Chapter Five Strategy formulation: Corporate, business

& functional strategy

5.1 Corporate - Level Strategy
 A corporate-level strategy is an action taken to gain a

competitive advantage through the selection & management of

a mix of businesses competing in several industries or product
markets.
 A corporate-level strategy is concerned with two key questions:

What business should the firm be in?

How should the corporate office manage its group of

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businesses?
 cont’d …
Corporate strategies are often called grand/master

strategies
These grand strategies (major Corporate Strategies)

can be:

1. Growth strategy - expand the company's activities.

2. Stability strategy - make no change to the

company’s current activities

3. Defensive strategy – reduce the company’s levels of

2 activities
 1. Growth Strategy

 Growth Strategy involves the attainment of

specific growth objectives by increasing the level

of a firm’s operations
 Typical growth objectives for businesses include:

Increase in sales revenues

Increase in earnings or profits

Other performance measures

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 1.1 Concentration Strategy

 Concentration strategy will be appropriate when the company

concentrates on the current business.

 The firm directs its resources to the profitable growth of a single

product, in a single market, with a single technology.

Advantages:

 Based on known competencies & same experience

 Lowest in risk & additional resources

Disadvantages:

 Steady but slow increases in growth & profitability

4  Narrow range of investment options

 cont’d …

Thus, concentration focuses on:

Increasing present customers’ rate of usage

Attracting competitors’ customers through price cuts

Attracting non-users through advertising, price

incentives etc.
There are two options that involve moderate cost & risk.

They are:
A. Market development &

5 B. Product development
 A. Market Development
Market development is selling present products in new

markets – additional regional, national & international

expansions.

Attracting other market segments through:

 Developing product versions to appeal to other

segments

 Entering other channels of distribution

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 Advertising in other media
 B. Product Development

Product development is developing new products for

present markets. This involves:

Developing new product features:

 Modifying (change color, form, shape, etc.)

 Magnify & minify

 Rearrange (layout, patterns, etc.)

Developing additional models & sizes (product

7 proliferation)
 cont’d …
Thus, it involves substantial modification of existing

products or creation of new but related items that can be

marketed to current customers through established
channels.

The idea is to attract satisfied customers to new products as

a result of their positive experience with company’s initial

offering.

The product development strategy is often adopted either to

prolong the life cycle of current products or to take

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 1.2 Innovation Strategy
Innovation strategy refers to original or novel ideas

when firms shift from market & product development as

the basis for profitability.

Thus, the main philosophy of innovation strategy is

creating a new product life cycle, thereby making any

similar existing products obsolete.

However, innovation is costly & risky – few innovative

ideas prove profitable because R&D, marketing, & other

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costs are extremely high.
 1.3 Integration Strategy
Integration strategy focuses on moving to different

industry level, different product & technology but the

basic market remains the same.
There are two types of integrative growths:

i. Vertical integration
ii. Horizontal integration

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 cont’d …

i. Vertical Integration
Vertical Integration involves extending an
organization’s present business in two possible
directions.
Forward integration moves the organization into

distributing its own products or services .

Backward integration moves an organization into

supplying some or all of the products or services

11 used in producing its present products or services.
 cont’d …

ii. Horizontal integration

Horizontal integration occurs when an organization

adds one or more businesses that produce similar

products or services and that are operating at the same
stage in the product market chain.

Almost all horizontal integration is accomplished by

buying another organization in the same business.

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 1.4 Diversification

The entry of a firm or business unit into new lines of

activity, either by processes of internal business

development or acquisition, which entail changes in
its administrative structure, systems and other
management processes
Diversification growth strategy is classified into two

categories:
a. Concentric (Related)
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b. Conglomerate (Unrelated)
a. Concentric (Related) Diversification
Diversifying into a different industry but one that’s related

in some ways to the organization’s current operations

Search for strategic “synergy”, which is the performance

of the whole is greater than the sum of the parts.

The idea that 2 + 2 = 5

Synergy happens because of the interactions and the

interrelatedness of the combined operations and the

sharing of resources, capabilities, & distinctive
14 competencies
cont’d
 Related diversification could be achieved through

economies of scope & market power

 Firms that have selected related diversification as their

corporate-level strategy seek to exploit economies of

scope between business units and get market power.
 Economies of scope are cost savings attributed to

transferring the capabilities and competencies

developed in one business to a new business
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 cont’d…..
 Economies of scope refers to sharing activities & transferring of

core competencies: operational & corporate relatedness.

 Value is created from economies of scope through operational

relatedness and corporate relatedness.

