sm lecture six : corporate strategy and diversification

Strategic Management BUSM 3200

These Lecture Slides summarize the key points covered in the respective chapters in your

recommended text; these slides do NOT substitute, at all, the required reading of the assigned

chapter from the text. These slides also may contain additional supplementary material extracted

from other texts and sources outside your text book.

6-1

BUSM 3200- Strategic Management (Jan 2013) GDS

Strategic choices

Figure II.i Strategic choices

Chapter Seven

6-2


Learning outcomes for Chapter 7

Identify alternative strategy options, including market penetration, product development, market development and diversification.

Distinguish between different diversification strategies (related and conglomerate diversification) and evaluate diversification drivers.

6-3 BUSM 3200- Strategic Management (Jan 2013) GDS

Learning outcomes for Chapter 7

Assess the relative benefits of vertical integration and outsourcing.

Analyse the ways in which a corporate parent can add or destroy value for its portfolio of business units.

Analyse portfolios of business units and judge which to invest in and which to divest.


6–5 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

STRENGTHENING A COMPANY’S MARKET POSITION VIA ITS SCOPE OF OPERATIONS

Range of its

activities

performed

internally

Breadth of its

product and

service offerings

Extent of its

geographic

market

presence and

mix of

businesses

Size of its

competitive

footprint on

its market

or industry

Defining the Scope of

the Firm’s Operations

6-5

Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &

Beamish/Strategic Management/4th edition

Levels of strategy

Business Strategy

Corporate Strategy Wesfarmers Limited

Forest Products

Chemicals

& Fertilisers

Supermarkets

Hardware

Insurance

Industrial &

Safety Energy

Functional Strategy Sales & Marketing Operations Finance

6-6



What is corporate strategy?

Corporate strategy deals with issues related to the portfolio mix of businesses held by a multi-business organisation/corporation.

Issues such as:

What the portfolio of businesses is or should be within the corporation

the rationale behind the design of the portfolio

allocation of resources to the various businesses

performance and returns required of the businesses

6-7

Strategic directions and corporate-level strategy

Figure 7.1 Strategic directions and corporate-level strategy


Some additional notes on the concept of diversification

Before we move into the Ansoff model discussion, it is important that you understand the concept of diversification

Diversification is an important topic and almost always appears in the exam paper

You need to know about the types of diversification, the motives for diversification and the advantages and disadvantages of diversification strategy




What is diversification?

Multi-business corporations have diversified beyond a single business.

Diversification is defined as:

‘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.’

Two types of diversification:

into ‘related’ businesses and industries

Into ‘unrelated’ businesses and industries

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Reasons for diversification

General environment becomes unattractive

Industry’s competitive environment becomes unattractive

Strategic intent of the organisation covers more than one business

Surplus capabilities or capability gaps

Diversification achieves managerial goals

Aggressive managerial goals

Defensive managerial goals

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WHEN TO DIVERSIFY

♦ A firm should consider diversifying when:

● It can expand into businesses whose technologies

and products complement its present business.

● Its resources and capabilities can be used as

valuable competitive assets in other businesses.

● Costs can be reduced by cross-business sharing or

transfer of resources and capabilities.

● Transferring a strong brand name to the products of

other businesses helps drive up sales and profits of

those businesses.

6-12


BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION FOR DIVERSIFYING

The industry

attractiveness

test

The cost-of-entry

test

The better-off

test

Testing Whether a Diversification

Move Will Add Long-Term

Value for Shareholders

6-13



Advantages and disadvantages of diversification

Advantages

Efficient capital allocation

Trains general managers

Spreads risk

More strategic options

Good control systems

Disadvantages

Shareholders have no say in capital allocation process

May not align with shareholder risk profile

Easier to hide poorly performing businesses

Performance measures usually concentrate on financial returns

6-14


Testing Whether Diversification Will Add Value for Shareholders

♦ The Attractiveness Test:

● Are the industry’s returns on investment as

good or better than present business(es)?

♦ The Cost of Entry Test:

● Is the cost of overcoming entry barriers so

great that profitability is too long delayed?

♦ The Better-Off Test:

● How much synergy will be gained by

diversifying into the industry?

6-15



Development of corporate strategy

Synergy and the resource-based view (RBV)

Corporations have capabilities that can be

transferred from one business to another

These core capabilities were the basis of competitive

advantage

Similar businesses could develop synergies by

sharing core capabilities

This view leads to related diversification not

unrelated conglomerates

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Better Performance through Synergy

Evaluating the

Potential for

Synergy

through

Diversification

Firm A purchases Firm B in

another industry. A and B’s

profits are no greater than

what each firm could have

earned on its own.

