughout North AmericaAkzo Nobel Slide 22 Danskin The Company's Danskin Division operates two full-priced stores and 32 outlet stores in 18 different states. The Company's outlet stores, in addition to offering in-line merchandise, provide a distribution channel for irregulars and excess inventory. Slide 23 Liz Claiborne Our brands include AXCESS, BORA BORA, C&C CALIFORNIA, CLAIBORNE, CRAZY HORSE, CURVE, DANA BUCHMAN, ELISABETH, ELLEN TRACY, EMMA JAMES, ENYCE, FIRST ISSUE, INTUITIONS, J. H. COLLECTIBLES, JANE STREET, JUICY COUTURE, LAUNDRY BY SHELLI SEGAL, LIZ, LIZ CLAIBORNE, LUCKY BRAND, MAMBO, MARVELLA, MEXX, MONET, MONET 2, REALITIES, SIGRID OLSEN, SPARK, SWC, TRIFARI and VILLAGER. In addition, we hold certain licenses for men's, junior's and women's sportswear, jeanswear and activewear under the DKNY(R) JEANS and DKNY(R) ACTIVE trademarks, women's sportswear under the CITY DKNY(R) trademark, jewelry products under the KENNETH COLE NEW YORK and REACTION KENNETH COLE trademarks, and fragrance, cosmetic and beauty products under the CANDIE'S trademark. Slide 24 Specialty Retail Stores. As of January 1, 2005, we operated a total of 269 specialty retail stores under various Company trademarks, comprised of 158 retail stores within the United States and 111 retail stores outside of the United States (primarily in Western Europe and Canada). The following table sets forth information, as of January 1, 2005, with respect to our specialty retail stores: U.S. RETAIL SPECIALTY STORES ------------------------------------------------------------------------------- Approximate Average Store Specialty Store Format Number of StoresSize (Square Feet) ------------------------------------------------------------------------------- LUCKY BRAND DUNGAREES 86 2,300 ELISABETH 30 3,000 SIGRID OLSEN 25 2,300 MEXX 7 10,100 DANA BUCHMAN 4 4,800 LAUNDRY BY SHELLI SEGAL 4 1,700 ELLEN TRACY 1 5,300 JUICY COUTURE 1 2,200