Chapter 10: Vertical Integration Strategies

Vertical integration is the process by which a company is responsible for producing all of the components that make up the end product which is eventually sold in the marketplace. A good example of a company that practices vertical integration is Apple. Apple which is responsible for some of the most popular technological products on the market (iPad, iPhone, iWatch) has become very successful adopting this model where they manufacture the pieces that comprise these items and sell the end product. However, Apple does not assemble these items.

Although the idea to vertical integrate may work for Apple, it does not seem as if this strategy would be ultimately lucrative for an restaurant such as Chipotle. Restaurants are continually patronized due to their excellent customer service and fare. Understandably, one cannot manufacture service; therefore, Chipotle is a bad candidate for this approach. However, one can produce food items that can be fashioned into the ingredients needed to service the restaurant's menu. Let us explore the lucrativeness of this possibility.

For Chipotle to take over the daunting task of manufacturing the products that go into making their entrees, they would need to manage and service several ranches/chicken farms, dairies, and several thousands of acres of farmland to keep up with demand. Also, they would need to acquire several warehouses or refrigerated storage facilities to keep the products cool until ready for transportation. Additionally, Chipotle would have to spend more money on transportation and logistics costs to get the products from the manufacturing site to the restaurants.

The extra costs listed above would be associated with a majority of restaurants that would attempt to vertically integrate their companies. However, Chipotle would have even more of an added expense as they are wholly devoted to GMO and hormone free/organic meats and produce. So the extra care and resources needed to produce items up to those specifications is even more of an expense that would be leveraged against the financial success/profits of the restaurant in itself, potentially resulting in a loss of money due to issues such as food spoilage and other issues associated with organic farming.

While vertical integration worked for Apple, that is not the accurate for all manufacturers of high ticket items. General Motors, one of the largest auto manufacturers in the world operated in a fashion that is the reverse of Apple in the assembly department as they were only responsible for the manufacturing and creative process of the vehicle. If they were to take on the responsibility of manufacturing the parts as well, it could increase the operational cost beyond the limits of profitability. Other companies in the region would relish the opportunity to partner with these mega companies so as they can have a steady revenue stream.

Ultimately, vertical integration works for some as a strategic process. There's no definitive indicator as to the type of company that should try to adopt this approach.

Chipotle Mexican Grill - Expansion and Growth Strategies

Owning your Supply Chain - Lessons from Chipotle Grill's Antibiotic-Free Beef Dilemma

There Aren't Enough "Naturally Raised" Cows to Meet Chipotle's Demand 

Chapter 9: Tacit Collusion: Coooperation to Reduce Competition

One of the primary focuses since the beginning of the course has been competition. What company's in competition with another? How to drive competition? Who's the biggest competitor? Are all questions that were used to guide discussions regarding our company position within their respective industries. However, chapter 9 in Barney's text leads the discussion in a completely different direction with the tacit collusion concept.

Described in the textbook as an act when

...firms in an industry agree to coordinate their strategic choices to reduce competition in an industry. In the extreme, collusion occurs when firms coordinate their output and pricing decisions. In some circumstances, such collusion can lead to economic profits. As suggested earlier in this chapter, explicit collusion exists when competition-reducing decisions are coordinated directly, through direct communication and negotiation. This kind of collusion is illegal in most developed economies. Tacit collusion exists when these decisions are not coordinated through direct communication and negotiation, but coordination develops nevertheless.

Through examination, it is observed that Chipotle really has no competition in their industry. As discussed in other posts, Chipotle is leading the way in revolutionizing the upscale fast food industry with innovative menu items, organic ingredients and trendy appeal to millennials. Therefore, the tacit collusion referenced in the text is not present in the strategic planning of Chipotle's business operations.

However, it should noted that Chipotle is the exception and not the rule. Overall, the fast food industry is full of collusion within the leading companies. The US fast food industry generated about $190 billion in revenue last year. While places like Chipotle, Chop't and Panera Bread are starting to gain great strides in the marketplace due to their devotion to "healthfulness" of their products; the average burger and fry restaurants are striking back.

Fast food over the two decades have transitioned from "fun time fare" to food for those who have limited access to healthier options. Places like Detroit which tote a high poverty and unemployment rate among its residents, live in a "food desert" where people mainly rely on these inexpensive fast food restaurants and convenience stores for meals as access to supermarkets are not simply attainable. Therefore, those lower end fast food chains (McDonald's, Burger King, Wendy's, Checkers) have acquired prominent placement in these communities to grow revenue.

While these is only so much diversification that can take place in this industry, it seems as if the major four companies engaged in some form of tacit collusion in their business strategies in the latter part of 2015 and early 2016 by unveiling their $5.00 meals. Similar to the dollar menu concept that emerged a decade ago, it seems as these companies now look to entice customers with affordable/cheap multi item meals that include a drink and dessert to contest the progress of companies like Chipotle in the marketplace.