Firm A purchases Firm C in

another industry. A and C’s

profits are greater than what

each firm could have earned

on its own.

No

Synergy

(1+1=2)

Synergy

(1+1=3)

6-17


STRATEGIES FOR ENTERING NEW BUSINESSES

Acquisition Internal new

venture (start-up) Joint venture

Diversifying into

New Businesses

These topics will be covered in Chapter 10 :

Mergers, Acquisitions and Alliances

6-18



Development of corporate strategy

Internationalisation

Continued internationalisation of business has

encouraged businesses to ‘stick to their knitting’

by accessing foreign markets instead of

unrelated domestic growth strategies

International expansion often financed by

divestment of unrelated businesses

Covered in next lecture on

International Strategy

6-19

Corporate strategy directions

Figure 7.2 Corporate strategy directions Source: Adapted from H.I. Ansoff, Corporate Strategy, Penguin, 1988, Chapter 6. Ansoff originally had a matrix with four separate boxes, but in practice strategic directions involve

more continuous axes. The Ansoff matrix itself was later developed – see Reference 1

6-20

Ansoff

Matrix


Market penetration

Market penetration refers to a strategy of increasing share of current markets with the current product range.

This strategy: strategic capabilities; builds on established

scope is unchanged; means the organisation’s

increased power; leads to greater market share and with buyers and suppliers;

economies of scale; and provides greater and experience curve benefits.


Constraints of market penetration

Retaliation

from

competitors

Legal

constraints

Economic

Constraints

(recession or

funding

crisis)

6-22 BUSM 3200- Strategic Management (Jan

2013) GDS

Consolidation & retrenchment

Consolidation refers to a strategy by which an organisation focuses defensively on their current markets with current products.

Retrenchment refers to a strategy of withdrawal from marginal activities in order to concentrate on the most valuable segments and products within their existing business.


Product development

Product development refers to a strategy by which an organisation delivers modified or new products to existing markets.

This strategy :

involves varying degrees of related diversification (in terms of products);

can be an expensive and high risk

may require new strategic capabilities

typically involves project management risks.


Market development (1)

Market development refers to a strategy by which an organisation offers existing products to new markets


Market development (2)

This strategy involves varying degrees of related diversification (in terms of markets) it; may also entail some product development (e.g. new styling or

packaging);

can take the form of attracting new users (e.g. extending the use of aluminium to the automobile industry);

can take the form of new geographies (e.g. extending the market covered to new areas – international markets being the most important);

must meet the critical success factors of the new market if it is to succeed;

may require new strategic capabilities especially in marketing.


Diversification

Diversification involves increasing the range of products or markets served by an organisation.

Related diversification involves diversifying into products or services with relationships to the existing business.

Conglomerate (unrelated) diversification involves diversifying into products or services with no relationships to the existing businesses.

6-27

See later discussion on this topic


Conglomerate diversification

Conglomerate (or unrelated) diversification takes the organisation beyond both its existing markets and its existing products and radically increases the organisation’s scope.


Drivers for diversification

Exploiting economies of scope – efficiency gains through applying the organisation’s existing resources or competences to new markets or services.

Stretching corporate management competences.

Exploiting superior internal processes.

Increasing market power.


Synergy

Synergy refers to the benefits gained where activities or assets complement each other so that their combined effect is greater than the sum of the parts.

N.B. Synergy is often referred to as the

‘2 + 2 = 5’ effect.


Value-destroying diversification drivers

Some drivers for diversification which may involve value destruction (negative synergies): Responding to market decline, Spreading risk and N.B. Despite these being common

justifications for diversifying, finance theory suggests these are misguided.

Managerial ambition.


So which is better?

Related Diversification

Unrelated Diversification

The following set of slides explain the differences in detail



CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES

♦ Related Businesses

● Have competitively valuable cross-business

value chain and resource matchups.

♦ Unrelated Businesses

● Have dissimilar value chains and resource

requirements, with no competitively important

cross-business relationships at the value

chain level.

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Related diversification

Businesses need to be ‘related’ in some way for synergy to occur. If no synergy, no value in having the combination within the corporation.

Related diversification strategies:

Capability-based diversification

Product-market diversification

Vertical integration

6-34


CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES

Related

Businesses

Unrelated

Businesses

Both Related

and Unrelated

Businesses

Which Diversification

Path to Pursue?

6-35



What is ‘relatedness’?

