Chapter 7Developing Corporate Strategy

2

OBJECTIVES

Define corporate strategy

Understand the roles of economies of scope and revenue-enhancement synergy in corporate strategy

Explain the different forms of diversification

Understand when it makes sense for a firm to own a particular business

Explain the corporate strategy implications of the stable and dynamic perspectives

Describe the relationship between corporate strategy and competitive advantage

3

DIVERSIFICATION

Diversification process Types of businesses

Heavy reliance on acquisition

Many seemingly un-related businesses

Primarily organic Many businesses clustered in a few related industries

Company

Product extensions/new product lines

Few related product lines

4

THREE CORPORATE STRATEGY DECISIONS THAT ARISE WHEN MAKING ENTRY/EXIT DECISIONS

In which business arenas should a com-pany compete?

Which vehicles should it use to enter/exita business?

What underlying economic logic makes it sensible to compete in multiple businesses?

Also, how do we create synergiesbetween our busi-nesses?

5

DIVERSIFICATION PROFILES

GE Product Scope

20%

14%

14%9%

8%

7%

6%

6%

5%

4%7%

Insurance

Commercial Finance

Power Systems

Consumer Finance

Aircraft Engines

Medical Systems

Industrial Products andSystems

Consumer Products

NBC

Plastics

Various other (<4%individually)

GE Geographic Scope

60%23%

10%

4% 3%

US

Europe

Pacif ic Basin

Americas

Other international

6

DIVERSIFICATION PROFILES (Continued)

3M Geographic Scope

40%

26%

25%

9%

US

Asia/Pacific

Europe & Middle East

Latin America, Africa &Canada

3M Product Scope

21%

19%

17%

14%

11%

9%

9% Health Care

Industrial

Display & Graphics

Consumer & Office

Safety & Protection

Electro &Communications

Transportation

7

DIVERSIFICATION PROFILES (Continued)

MITY Enterprises Geographic Scope

85%

15%

U.S.

International

MITY Enterprises Product Scope

86%

14%

Multipurpose roomfurniture

Healthcare seating

8

EVOLUTION OF DIVERSIFICATION

1. Vertical Integratione.g. General Motors began operating steel plants to ensure supply of raw materials

2. Expansion into related businessese.g. Dupont moved from gunpowder making onto dynamite, nitro-glycerine, guncotton, and smokeless power

3. Rapid consolidation at turn of the century led to antitrust lawse.g. Standard Oil

4. Wave of conglomerations in 1960s* Unrelated acquisitions expanded the size of companies* Widespread use of portfolio planning (e.g. BCG Matrix – see my research)

5. Corporate Raiders in 1980s broke up many conglomerates6. New wave of acquisitions in 1990s and 2000s

* Mainly related acquisitions

9

A BRIEF HISTORY AND GENEOLOGY OF A CONGLOMERATE :ITT

1920International Telephone

and Telegraph

1925: telecom

equipment mfr.

1940: Electronics businesses

1980: fluid control industry

1995: ITT Industries (auto, defense & electric systems, & fluid-control)

The Surviving ITT

1979: Begins selling 250

business units, including all

telecom businesses

1995: ITT Hartford (financial services)

Now Hartford Financial Services

1969: Buys Hartford Insurance

1960 Enters auto parts industry

1968: Buys Sheraton Hotels

1968: Buys Continental

Bakery (Hostess)

Sold in 1984 to Interstate

Bakery

1995: ITT Corporation (hospitality,

entertainment, IT services)

Now part of Starwood Hotel &

Resorts

10

MUST DETERMINE VALUE CREATION

Geographic diversification

Horizontaldiversification

Verticaldiversification

Does this createvalue?

• Economies of scope?

• Revenue- enhancement opportunities?

11

SOURCES OF VALUE FROM DIVERSIFICATION/EXPANSION

Economies of scope

Lower price of a common resource by combining purchases

Share manufacturing capacity to reduce average costs

Share distribution to reduce average distribution costs

Revenue-enhancement synergies

Bundle products to appeal to new customers

Cross sell to existing customers

Achieve higher valuation from larger, more predictable cash flows

12

DIVERSIFICATION DOES NOT NECESSARILY CREATE VALUE

Profit

Revenue

ValueCosts

Valuation of profit

Non-value generating

• No cross-sell opportunities

• Dis-economies of scope

• No perceived value logic

Value generating

• Revenue enhancement

• Economic of scope

• Investor-perceived “quality”

13

EXAMPLE OF POOR ECONOMIC LOGIC

• In 1990s, Diversified from long-distance telephone services into wireless cell phone service and cable TV

• In 2002, decided to split thecompany apart

14

DIVERSIFICATION IS DIFFICULT TO MANAGE

Diversification and Performance in S&P 500 and S&P MidCap Firms (1992-2000)

0%

1%

2%

3%

4%

5%

6%

7%

Low (25 %tile) Moderate (50th %tile) High (75th %tile)

Level of Diversification

RO

A

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

To

tal

Sh

areh

old

er R

etu

rns

ROA

TSR

15

OPPORTUNUTIES TO EXPLOIT POTENTIAL ECONOMIES OF SCOPE

Fit among parent-subsidiary resources

Fit of parent-subsidiary dominant logic

What is a dominant logic?