 Operational relatedness / sharing activities

Require strategic control over business units

Primary & support activities can be shared efficiently

 Its main limitation is the difficulty to explicitly differentiate the

16 outcomes of each firm

 cont’d …

Corporate relatedness – transferring of core competencies:



Corporate core competencies are complex sets of resources & capabilities

that link different businesses trough:

 Managerial, technological knowledge, experience & expertise.


Market power exists when a firm is able to:
Sell its products above the existing competitive level

Reduce the costs of its primary & support activities below the competitive

level
Blocking competitors through multi-point competition

Market power could be gained through:



a. Multi point competition

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b. Vertical integration
 cont’d …
a. Multi-point competition exists when:

Two or more diversified firms compete in the same

product areas or geographic markets

Multipoint competition will not create potential

gains when there is excessive competitive activity

Therefore, firms develop mutual forbearance to

create value by engaging in less competitive

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rivalry
cont’d …

b. Vertical integration
 Exists when a firm produces its own inputs

(backward integration) or owns its source of

distribution of outputs (forward integration)
 A firm pursuing vertical integration usually is

motivated to strengthen its position in its core

business by gaining market power over competitors

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b. Conglomerate(Unrelated) Diversification
 Diversifying into completely different industry from

the firm’s current operations

 Firm move into industries where there is

 No strategic fit to be exploited

 No meaningful value chain relationships

 No unifying strategic theme

 Approach is venture into any business with good

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profitability prospects
 cont’d …
 Unrelated diversification could be achieved through financial economies
 These are cost savings realized through improved allocations of
financial resources and based on investments inside or outside the firm
 Value is created through two types:
a. Efficient internal capital allocations
 Development of a portfolio of businesses with different risk
profiles thereby reducing the business risk for the total
corporation
b. Purchasing other corporations and restructuring their assets
 Buying and selling businesses in the external market with the
intent of increasing the total value of the firm.
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  Major Reasons for Diversification
 Antitrust regulation

 Tax laws

 Low performance

 Uncertain future cash flows

 Risk reduction for firm

 Tangible resources

 Intangible resources

 Managerial motives for diversification may lead to value reduction

 Diversifying managerial employment risk
 Increasing managerial compensation
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Means of Diversification

All the previously discussed growth strategies could be

implemented either through internal growth or through
acquisition, merger, or joint ventures.

Internal Growth
Internal growth occurs when a company expands its current

market share, its markets, or its products through the use of

internal resources.
Internal growth is generally slower and less traumatic for

the organization. It usually takes place over an extended

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 cont’d …

Although exceptions exist, internal growth is

generally less risky than an acquisition or a merger.
This is because growth, through internal means, is
incremental and can be terminated at any time.

Generally speaking, internal growth strategies work

well for companies want to grow via product

development or market development.

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2. Stability Strategy
It is also called neutral strategy: occurs when an organization is satisfied


with its current situation & wants to maintain the status quo.
Reasons for using stability strategy:


The company is doing well

The management wants to avoid additional hassles associated with growth

Resources has been exhausted because of earlier growth strategies

3. Defensive Strategies
Defensive Strategies most often used as a short-term solution to:

Reverse a negative trend

Overcome a crisis or problem situation

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 cont’d …

Reasons:
The company faced financial problems – certain parts
of the organization are doing poorly
The company forecasts hard times ahead related to:
Challenges from new competitors & products
Changes in government regulations

Owners are tired of the business or have to have an

opportunity to profit substantially by selling
It could be classified into decline & closure strategies

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 a. Decline strategy
a. It includes:

i. Retrenchment/cut production costs

ii. Harvesting,

iii. Turn around and

iv. Divestiture

i. Retrenchment strategy will be used when the company wants

to reduce its operations primarily, by reducing product lines.

 The main purpose of retrenchment is economizing through cutting

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production costs
 cont’d …

ii. Harvesting occurs when future growth appears doubtful or not cost
effective – the main reason could be because of new competition or
changes in consumer preferences
 In this case the firm limits additional investment & expenses but

maximizes short-term profit & cash flow through maintaining market

share over the short-run

iii. Cutting back employee compensation or benefits

Replacing higher-paid employees with lower-paid employees

Leasing rather than buying equipment

28Cutting back marketing expenses


 cont’d …

iv. Divestiture strategy occurs when an organization

sells or divests itself of a business or part of a
business – previous diversification is not successful
Moreover, when the firm is highly indebted – it might

prefer to survive by selling some of its businesses by

raising sufficient capital to:
 Increase the performance of the remaining businesses

 Settle its debt

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 b. Closure Strategies
Closure strategy consists of liquidation & filing of bankruptcy

Liquidation occurs when an entire company is either sold or

dissolved either by choice or force

 When by choice, it can be because the owners are tired of

the business or near retirement; the organization’s future

prospect is not good and sell at this time

 When by force, the decision often occurs because of a

deteriorated financial condition

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 5.2 Business-Level Strategy
.

