Corporate Strategy

1
Corporate Strategy

• Identifying business areas in which a company
  should participate to maximize long-term profits
  (i.e Pepsi Diversification Evolution).
• Four General Choices
• Single business focus
• Diversification (Related and Unrelated)
• Vertical integration
• Strategic alliances
• Major goal should be to maximize creation of
  value (which is often neglected)

2
Single Business Focus

• Advantages
• Allows company to focus on the flagship and
  competencies
• Important in fast-growth industries
• Lets you do what you know best
• Disadvantages
• May miss out on value creating opportunities
• If a firm decides to diversify, two questions
  must be addressed
• How attractive is the industry to be entered
  (external)?
• Can the firm establish CA within the new industry
  (internal)?

3
VI Diversification Evolution/Causes

• The Trend Toward Diversification Vertical
  Integration
• Management innovations reducing cost of internal
  admin
• Evolution of the multi-divisional structure
• Skilled managers and standardized controls
• Development of portfolio planning matrices
• 1960s - 1980s
• Single Business Diversification
  VI
• 1980s - 1990s
• The Trend Toward SBF
• Emphasis on shareholder value (not just growth)
• The effect of turbulence on transaction costs
• Management thinking about synergy and core
  competencies

4
Vertical Integration

• When a firm
• produces its own inputs (backward, upstream)
• buys its own outputs (forward, downstream)
• Raw Materials Manufacturing Assembly
  Distribution Retail You
• Upstream Downstream
• Backward Forward
• Full Integration Controlling all inputs/outputs
  in the process
• Tapered/Partial Integration Controlling some of
  the input/outputs in the process
• Value is added to the product at each stage

5
Vertical Integration

• VI is generally undertaken when the costs of
  market transactions exceed the costs of
  internalization.
• Transaction Costs
• Cost of search, negotiation, contracts,
  monitoring, and litigation (should it be needed).
• The effect of asset specificity (transaction
  specific investments).
• Hold-up and opportunism
• Administrative Costs (internalization)
• Differences in the optimal scale of operation
  between different stages of production (i.e.
  FedEx trucks)
• Managing strategically different businesses
• Developing distinctive capabilities (vs. vertical
  specialization)
• The agency problem
• Flexibility (i.e. construction)
• Compounding risk (internal production or pricing)

6
Vertical Integration

• Advantages
• Builds barriers to entry limits competition
• Facilitates investments in specialized assets
• Sometimes firms need specific assets for
  production
• Assets are non-standard so suppliers may not
  invest
• May realize EOS associated with specific assets
• Without VI, mutual dependence (hold-up) would
  exist
• Protect product quality
• Improve coordination JIT, eliminates excessive
  inventories, better response to changing demand

7
Vertical Integration

• Disadvantages
• Cost
• commitment to purchase from firm-owned suppliers
• not having to compete disincentivizes
  company-owned supplier to control costs or
  innovate
• Technological change
• invest, or lose out to competition who has
  contract supply
• Demand uncertainty
• under full VI coordination may be difficult
• tapered integration can help solve this problem
• Bureaucratic costs
• costs of running a business sometimes VI can
  create costs

8
Alternatives to VI

• Alternatives are generally relationships that
  fall between market and internalization.
• Long-term cooperative relationships (strategic
  alliances)
• Franchising
• Short-term competitive bidding more market based
  and may create a trust gap or even hostility
  (military)
• Long-term contracts create opportunities for both
  firms to find ways to lower cost or increase
  quality allows use of specific assets.
• Outsourcing (see next slide)

9
Outsourcing

• Opposite of VI
• Usually non-core activities
• Network/virtual organizations (Nike)
• Advantages
• supplier may be more skilled, so you could save
• may create a differentiation for your product
• allows you to focus on your core competencies
• Disadvantages
• lose control and ability to learn
• may create too much dependence
• may outsource value creating activities

10
Diversification

• 2 Types Related Unrelated
• Related - Linked by value chain - strategic fit
• Unrelated - No value chain link - financial fit
• Diversified Firms create value 4 ways
• (1) Superior Internal Governance (Acquiring and
  restructuring)
• acquire poorly run firms and improve
  effectiveness
• replace top management
• sell off unproductive assets
• intervene in operations

11
Diversification

• (2) Transfer competencies
• value chain relatedness (use Porters Fat Arrow)
• can lead to low-cost or differentiation advantage
• commonality isnt enough must involve
  competencies and competitive advantage
• (3) Realize EOS
• ability to share resources (facilities,
  distribution, RD, etc.)
• (4) Utilize functions better (economies of scope)

12
Bureaucratic Costs Diversification

• Bureaucratic costs arise from of firms in the
  portfolio coordination required to create
  value.
• of businesses
• lack of time for management
• resource allocation
• squeaky wheel management
• coordination among businesses
• shared function time (accountability)
• monitoring costs
• curvilinear relationship between firms owned
  value

13
Diversification

• Management generally favors diversification
  because it builds empires (agency problem)
• Cited reasons for diversification
• offset cyclical downturns
• risk pooling decreases chances of a loss
• greater growth is always good (?)
• but.
• industry cycles are generally unpredictable
• stockholders can perform their own
  diversification
• growth must create value stockholder wealth

14
Essential Tests (Porter)

• Attractiveness Test Industry chosen for entry
  must be structurally attractive or capable of
  being made attractive (i.e. Porters 5 Forces).
• Cost-of-Entry Test We cant forget barriers to
  entry if an industry is attractive, do you think
  the incumbents want you there? Entry to a new
  industry shouldnt eat up all the profits.
• Cost-of-entry and attractiveness tests must both
  be passed before diversificationbetter-off test
  is optional.
• Better-off Test can value be created by
  exploiting linkages between companies and is
  creating this value practical?

15
Diversification
16
Strategic Alliances

• Good way to spread/share risk
• Pooling resources or sharing complementary
  resources provides competitive advantage
• Can circumvent international barriers
• But poses many difficulties about control
• technology transfer
• knowledge transfer/races
• trust, trust, trust

17
Summary

• A quote from the book Diversification is like
  sex. Its attractions are obvious, often
  irresistible. Yet, the experience is often
  disappointing. (But I would have to counter with
  the old saying when it comes to sex, the worst
  I ever had waswonderful!)
• The most important point is that managers need to
  avoid the errors of the past through strong
  strategic analysis of diversification decisions.
  The objectives need to be clear and explicit.
  Diversification as a form of escapism from
  dealing with the difficulties of the core
  business or as a form of empire building is, at
  best, misguided.