‘Relatedness’ concerns degree of similarity or fit between the businesses held within the corporation

What appears to be related to one observer, may seem to be quite unrelated to another

There is no hard and fast definition of relatedness

6-36


STRATEGIC FIT AND DIVERSIFICATION INTO RELATED BUSINESSES

♦ Strategic Fit Benefits

● Occur when the value chains of the different

businesses present opportunities for:

Transfer of resources among businesses.

Lowering of costs in combining related value

chain activities or resource sharing.

Use of a potent brand name across businesses.

Cross-business collaboration to build stronger

competitive capabilities.

6-37


Related Businesses Provide Opportunities to Benefit

from Competitively Valuable Strategic Fit

6-38


Identifying Cross-Business Strategic Fit along the Value Chain

R&D and

Technology

Activities

Supply Chain

Activities

Manufacturing-

Related Activities

Distribution-

Related Activities

Customer

Service Activities

Sales and

Marketing

Activities

Potential

Cross-Business Fits

6-39


Strategic Fit, Economies of Scope, and Competitive Advantage

Transferring

specialized and

generalized

skills and\or

knowledge

Combining

related value

chain activities

to achieve

lower costs

Leveraging

brand names

and other

differentiation

resources

Using cross-

business

collaboration

and knowledge

sharing

Using Economies of Scope to Convert

Strategic Fit into Competitive Advantage

6-40


Economies of Scope Differ from Economies of Scale

♦ Economies of Scope

● Are cost reductions that flow from cross-

business resource sharing in the activities

of the multiple businesses of a firm.

♦ Economies of Scale

● Accrue when unit costs are reduced due

to the increased output of larger-size

operations of a firm.

6-41


From Competitive Advantage to Added Profitability and Gains in Shareholder Value

Builds more

shareholder

value than

owning a stock

portfolio

Is only possible

via a strategy

of related

diversification

Yields value in

the application

of specialized

resources and

capabilities

Requires that

management

take internal

actions to

realize them

Capturing the Cross-Business Benefits

of Related Diversification

6-42


DIVERSIFICATION INTO UNRELATED BUSINESSES

Evaluating the

acquisition of a

new business or

the divestiture of

an existing

business

Can it meet corporate targets

for profitability and return on

investment?

Is it is in an industry with

attractive profit and growth

potentials?

Is it is big enough to contribute

significantly to the parent firm’s

bottom line?

6-43


Building Shareholder Value via Unrelated Diversification

Astute Corporate

Parenting by

Management

Cross-Business

Allocation of

Financial

Resources

Acquiring and

Restructuring

Undervalued

Companies

Using an Unrelated Diversification

Strategy to Pursue Value

6-44


Building Shareholder Value via Unrelated Diversification

Astute Corporate

Parenting by

Management

• Provide leadership, oversight, expertise, and guidance.

• Provide generalized or parenting resources that lower

operating costs and increase SBU efficiencies.

Cross-Business

Allocation of

Financial

Resources

• Serve as an internal capital market.

• Allocate surplus cash flows from businesses to fund

the capital requirements of other businesses.

Acquiring and

Restructuring

Undervalued

Companies

• Acquire weakly performing firms at bargain prices.

• Use turnaround capabilities to restructure them to

increase their performance and profitability.

6-45


The Path to Greater Shareholder Value through Unrelated Diversification

Actions taken by

upper management

to create value and

gain a parenting

advantage

Do a superior job of diversifying into

businesses that produce good

earnings and returns on investment.

Do an excellent job of negotiating

favorable acquisition prices.

Provide managerial oversight and

resource sharing, financial resource

allocation and portfolio management,

and restructure underperforming

businesses.

6-46


The Drawbacks of Unrelated Diversification

Pursuing an

Unrelated

Diversification

Strategy

Limited

Competitive

Advantage

Potential

Demanding

Managerial

Requirements

Monitoring and

maintaining

the parenting

advantage

Potential lack of

cross-business

strategic-fit

benefits

6-47


Inadequate Reasons for Pursuing Unrelated Diversification

Seeking

reduction of

business

investment risk

Pursuing rapid

or continuous

growth for its

own sake

Seeking

stabilization to

avoid cyclical

swings in

businesses

Pursuing

personal

managerial

motives

Poor Rationales for

Unrelated Diversification

6-48


A Company’s Four Main

Strategic Alternatives

After It Diversifies

6-49

Diversification and performance

Figure 7.3 Diversity and performance


Vertical integration

Vertical integration describes entering activities where the organisation is its own supplier or customer.

Backward integration refers to development into activities concerned with the inputs into the company’s current business.

Forward integration refers to development into activities concerned with the outputs of a company’s current business.



VERTICAL INTEGRATION STRATEGIES

♦ Vertically Integrated Firm

● Is one that participates in multiple segments

or stages of an industry’s overall value chain.

