Vertical Inttegration

A look through Starbucks INC

The idea of “vertical architecture” defines the range or scope of a business and the level to which it remains open to intermediate and final markets. It designates the arrangements of transactional decisions along a business’ value chain. A business can make or purchase inputs, as well as transfer outputs downstream, even sell them. Permeable vertical architectures represent partly open and partly integrated to the markets in connection with a business’ firm value chain. Augmented permeability enables higher levels of effective use of capacities and resources. This means better matching of said capabilities with the needs of the market. Furthermore, benchmarking to augment efficiency (McNutt, 2013).

Fractional integration promotes a more creative and openly innovative platform. It improves strategic competences through the linking of key parts of a value chain. The penetrable vertical architecture, complemented by suitable incentive design and transfer prices, facilitates adequate resource allocation. It also guides a business’ growth/expansion process. An article by Jacobides and Billinger, highlights through a study showing how a well-known European manufacturer. “…to understand how firm boundaries are set and what their impacts are, we need to complement the microanalytic focus on transactions with a systemic analysis at the level of the firm. It also shows how, over and above transactional alignment” (Jacobides and Billinger, 2006, p. 249). The authors also highlight boundaries, how vertical architectures may transform a business’ productive and strategic prospects and capabilities.

When looking at contraction theories/concepts of vertical integration, they originate firm boundaries as an effective reaction to market transaction expenses. The notions predict an association among underlying features of transactions, including observed integration choices. Starbucks for instance has a value chain that consists of farmers, roasting, distribution, and of course, retail. Although some may not see Starbucks INC as vertically integrated, it actually is for one reason alone, maintenance of perfect quality throughout the aforementioned value-chain.

Essentially Starbucks has an internationally orientated business, with both coffee shops and suppliers all across the globe, selling a premium product. This strategy comes from an organizational structure with that began as a retailer and roaster of coffee beans. The company’s core competencies, quality coffee, sold at premium prices drives business and price stability. Owning the components, having the people that generate this quality, controls how much quality reaches the customer. Starbucks has many people working for it, creating vertical integration. Although it gets complicated with more layers in a command structure, which may result in higher expenses, by Starbucks focusing on high quality and charging premium prices, it helps offset the additional expenses. Controlling the value chain controls the customer experience. It also maintains the level of quality instead of when a firm remains dependent on external partners. Although Starbucks does not grow its own coffee, it keeps the buyers close and controlled so they get a high quality product they can in turn give to their customers.

IT firms face similar worries. Should they hire programmers or simply train them? In a way man firms are vertically integrated, even those that appear to not be. McDonalds is one example. McDonalds made McDonalds University. The university offers additional training to franchisees. The training enables shared values through the business name.

Profit = Sales (unit price x volume) — Costs (volume x unit costs). Therefore, when Starbucks increased their price for coffee, they provided themselves with a higher budget for quality. Vertical chain arrangements and outsourcing for modern companies like Starbucks are driven by the desire of management to gain high profitability and competitive unit expense advantage. Nevertheless, modern business may produce with excess capacity in mind because they often face an ever increasing customer demand for their product/merchandise at any given time if they are unable to product differentiate quickly enough to meet said customer demand.

Chapter 3 of Besanko’s book finishes stating that the production of any services or good typically needs a range of activities structured within a vertical chain. In the case of Starbucks, they had to decide which activities in the vertical chain they should perform themselves and which should be left to independent firms in the market. Although Starbucks controls certain aspects of their business, they still have independent farmers grow their coffee beans. Trader Joes does not do this. They grow most of the produce and grocery items they sell.

Influence costs may firms may sometime sell unprofitable sections or leave some aspects of their products to independent producers. Using resources that would be sent on fully controlling every aspect of production may be used to expand the firm and make it more available to the public, therefore increasing consumer demand and brand appeal. Besanko uses an example of the vertical chain of production for furniture explaining the handling process as well as support services.

At first, the chain begins with raw inputs. These would be iron, cows, and trees. Then it goes to transportation and warehousing to deliver and store goods. The next step is intermediate goods preprocessors. These would be tanneries, metalworking shops, and lumber mills. Then comes warehousing and transportation again with assemblers, transporting and warehousing and finally, retailers like furniture stores. The support services would include finance, human resource management, accounting, legal support, planning, marketing, and other support services (Besanko, 2013).

Starbucks among other firms recognize vertical arrangements as the mode of entry or supply-chain into product markets. Meaning, it is designed particularly to improve both the effectiveness of distribution while maintaining efficient competition within markets. The 1960’s had very different modes of operation than modern firms. The continual integration process delivers an additional dimension to the examination of vertical restraints granting a kind of springboard for competitiveness, in increasingly international and competitive world markets.