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Core The resources and capabilities that
Competency have been determined to be a source of
competitive advantage for a firm over
its rivals.

An integrated and coordinated set of

Strategy actions taken to exploit core
competencies and gain a competitive
advantage.

Actions taken to provide value to

Business customers and gain a competitive
Level advantage by exploiting core
Strategy competencies in specific,
individual product markets.
Generic Business Level Strategies
Source of Competitive Advantage

Cost Uniqueness

Broad Cost
Cost Differen-
Target Leadership tiation
Leadership
Market
Breadth of
Competitiv
e Scope Focused
Narrow Focused
Differen-
Target Low Cost
Market tiation
1. Cost Leadership
Key Criteria:
Relatively standardized products

Features acceptable to many customers

Lowest competitive price

Con’t…
Requirements:- Constant effort to reduce costs
through:

Building efficient scale facilities

Tight control of production costs and overhead
Minimizing costs of sales, R&D and service
State of the art manufacturing facilities
Monitoring costs of activities provided by outsiders
Simplification of processes
Con’t…
How to Obtain a Cost Advantage
1. Determine and Control Cost Drivers

2. Reconfigure the Value Chain as needed

Alter production process New raw material

Change in automation Forward integration
New distribution channel Backward integration
New advertising media Change location relative
Direct sales in place of to suppliers or buyers
indirect sales
Con’t…
Choices That Drive Costs
Economies of scale Product features
Asset utilization Performance
Capacity utilization pattern Mix & variety of products
- Seasonal, cyclical Service levels
Interrelationships Small vs. large buyers
- Order processing
and distribution Process technology

Value chain linkages Wage levels

- Advertising & Sales Product features
- Logistics & Operations
Hiring, training, motivation
Con’t…
Major Risks of Cost Leadership Business Level
Strategy

Dramatic technological change could take

away your cost advantage

Competitors may learn how to imitate

Value Chain

Focus on efficiency could cause Cost Leader

to overlook changes in customer preferences
2. Differentiation
Key Criteria:
 Value provided by unique features and value
characteristics

 Command premium price

 High customer service

 Superior quality

 Prestige or exclusivity

 Rapid innovation
Con’t…
Requirements:
Constant effort to differentiate products through:
Developing new systems and processes

Shaping perceptions through advertising

Quality focus

Capability in R&D

Maximize Human Resource contributions

through low turnover and high motivation
Con’t…
Create Value with Differentiation by:
Lowering Buyers’ Costs

Raising Buyers’ Performance

Creating Sustainability through:

• Creating barriers by perceptions of uniqueness
• Creating switching costs through differentiation
Con’t…
Drivers of Differentiation
Examples:

Unique product features

Unique product performance
Exceptional services
New technologies
Quality of inputs
Exceptional skill or experience
Detailed information
Con’t…
Major Risks of a Differentiation

Customers may decide that the cost of

“uniqueness” is too great

Competitors may learn how to imitate

Value Chain

The means of uniqueness may no longer be

valued by customers
 3. Focused low cost & Differentiation

A focus strategy must exploit a narrow pocket that

is different from the balance of the industry by:
– isolating a particular buyer group
– isolating a unique segment of a product line
– concentrating on a particular geographic
market
– finding their “niche”
Con’t…
Factors That May Drive Focused Strategies.

Large firms may overlook small niches

Firm may lack resources to compete industry-wide
May be able to serve a narrow market segment
more effectively than industry wide competitors

Focus can allow you to direct resources to certain

value chain activities to build competitive advantage
Con’t…
Major Risks Involved With a Focused Business Level Strategy

Firm may be “outfocused” by competitors

Large competitor may set its sights on your

niche market

Preferences of niche market may change to

match those of broad market
5. Integrated Low Cost/Differentiation Strategy

Firms using an Integrated Strategy may:

Adapt more quickly
Learn new skills and technologies

Utilize Flexible Manufacturing Systems to create

differentiated products at low costs
Leverage core competencies through Information
Networks across multiple business units

Utilize Total Quality Management (TQM) to

create high quality differentiated products which
simultaneously driving down costs
Con’t…
Benefits of Integrated Strategy

Successful firms using this strategy have above-

average returns
Firm offers two types of values to customers

some differentiated features (but less than a

true differentiated firm)

relatively low cost (but now as low as the cost

leader’s price)
Con’t…
Major Risks
Recognize that the Integrated Low Cost/ Differentiation
business level strategy involves a Compromise

The risk is that the firm may become “Stuck in the

Middle” lacking a strong commitment to or expertise
with either type of generic strategy
5.3 Functional level strategy
Reading Assignment