♦ Vertical Integration Strategy

● Can expand the firm’s range of activities

backward into its sources of supply and/or

forward toward end users of its products.


Types of Vertical Integration Strategies

Full

Integration

Partial

Integration

Tapered

Integration

Vertical Integration

Choices


Types of Vertical Integration Strategies

♦ Full Integration

● A firm participates in all stages

of the vertical activity chain.

♦ Partial Integration

● A firm builds positions only in selected

stages of the vertical chain.

♦ Tapered Integration

● Involves a mix of in-house and outsourced

activity in any stage of the vertical chain.


Backwards Integration Towards Suppliers

♦ Integrating Backwards By:

● Achieving the same scale economies as outside

suppliers—low-cost based competitive advantage.

● Matching or beating suppliers’ production efficiency

with no drop-off in quality—differentiation-based

competitive advantage.

♦ Reasons for Integrating Backwards:

● Reduction of supplier power

● Reduction in costs of major inputs

● Assurance of the supply and flow of critical inputs

● Protection of proprietary know-how

Diversification and integration options

Figure 7.4 Diversification and integration options: car manufacturer example



Integrating Forward to Enhance Competitiveness

♦ Reasons for Integrating Forward:

● To lower overall costs by increasing channel

activity efficiencies relative to competitors.

● To increase bargaining power through control

of channel activities.

● To gain better access to end users.

● To strengthen and reinforce brand awareness.

● To increase product differentiation.


Disadvantages of a Vertical Integration Strategy

♦ Increased business risk due to large capital investment.

♦ Acceptance of technological advances or more efficient

production methods.

♦ Loss of operating flexibility through dependence on

internally self-produced parts and components.

♦ Less flexibility in meeting buyer preferences if they

require non-internally produced parts and components.

♦ Internal production levels and capacity matching

problems may not allow for economies of scale.

♦ Requirements for new skills and business capabilities.


Weighing the Pros and Cons of Vertical Integration

♦ Can vertical integration enhance the performance of

strategy-critical activities in ways that lower cost, build

expertise, protect proprietary know-how, or increase

differentiation?

♦ What is the impact of vertical integration on investment

costs, flexibility and response times, and the

administrative costs of coordinating operations across

more vertical chain activities?

♦ How difficult it will be for the company to acquire the set

of skills and capabilities needed to operate in another

stage of the vertical chain.


Benefits of Increasing Horizontal Scope

♦ Increasing a firm’s horizontal scope strengthens

its business and increases its profitability by:

● Improving the efficiency of its operations

● Heightening its product differentiation

● Reducing market rivalry

● Increasing the firm’s bargaining power over

suppliers and buyers

● Enhancing its flexibility and dynamic capabilities

Outsourcing

Outsourcing is the process by which activities previously carried out internally are subcontracted to external suppliers.



OUTSOURCING STRATEGIES: NARROWING THE SCOPE OF OPERATIONS

♦ Outsourcing

● Involves farming out value chain activities to outside vendors.

♦ Outsource an Activity When It:

● Can be performed better or more cheaply by outside specialists.

● Is not crucial to achieving sustainable competitive advantage and

does not hollow out the firm’s core competencies.

● Improves organizational flexibility and speed time to market.

● Reduces risks due to new technology and/or buyer preferences.

● Assembles diverse kinds of expertise speedily and efficiently.

● Allows a firm to concentrate on its core business, leverage key

resources, and do even better what it does best.

To outsource or not?

The decision to integrate or subcontract rests on the balance between two distinct factors:

Relative strategic capabilities:

Does the subcontractor have the potential to do the work significantly better?

Risk of opportunism:

Is the subcontractor likely to take advantage of the relationship over time?



The Risks of Outsourcing Value Chain Activities

♦ Hollowing out the resources and capabilities that

the firm needs to be a master of its own destiny.

♦ Loss of control when monitoring, controlling, and

coordinating activities of outside parties by means

of contracts and arm’s-length transactions.

♦ Lack of incentives for outside parties to make

investments specific to the needs of the

outsourcing firm’s value chain.

Value-adding activities

Envisioning Coaching and

facilitating

Providing central

services and

resources

Intervening


2013) GDS

Value-destroying activities

Adding management costs

Adding bureaucratic complexity

Obscuring financial performance


2013) GDS

Corporate rationales (1)

Figure 7.5 Portfolio managers, synergy managers and parental developers Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994


Corporate rationales (2)

The portfolio manager operates as an active investor in a way that shareholders in the stock market are either too dispersed or too inexpert to be able to do.

