Ch 7. Corporate Strategy

Beau Gould - Larry Griffin - Cristian

Marsico - Teresita Pinon

Corporate strategy is concerned with where a firm competes whereas business strategy is how a firm competes.

The Scope of the FirmDeciding “What business are we in?”

Product Scope - Breadth of the firm’s product range

Vertical Scope - Extent of the involvement in the industry value chain

Key Concepts for Analysing Firm ScopeEconomies of Scope

Cost economies is the reduction in average costs that result from an increase in the output of multiple products

This exists when using a resource across multiple activities uses less of that resource than when the activities are carried out independently

Examples: Tangible -

centralized administrative and support services through shared service organizations

Intangible - corporate reputation through brand extension

Transaction Costs

Making a sale or purchase involves search costs, negotiation costs, costs for drawing up a contract, cost of monitoring the deal, and costs for arbitration in the case of a dispute

Key Concepts for Analysing Firm ScopeThe Cost of Corporate Complexity

If a firm extends its scope of operations by directly being involved in additional business activities it may benefit from economies of scope and eliminating transaction costs

By doing this firms are incurring additional management costs

This in turn leads to the possibility that management costs may exceed the savings from directly engaging in these activities

Hence the constant awareness needed to balance corporate activities for overall profitability

DiversificationDiversification

This refers to the expansion of an existing firm into another product line or field of operation

Horizontal diversification involves the firm moving into the same stage of production

Vertical Diversification occurs when a firm undertakes successive stages in the production of a good or service

The Costs and Benefits of DiversificationGrowth - Companies are always looking to expand into other industries

Risk Reduction - “Don’t put all your eggs in one basket”

Value Creation - Is shown by exploiting linkages between different businesses

Exploiting Economies of Scope - Brand recognition and company reputation

Internal Capital Markets - Keeps cash-flowing internally by eliminating outside borrowing and debt/equity fundraising; Better access to information on their financial prospects

Internal Labor Markets - Relies less on hiring/firing but more on internal promotions and employee transfers to different divisions

When Does Diversification Create Value

Attractiveness Test - The industries chosen for diversification must be structurally attractive or capable of being made attractive

Cost of Entry Test - The cost of entry must not capitalize all the future profits

Better-off Test - Either the new unit must gain competitive advantage from its link with the corporation, or vice versa

Diversification ContinuedDiversification and Performance

The performance effects of diversification depend on the mode of diversification.

In general, when companies divest diversified businesses and concentrate more on their core businesses, the result is increased profitability and higher stock valuation.

Related and Unrelated Diversification

Companies can choose to diversify into related or unrelated industries

The distinction between what is related and unrelated is not always a fine line

Overall it seems likely that diversification into related industries should be more profitable than diversification into unrelated industries

Vertical Integration refers to the firm’s ownership of vertically related activities.

Benefits of Vertical Integration1. Reduces Risk

2. Cost savings due to the integration of processes

3. Eliminate certain transaction costs

4. Facilitate transaction specific investments

5. Quickly adapt entire value chain

Cons of Vertical Integration1. The incentive problem

2. Lack of flexibility

3. Compounding risk

4. Shifting assets to non-core competencies

5. Limited scope for economies of scale

Vertical Integration ContinuedTypes of Vertical Relationships

Long-term contracts

Vendor partnerships

Franchising

Recent Trends in Vertical Integration

“Hybrid” vertical relationships

Long-term sole supplier contracts

Supplier networks

Outsourcing + competencies

Purchasing small stakes in supplier/service network

Virtual corporations

Realogy Holdings CorpExamples of Vertical Integration

10/2005 - Spun off from Cendant

07/2014 - Acquired ZipRealty

10/2014 - Acquired Title Resource Group

Kent noted, "What we viewed to be a pure play, easy story has turned more complex with acquisitions, tough comps, and charges offsetting improving existing home sales."

CBRE GroupExamples of Vertical Integration

1989 - Sold off from Coldwell Banker

10/2006 - Merged with developer TramwellCrow

02/2011 - Acquired ING’s real estate investment arm

02/2011 - Acquired ING’s listed securities business

CBRE Revenue vs Earnings Growth

Jones Lang LasalleExamples of Vertical Integration

Over 35 mergers and acquisitions since 2007

Recent Acquisitions

Propell Valuations in Australia

AGL Financial Advisory in Sweden

Oak Grove Capital in the US

Bill themselves as a professional services firm with a focus in real estate

Portfolio planning allow firms to manage multiple businesses to create the most value possible.

GE/McKinsey MatrixMarket Attractiveness:

Market size, growth rate, and profitability

Cyclicity

Inflation recovery

International potential

Business Unit Strength:

Market Share

Return on sales (relative to competitors

Market position (in terms of quality, technology, manufacturing, distribution, marketing, and cost)

BCG Growth Share MatrixSimilar to GE/McKinsey but more

limited

Uses only market share and market growth rate as defining factors

Simplicity makes for ease of use and clear picture of company standing but also masks certain problems

BMW: 2% share of world auto market

Cow or dog?

Ashridge Portfolio DisplayFocuses on overall fit between parent

company and potential business acquisition

Fit (Horizontal Axis)

Potential for parent to generate profit through by applying management capabilities, resource sharing, and economies of scale

Misfit (Vertical Axis)

Potential for value destruction by parent by added costs of corporate overhead or mismatch of management needs/styles

Uses subjective criteria, therefore can be more complicated to use

Extremely important, given today’s complex business environment

What Does This Mean for ?

The GE/McKinsey matrix helps to identify which businesses to grow and which to harvest based on market and business analysis

The BCG growth matrix allows the company to easily classify existing business to determine strategies moving forward

The Ashridge Portfolio Display helps to analyze potential businesses and assist with selecting the ones that would be a proper fit

In SummaryAnalyzing a firm’s scope is imperative for creating a diversification

strategy that reduces risk and creates value

Trends have shifted to corporate networks but traditional vertical integration can still be a valuable tool

Portfolio planning, through the use of various charts and matrixes, helps companies to develop the optimal mix of businesses and investments