Corporate Strategy

Plan for a diversified company

Diversification and Corporate Strategy

A company is diversified when it is in two or more lines of business that operate in diverse market environments

Diversification and Corporate Strategy

Strategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single line-of-business

A diversified company needs a multi-industry, multi-business strategy A strategic action plan must be developed for several different businesses competing in diverse industry environments

When Should a Firm Diversify?

It is faced with diminishing growth prospects in present business It has opportunities to expand into industries whose technologies and products complement its present business It can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factors It can reduce costs by diversifying into closely related businesses It has a powerful brand name it can transfer to products of other businesses to increase sales and profits of these businesses
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Diversification Parameters

Diversification is capable of building shareholder value if it passes three tests: 1. Industry Attractiveness Testthe industry presents good long-term profit opportunities 2. Cost of Entry Testthe cost of entering is not so high as to spoil the profit opportunities 3. Better-Off Testthe companys different businesses should perform better together than as stand-alone enterprises, such that company As diversification into business B produces a 1 + 1 = 3 effect for shareholders
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Why Diversify?

To build shareholder value!

1+1=3

What Is Related Diversification?

Involves diversifying into businesses whose value chains possess competitively valuable strategic fits with the value chain(s) of the present business(es) Capturing the strategic fits makes related diversification a 1 + 1 = 3 phenomenon

Core Concept: Strategic Fit

Exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for

Transferring competitively valuable expertise or technological know-how from one business to another Combining performance of common value chain activities to achieve lower costs Exploiting use of a well-known brand name

Cross-business collaboration to create competitively valuable resource strengths and capabilities

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Value Chain Relationships for Related Businesses

Types of Strategic Fits

Cross-business strategic fits can exist anywhere along the value chain

R&D and technology activities

Supply chain activities

Manufacturing activities
Distribution activities

Sales and marketing activities

Managerial and administrative support activities
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Core Concept: Economies of Scope

Stem from cross-business opportunities to reduce costs

Arise when costs can be cut by operating two or more businesses under same corporate umbrella Cost saving opportunities can stem from interrelationships anywhere along the value chains of different businesses

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What Is Unrelated Diversification?

Involves diversifying into businesses with

No strategic fit

No meaningful value chain relationships

No unifying strategic theme

Basic approach Diversify into any industry where potential exists to realize good financial results While industry attractiveness and cost-of-entry tests are important, better-off test is secondary
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Fig. 9.3: Value Chains for Unrelated Businesses

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Appeal of Unrelated Diversification

Business risk scattered over different industries Financial resources can be directed to those industries offering best profit prospects If bargain-priced firms with big profit potential are bought, shareholder wealth can be enhanced Stability of profits Hard times in one industry may be offset by good times in another industry
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Combination Related-Unrelated Diversification Strategies

Dominant-business firms One major core business accounting for 50 - 80 percent of revenues, with several small related or unrelated businesses accounting for remainder Narrowly diversified firms Diversification includes a few (2 - 5) related or unrelated businesses Broadly diversified firms Diversification includes a wide collection of either related or unrelated businesses or a mixture Multibusiness firms Diversification portfolio includes several unrelated groups of related businesses

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Diversification and Shareholder Value

Related Diversification

A strategy-driven approach to creating shareholder value

Unrelated Diversification

A finance-driven approach to creating shareholder value

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Identifying a Diversified Companys Strategy

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How to Evaluate a Diversified Companys Strategy

Step 1: Assess long-term attractiveness of each industry firm is in Step 2: Assess competitive strength of firms business units Step 3: Check competitive advantage potential of crossbusiness strategic fits among business units Step 4: Check whether firms resources fit requirements of present businesses Step 5: Rank performance prospects of businesses and determine priority for resource allocation Step 6: Craft new strategic moves to improve overall company performance

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Diversification Will Succeed Only If It Passes Three Essential Tests

The attractiveness test:

industries chosen for diversification must be structurally attractive or capable of being made attractive. The cost of entry test : the cost of entry must not capitalise all future profits . The better-off test : either the new unit must gain competitive advantage from its link the corporation or vice versa.
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How Attractive Is the Industry ?

In the long run the rate of return available from competing in an industry is a function of its underlying structure

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Industry Attractiveness
Attractive industry

Unattractive industry

High ROI High entry barriers Low bargaining power of buyers & suppliers Few substitute products Stable rivalry amongst existing competition

Structural flaws. Large group of competitors(even state supported). Powerful and price sensitive buyers. Large substitute materials. Excessive rivalry caused by high fixed costs.

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Companies Tend to Ignore Industry Attractiveness Test If ...

Vague belief that the industry fit very closely with their own businesses. Low entry cost. Many rush into fast growing industries were burned because they mistook early growth for long term profit potential.

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What Is the Cost of Entry ?

Diversification cannot add shareholder value if the cost of entry eats up its expected returns. Acquisitions : take over price < market value. Start up: strive to reduce entry barriers cost.

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Will the Business Be Better off ?

A corporation must bring in significant advantage to the new unit , or the new unit must offer potential for significant advantage to the corporation. Corporate planners tend to ignore this test or deal with it through arm waving or trumped up logic rather than hard strategic analysis.
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Diversification - Strategic Options

Portfolio management .

Restructuring . Transfer of skills . Sharing activities.

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Portfolio Management
Primarily diversification through acquisition. Acquiring sound attractive companies with competent managers. Acquired units need not be in the same business as existing units.

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Portfolio Management
New units are treated as autonomous . Parent units provide capital and infuses professional management . Top management provides objectives and dispassionate review of business results.
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Success of Portfolio Management Depends on...