The synergy manager is a corporate parent seeking to enhance value for business units by managing synergies across business units.

The parental developer seeks to employ its own central capabilities to add value to its businesses.


Portfolio matrices

Growth/Share (BCG) Matrix

Directional Policy (GE-McKinsey) Matrix

Parenting Matrix

6-69 69 BUSM 3200- Strategic

Management (Jan 2013)

GDS

The growth share (or BCG) matrix (1)

Figure 7.6 The growth share (or BCG) matrix



A star is a business unit which has a high market share in a growing market.

A question mark (or problem child) is a business unit in a growing market, but it does not have a high market share.

A cash cow is a business unit that has a high market share in a mature market.

A dog is a business unit that has a low market share in a static or declining market.



Problems with the BCG matrix:

definitional vagueness,

capital market assumptions,

motivation problems,

self-fulfilling prophecies and

possible links to other business units.


The directional policy (GE–McKinsey) matrix (1)

Figure 7.7 Directional policy (GE–McKinsey) matrix


The directional policy (GE–McKinsey) matrix (2)

Figure 7.8 Strategy guidelines based on the directional policy matrix


The parenting matrix (1)

Figure 7.9 The parenting matrix: the Ashridge Portfolio Display Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994


The parenting matrix (2)

1. Heartland business units - the parent understands these well and can add value. The core of future strategy.

2. Ballast business units - the parent understands these well but can do little for them. They could be just as successful as independent companies.

If not divested, they should be spared corporate bureaucracy.

3. Value-trap business units are dangerous. There are attractive opportunities to add value but the parent’s lack of feel will result in more harm than good The parent needs new capabilities to move value-trap businesses into the heartland. It is easier to divest to another corporate parent which could add value.

4. Alien business units are misfits. They offer little opportunity to add value and the parent does not understand them. Exit is the best strategy.


Summary (1)

Many corporations comprise several, sometimes many business units. Decisions and activities above the level of business units are the concern of what in this chapter is called the corporate parent.

Organisational scope is considered in terms of related and unrelated diversification.

Corporate parents may seek to add value by adopting different parenting roles: the portfolio manager, the synergy manager or the parental developer.


Summary (2)

There are several portfolio models to help corporate parents manage their businesses, of which the most common are: the BCG matrix, the directional policy matrix and the parenting matrix.

Divestment and outsourcing should be considered as well as diversification, particularly in the light of relative strategic capabilities and the transaction costs of opportunism.


PRACTICE ESSAY QUESTIONS

IMPORTANT NOTE: →

These questions are provided for your reference only – they are only INDICATIVE of the standard of questions you might expect in the final exam.

DO NOT use these questions to “spot”

The RMIT examiner will post advice on the exam on the Learning Hub closer to the exam; you are required to pay attention to that advise

The questions here show the range of topics that could be tested from this lecture; they are NOT exhaustive

To score a high grade it is important to LINK the theory to applications and examples. Where from?

You have been assigned specific cases to read from the text. Each case study will show you the kinds of strategic decisions the case company needs to make. You can draw from these examples.

You have selected a case company for your project; you may use examples from there.

You are supposed to read widely from the business press about local, regional and international companies strategies. You can use examples from there as well.


Sample essay question

Discuss the benefits and risks associated with related and unrelated diversification strategy.

Use specific examples from one of the cases studied in this course to illustrate how potential risks might be managed effectively for a firm to achieve sustainable competitive advantage.



Discuss the advantages and disadvantages associated with related and unrelated diversification strategy for international expansion. Illustrate your answer with examples from one case studied in this course.

Hint: Question is tricky: need to LINK two chapter content, one on diversification (Chapter 7) and one on international strategy (Chapter 8)


Sample essay questions

Explain using examples, how a company can implement a diversification strategy for long term advantage.

Consider an alternative approach that might have been more successful and discuss why such a company might not have adopted this approach.


Sample essay questions

Explain the three corporate rationales of diversification and discuss their logic, strategic requirements and organizational requirements. Can more than one rationale co-exist in a particular organization?



Synergy is often said to be important in the selection of a corporate level strategy. Is synergy necessary to ensure corporate success? Your answer must address the three corporate parenting roles associated with corporate strategy and give examples whenever necessary to illustrate the points.



There are broad three ways or rationales for corporate headquarters to add value. Explain these three corporate rationales and discuss their logic, strategic requirements and organisational requirements. Can more than one rationale co-exist in a particular corporation? Use Wesfarmers case as an example to support your argument.


sm lecture six : corporate strategy and diversification

Documents

high market

companys current

relative strategic

corporate

vertical integration

directional

competitive

resource sharing