Through this collusion, the willingness customers have for wanting to purchase higher end fast food items could potentially diminish thereby eliminating the Panera Breads and Chipotle of the world. Certainly, the higher end fast food would still continue do business in the same marketplace but its revenue would be hampered as the cheaper places would be seen as the go to for many individuals for its price point. For those who did not buy into the marketing schemes, an overall reduction in the purchase of fast food would be likely as the overall marketplace would be devalued.

Chapter 8: Flexibility: Real Options Analysis Under Risk and Uncertainty

All aspects of business (similar to life) are filled with risk and uncertainty. The very actions associated with business in and of itself is quite risky to say the least. A company creates and initiates a business model and course of action to provide to the public that may or may not be profitable. While all hope to thrive in the marketplace, a certain level of flexibility must be present to assist in the re-organization, re-thinking or re-tooling of the product or service to acquire the profits truly desired. 

The textbook "Gaining and Sustaining Competitive Advantage" by Barney cites, 

Flexibility can take numerous forms in an uncertain strategic investment, including the option to defer, the option to grow, the option to shut down and restart, the option to abandon, and the option to expand. There often exist trade-offs between retaining these options and other business strategies. For example, a manufacturing plant designed to implement a low-cost leadership strategy may be very different than a plant designed to maximize flexibility. Thus flexibility should only be a strategic objective for a firm when it is likely to be valuable, that is, under conditions of high uncertainty.

Recently since Chipotle's Ecoli scare, the Mexican restaurant chain had to definitely maintain a great deal of flexibility within the company maintain its customer base and profits. When the first few illnesses occurred, Chipotle alerted the public, temporarily closed those locations, and pulled the alleged affected meat from the stores. While this was thought to potentially remedy the problem, this was not the case as another outbreak occurred in another location. Seemingly, after much analysis, investigation and deliberation the company asserted its flexibility and closed all of its locations (whether affected or not) on February 8, 2016. 

For one of the leading fast food restaurants to opt to lose profits across the country for a day in order to get in front of this continual problem exhibited a great deal of flexibility. All of the major fast food chains have experienced Ecoli or other food product related illnesses in their history. However, there has been no documented restaurant shutdown for an entire chain in United States history. If so, it was not of the magnitude of Chipotle.   

Seemingly, the shutdown and action taken by Chipotle was well received by consumers as revenue has begun to rise once again for the fast food chain. Analyzing the risk associated with this action was integral in the retention of customers who may have abandoned the chain as a whole due to safety concerns and has certainly paid off. 

Chipotle Announces Mass Shutdown for One-Day Food-Safety Conference

43 Washington and Oregon Chipotle restaurants closed after E. Coli outbreak

CHIPOTLE: A FOCUS ON FOOD SAFETY

Chapter 7: Product Differentiation

Last week, it was discussed how some companies use the Cost Leadership model as an economic strategy in which to grow their business. Organizations who utilize Cost Leadership operate on the assertion that the best way to grow profit is through low operational and production costs. While it is still possible for these companies to produce high quality items, primarily groups that employ this tactic tend to create goods and services that are cost efficient/discount alternatives to the pre-existing standards. While some may think that this would be highly unpopular with the public as the most individuals would like to spend their funds on high quality items, the idea of getting "more bang for your buck" has taken over.

However, not all companies utilize this strategy. Chipotle for example operates by what is known as Product Differentiation. According to Barney, "Product Differentiation is a competitive business strategy whereby firms attempt to gain a competitive advantage by increasing the perceived value of their products and services relative to the perceived value of other firm's products and services." As was mentioned in previous posts, Chipotle prides itself of providing food with integrity which is exemplified in its GMO and hormone free entrees and sides. While this a somewhat "safer" (more healthful) alternative that makes customers happy (thereby creating customer loyalty/value), it is extremely costly undertaking as organic products are more expensive than the standard alternatives.

Also, Chipotle rarely charges extra for additional items on their entrees (unless it's meat or guacamole). This boosts customer patronage as consumers recognize the value in their purchase as the mantra of the "customer is always right" is seemingly followed to a tee. The extra money Chipotle spends on creating a pleasant customer experience through acquiring excellent employees (which costs a bit more) adds to the operating costs as well.

Overall, Chipotle does not skimp on extras and goes the extra mile to provide exemplary service at the expense of it's bottom line. However, the revenue/profit Chipotle hopes to acquire from their product differentiation strategy has proven to be successful in creating one of the largest fast food restaurants in the marketplace today.

Quality Product and Customer Service: How Chipotle Conquered a Crowded Market