16

OTHER REASONS TO DIVERSIFY

Risk reduction

Empire building

Compensation

More efficient for investors to diversify themselves

Rarely results in higher share- holder value or margins

Acquisition motivated by executive pay - a bigger company usually impliesa bigger pay check -rarely creates value

17

FORMS AND SCOPE OF DIVERSIFICATION

Geographic

Horizontal• From one market

segment to another• From one industry

to another

Vertical

Wal-Martexpanded into

Europe

Coke andPepsi expanded

into water

Pulte HomesInc. created Pulte

Mortgage LLC)

18

THE U.S. AUTO INDUSTRY’S PROFIT POOL

25%

15

10

5

0

0100%

Share of Industry Revenue

op

era

ting m

arg

in

auto manufacturing

new car dealersused car dealers

auto loans

auto insurance

aftermarket partssource: Harvard Business Review, May-J une 1998

20

leasing

warranty

gasolineservice repair

auto rental

The automotive industry encompasses many value-chain activities. The way that profits and revenues are distributed among these activities varies greatly. The most profitable areas of the car business are not the ones that generate the biggest revenues.

PROFIT POOLS

Profit pool analysis helps identify opportunities

Profit pool analysis helps identify opportunities

19

WHO SHOULD OWN THE BUSINESS?

??

Two key questionsTwo key questions

Does the business unit add value to the corporation?

1

Does the corporation owning the business unit add more value than alternative ways of linking a business to the corporation? (would an alliance, a joint venture, internal business development or acquisition of a differ-ent business generate more value?)

2

20

COMPETITIVE ADVANTAGE

ArenasArenas

SpecializedSpecialized GeneralGeneralOrgani-zationalstructure

Organi-zationalstructure

SystemsSystems ProcessesProcesses

ResourcesResources ImplementationImplementation

21

MASCO CORPORATION

Independent – unattractiveIndependent – unattractive Combined – profitableCombined – profitable

Cabinets Cabinets

Plumbing Plumbing

Decorative architectural products

Decorative architectural products

Specialty productsSpecialty products

Home depot Home depot

Lowe’sLowe’s

Homedepot Homedepot

Lowe’sLowe’s

Sales Sales

Manu-facturing design

and Marketing

Manu-facturing design

and Marketing

22

CORPORATE OWNERSHIP IN A DYNAMIC CONTEXT

• Nimbleness

• Response time

• Economies of scope

• Revenue enhancement

• In dynamic markets, diversification can hinder competitiveness

• This is why Adaptec, Palm, and 3Com spun off businesses

23

Dynamic Collaboration is fluid with networks being created, changed, and disassembled between combinations of owned and alliance businesses

Dynamic Collaboration is fluid with networks being created, changed, and disassembled between combinations of owned and alliance businesses

Collaboration is solidified through static structural arrangement among wholly-owned businessesCollaboration is solidified through static structural arrangement among wholly-owned businesses

Key objectives are growth, maneuverability, and economies of scopeKey objectives are growth, maneuverability, and economies of scope

Key objectives are the pursuit of economies of scale and scopeKey objectives are the pursuit of economies of scale and scope

Top management team emphasizes collaboration among the businesses and the form of that collaboration

Top management team emphasizes collaboration among the businesses and the form of that collaboration

Top management team emphasizes the creation of a collaborative context that is rich in terms of content and linkages

Top management team emphasizes the creation of a collaborative context that is rich in terms of content and linkages

The business units’ roles are to execute their given strategyThe business units’ roles are to execute their given strategy

The business units’ roles are to execute their strategy and seek new collaborative opportunitiesThe business units’ roles are to execute their strategy and seek new collaborative opportunities

Business units’ incentives combine business with corporate-level rewards to promote cooperationBusiness units’ incentives combine business with corporate-level rewards to promote cooperation

Business units’ incentives emphasize business-level rewards to promote aggressive execution and collaborative-search objectives

Business units’ incentives emphasize business-level rewards to promote aggressive execution and collaborative-search objectives

Balanced-scorecard objectives emphasize performance against budget and in comparison to within-firm peer unit

Balanced-scorecard objectives emphasize performance against budget and in comparison to within-firm peer unit

Balanced-scorecard objectives gauge performance relative to competitors in terms of growth, market share, and profitability

Balanced-scorecard objectives gauge performance relative to competitors in terms of growth, market share, and profitability

CORPORATE STRATEGY IN STABLE AND DYNAMIC CONTEXTS

Dynamic ContextsDynamic ContextsStable ContextsStable Contexts

24

HOW WOULD YOU DO THAT?

Walt Disney wants to enter more mature film entertainment (e.g., Kill Bill)Walt Disney wants to enter more mature film entertainment (e.g., Kill Bill)

ProsPros ConsCons

Leverage productionLeverage production

Leverage distributionLeverage distribution

??

Damage core brandDamage core brand

Requires producersand directors withdifferent skills

Requires producersand directors withdifferent skills

??

What are Walt Disney’s strategic options?

What are Walt Disney’s strategic options?

25

SUMMARY

Define corporate strategy1

Understand the roles of economies of scope and revenue-enhancement synergy in corporate strategy

2

Explain the different forms of diversification3

Understand when it makes sense for a firm to own a particular business

4

Explain the corporate strategy implications of the stable and dynamic perspectives

6

Describe the relationship between corporate strategy and competitive advantage

5

26

EXERCISES

1. Identify the vertical, horizontal and geographical scope of MGM-Mirage of your choice. How similar are the resource requirements (how related is the firm)? Determine if there is a dominant logic connecting the businesses.

2. Design a future corporate strategy for MGM-Mirage.