R.H Coase and “The Nature of the Firm” are widely regarded as the predecessor of the nexus-of-contracts theory of the firm. “This account, which has dominated legal scholarship for four decades, describes a corporation as a nexus of contracts between the various claimants to the earnings of the business — shareholders, directors, officers, employees, customers, suppliers and other factors of production.” (O’Kelley, 2012). The term nexus of contracts brings with it some problematic features. “First, the term contract may suggest a focus on legal notions such as consideration and mutuality. Second, the paradigm contract used in law school typically is a transaction on a spot market that is thick and relatively untroubled by asymmetric information” (Bainbridge, 2008, p. 24). Thusly, nexus of contracts is more of a metaphor instead of a positive account of financial/economic reality. What this means is, a firm should be thought of as having instead of being a nexus of contracts.

When examining Starbucks, they have many competitors, as they are the number one Coffee retailer in the world with over 21,000 shops and cafes. For example, South Korea has around 10,000 coffee shops and Caffeebene reaching 1,860 cafe worldwide in fourteen countries. “The company, which boasts system wide revenues of $180 million, last year, wants a staggering 10,000 shops across the world by 2020. In the U.S. two dozen stores are open and more than that are being built — and the center of action is metro New York” (Ong, 2014).

Since outside competitors wish to branch out globally, even with Starbucks attempting to sustain their international expansion, other companies like Caffeebene may overshadow them. For Starbucks to maintain its number one position, they have to continue the social movement that generated through their pursuit of quality coffee and their message of conservation, diversity in the workplace, and desire to produce quality service and overall product to customers. “Often, however, these organizations overcome substantial obstacles through collective strategies that bear an uncanny resemblance to tactics and strategies adopted by organizations that spearhead social movements. Like social movements, a key task for participants in emerging industries is to gain cognitive and sociopolitical legitimacy” (SWAMINATHAN and WADE, 1999, p. I1). Maintaining quality and producing an attractive brand name spearheaded Starbucks into what it is today.

Very frequently, firms like Starbucks find themselves in the region of make or buy choices without it being the original desire. Efforts like Starbucks made to be more selective concerning the quality and number of suppliers, argue about where such a firm should truly focus its resources, or attempt to label core competences of the firm. All of this can lead to the need for assessment of which activities must be carried out inside the firm and which outside. Similarly, there may be an increasing awareness that profitable and successful firms may have varied methods to the scope of activities, which they may implement in house or subcontract out (Probert, 1997). As Guidi and Parisi Acquaviva explain, “The make/buy dilemma has a direct impact on the organization of the firm, so that the concept of organization has a meaning much broader than that of bureaucracy because it also includes the market and forms intermediate between bureaucracy and the market” (Guidi and Parisi Acquaviva, 2005, p. 76). Starbucks should compete with competitors and have with higher quality product and better service.

References

Bainbridge, S. (2008). The new corporate governance in theory and practice. Oxford University Press: New York.

Besanko, D. (2013). Economics of strategy. Hoboken, NJ: John Wiley & Sons.

Guidi, M. And Parisi Acquaviva, D. (2005). The Changing Firm. Milano: F. Angeli.

Jacobides, M. And Billinger, S. (2006). Designing the Boundaries of the Firm: From “Make, Buy, or Ally” to the Dynamic Benefits of Vertical Architecture. Organization Science, 17(2), pp.249-261.

Lipsey, R. And Chrystal, K. (2007). Economics. Oxford: Oxford University Press.

McNutt, P. (2013). Decoding strategy. 2nd ed. McGraw-Hill Education.

O’Kelley, C. (2012). Coase, Knight, and the Nexus-of-Contracts Theory of the Firm: A Reflection on Reification, Reality, and the Corporation as Entrepreneur Surrogate. Seattle University Law Review, [online] 35(4), p.1. Available at: http://papers.ssrn.com/Sol3/papers.cfm?abstract_id=2017237 [Accessed 20 Feb. 2015].

Ong, Y. (2014). Can South Korean Coffee Chain Caffebene Achieve World Domination?. [online] Forbes. Available at: http://www.forbes.com/sites/yunitaong/2014/09/24/can-south-korean-coffee-chain-caffebene-achieve-world-domination / [Accessed 20 Feb. 2015].

Probert, D. (1997). Developing a make or buy strategy for manufacturing business. London: Institution of Electrical Engineers.

Schultz, H. And Gordon, J. (2011). Onward. New York, NY: Rodale.

SWAMINATHAN, A. And WADE, J. (1999). SOCIAL MOVEMENT THEORY AND THE EVOLUTION OF NEW ORGANIZATIONAL FORMS. Academy of Management Proceedings, 1999(1), pp.I1-I6.