Companies must locate strong , but undervalued units , where parent company can provide resources (funds,professional management). The style of operating through highly autonomous business units must develop sound business strategies and motivate managers.

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Portfolio Management - Pitfalls

Limited candidates available for

acquisition. Benefit of giving complete autonomy is also questionable now. Strong need for industry specific knowledge for parent company to effectively handle a diverse portfolio.
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Portfolio Management - Recent Views

A strong sense of Corporate identity is as important as slavish adherence to Business unit financial results

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Restructuring Corporation seeks underdeveloped, sick or threatened companies or industries on the threshold of a significant change. Active involvement of parent company in turnaround operations at all levels.

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Restructuring Parent company changes management team,shifts strategy,infuses new technology. Parent co may make follow up acquisitions to build critical mass.

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Restructuring Success Depends on ..

Requires corporate management team with the insight to spot undervalued companies or positions in industries ripe for transformation. Strong capabilities for turnaround management.

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Restructuring - Pitfalls
Mistaking rapid growth of HOT industry as

evidence for restructuring.

Best companies realise they are not just acquiring companies but restructuring an industry.

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Purpose of portfolio management and restructuring is to create value through a companys relation ship with each autonomous unit . The corporations role is to be a selector, a banker , and an intervener. Last two strategic options transfer of skills and synergy exploit the interrelationships between businesses.
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Transfer of Skills
Starting point is value chain and synergy.

Depends on companys capability to transfer skills or expertise among similar value chains. Transfer of expertise from existing units to new operations.

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Success of Transfer of Skills Depends on .

Activities involved in businesses are similar enough that sharing expertise is meaningful. The transfer of skills involves activities important to competitive advantage. The skills transferred represent a significant source of competitive advantage for the receiving unit. The expertise or skills to be transferred are both advanced and proprietary enough to be beyond the capabilities of competitors.
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Sharing of Activities
Sharing activities in the value chains among business units . Ability to share activities is potent basis for lowering cost and raise differentiation. Cost benefit analysis of prospective sharing to check synergy. Economies of scale should drive costs lower. Coordination costs must not outweigh sharing benefits.
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Action Plans
Identifying the interrelationships among already existing business units. Selecting the core business that will be the foundation of corporate strategy. Creating horizontal organisational mechanisms that will facilitate future related diversification.

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Action Plans
Pursuing diversification opportunities

that allow shared activities. Pursuing diversification through transfer of skills. Pursuing strategy of restructuring if this fits the skills of management. Portfolio management as last option.

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Vertical Integration Strategies

Vertical integration extends a firms competitive scope within same industry Backward into sources of supply Forward toward end-users of final product

Activities, Costs, & Margins of Suppliers

Internally Performed Activities, Costs, & Margins

Activities, Costs, & Margins of Forward Channel Allies & Strategic Partners

Buyer/User Value Chains

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Vertical Integration Strategies

Can aim at either full or partial integration

Activities, Costs, & Margins of Suppliers

Internally Performed Activities, Costs, & Margins

Activities, Costs, & Margins of Forward Channel Allies & Strategic Partners

Buyer/User Value Chains

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Competitive Strategy Principle

A vertical integration strategy has appeal ONLY if it significantly

strengthens a firms competitive

position!

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Pros and Cons of Vertical Integration

The appeal of a vertical integration strategy depends on Its ability to enhance performance of strategy-critical activities by Lowering costs or Increasing differentiation Its impact on Resource requirements Flexibility and response times Administrative overhead of coordination Its ability to create a competitive advantage
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Appeal of Backward Integration

Generates cost savings only if volume needed is big enough to capture efficiencies of suppliers Potential to reduce costs exists when Suppliers have sizable profit margins Item supplied is a major cost component Resource requirements are easily met

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Appeal of Backward Integration

Can produce a differentiation-based competitive advantage when it results in a better quality part Reduces risk of depending on suppliers of crucial raw materials / parts / components

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Appeal of Forward Integration

Advantageous for a firm to establish its own distribution network if Undependable distribution channels undermine steady production operations

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Appeal of Forward Integration

Integrating forward into distribution and retailing May be cheaper than going through independent distributors May help achieve stronger product differentiation, allowing escape from price competition May provide better access to users

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Strategic Disadvantages of Vertical Integration

Poses problems of balancing capacity at each stage of value chain May require radically different skills / capabilities

Reduces manufacturing flexibility, lengthening design time and ability to introduce new products

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Strategic Disadvantages of Vertical Integration

Boosts resource requirements Locks firm deeper into same industry Results in fixed sources of supply and less flexibility in accommodating buyer demands for product variety

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Unbundling and Outsourcing Strategies

Concept
Involves not performing certain value chain activities internally and relying on outside vendors to perform needed activities and services

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Advantages of Outsourcing Strategies

Outside specialists may / can perform the activity better or more cheaply Activity is not crucial to achieving competitive advantage Reduces risk exposure to changing technology and/or changing buyer preferences

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Advantages of Outsourcing Strategies

Streamlines operations to Cut cycle time Speed decision-making Reduce coordination costs Allows firm to concentrate on its core business

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Cooperative Strategies
Companies sometimes use strategic alliances or strategic partnerships or collaborative agreements to complement their own strategic initiatives and strengthen their competitiveness. Such cooperative strategies go beyond normal company-to-company dealings but fall short of merger or formal joint venture

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Why Are Strategic Alliances Formed?

To collaborate on technology development or new product development To improve supply chain efficiency To gain economies of scale in production and/or marketing

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Why Are Strategic Alliances Formed?

To fill gaps in technical or manufacturing expertise To speed new products to market To acquire or improve market access

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