Corporate Level Strategy

Growth of Product Marketsthrough Concentration

and Diversification

Corporate Level Strategy

Portfolio: Which businesses should we enter? Which should we exit? What binds our businesses together?

Resource allocation: How should money and other resources be allocated among business units?

Horizontal units: Which functions should be shared? What are the costs of coordination?

M-form Organization Structure

Reasons for Growth

Attract investors with competitive returns

Attract & retain talented managers and employees

Scale and scope economies

Better leverage with buyers, suppliers

Can there be too much growth?

At 20%, firm would double in < four years Problems

Overburden internal processes Second and third tier management teams can’t

keep up pace

Concentrated Growth

Expansion within single product marketProduct Development

Extend product line: add models and sizes Modify product: add features, ingredients Complementary products

Market Development New geographic markets New channels of distribution New uses

Horizontal Integration

Acquisition of firms at same stage of supply chain

Objectives Greater market share Economies of scale Increased power over suppliers and buyers Fast growth Remove competitors

Diversified Growth

Expansion into new product markets

Types of Diversification Related Diversification Vertical Integration By-product Diversification Unrelated (Conglomerate) Diversification

Related Diversification

Purpose: scope economies (synergies)Cost sharing (procurement, distribution)Enhanced revenues (cross-selling, bundling, one-stop

shopping)Resource sharing: common brand, reputation,

technological expertise, managerial talent, systems and processes, culture

Examples of Related Diversification

Honda into cars, motorcycles, lawn mowers and generators: competence in engines and power trains

Canon into copiers, laser printers, and cameras: competencies in optics, imaging and processor controls

Minebea from ball bearings to semiconductors: competence in miniaturized manufacturing

A Portfolio of Resources

Resource-based view of the firm Resources: root of competitive advantage Portfolio of capabilities, not businesses

Don’t enter markets without a resource advantageUse single resource in several business, e.g., Bic --

pens, lighters, razorsDevelop resource in one market; move into others

from position of strength

Vertical Integration

Entry into new business at earlier (backward) or later (forward) stages of the supply chain

Stages of the Supply Chain1. Raw material extraction2. Primary manufacturing3. Fabrication of commodity products4. Product production5. Marketing and distribution6. Retailing

Aluminum: An Example

Upstream: add value by creating commodities Mining Refining of mined ore Manufacture of primary aluminumDownstream: add value through designing, positioning,

marketing of products Fabrication of aluminum products Marketing and distribution of products Sale in retail stores

Upstream versus Downstream

Upstream1. Standardization2. Low cost3. Process Innovation4. Manufacturing5. Technology Intensive6. Supply Dominated7. Maximize End Users8. Sales Push

Downstream1. Differentiation2. High margins

3. Product Innovation4. R&D, Advertising5. People Intensive6. Marketing Dominated7. Target End Users8. Market Pull

Purposes of Vertical Integration

Achieve control over qualityImprove supply and distribution coordinationScarce resources: increase dependability of supply

or distributionRaise entry barriers against new competitorsProtection of proprietary knowledgeContracts can’t be written due to uncertainty or

low frequency of transactions

Drawbacks to Vertical Integration

No competition = less efficiency, higher costsSignificant in-house development = reduced product

varietyBureaucratic costs increaseFirm competes with buyers and suppliersResources spent on new core competencies

compromise existing competenciesCapacity imbalance (excess upstream capacity to

ensure supply under all demand conditions)

By-product Diversification

Selling secondary output of firm products in the open market

e.g., a lumber company sells sawdust, an airline sells training

Alcoa Aluminum 1969

Unrelated Diversification (Conglomerates)

Collection of autonomous divisions with no shared functions/resources

Some of the best known companies in history: Beatrice, GE, ITT, Siemens

At different times both admired and vilified

Do they add value to their component businesses?

Arguments in Favor of Conglomerates

Portfolio is efficient Better information on businesses than outside

investors Quicker transfer capital between divisions than

market mechanismsParent supports divisions through economic slumps Effective in mediating transactions when markets

don’t work well (e.g., internal capital market)

Arguments Against Conglomerates

Portfolio is inefficient Divisions assume cost of running HQ Can’t dispose of unwanted properties quickly Acquisitions are made at a premium

Parent companies support troubled divisions longer than investors keep troubled stocks

Debt, reputation of one division negatively affects entire company

Difficult to manage

Diversification Through Merger and Acquisition

Key Drivers

Seeking synergyScale and scope economiesGaining access to restricted marketsOvercoming barriers to entryGaining market power (market share)Acquiring technologies, products, quicklyAcquiring otherwise unavailable resourcesPooling resources, e.g., R&DIndustry overcapacity

Tests of Entry by Acquisition

1. Will returns exceed cost of capital?2. Will the firm have a competitive advantage?3. Is the cost reasonable?

Price of premiums Cost of overcoming entry barriers

4. Will the acquisition add value? One-time value (make changes, then sell Ongoing value (keep for long term)

Reasons for Failure of Acquisitions

Empire building versus true business needInsufficient due diligence (target and alternatives)Overpayment (hard to value acquisition targets)Assimilation difficulties

Underestimate difficulties of integration Unfamiliarity: foreign market, new business Culture clashes Failure to retain key managers and personnel

Diversification Through Alliances andJoint Ventures

Types of Strategic Alliances

Non-equity alliance: cooperation between firms managed through contracts (licensing, supply or distribution)

Equity alliance: equity investments by one firm in the other in addition to contracts; creates a partnership

Joint venture: type of equity alliance; cooperating firms form new, independent firm in which partners invest and share any profits

Motivations for Equity Alliances/Joint Ventures

Exploit economies of scaleManage risk by sharing costsLearn from competitors (risky)Entry into new markets, especially foreignManage uncertainty

Using Joint Venture for Acquisition

Buyer and seller form joint ventureBuyer has time to assess value of intangible

assets (e.g., brands, distribution networks) and learn the business

Time period defined but buyer has choicesPrice depends on length and final value of JVFor selling an underperforming but high-potential

business When disentanglement will be slow, complex

JV for Acquisition: Pros and Cons

AdvantagesHigh caliber people more likely to stayFewer defections of suppliers and distributorsSeller gets better priceBuyer assured of valueDisadvantagesSeller burden high in time and attentionComplicated structure adds to overheadEffort of getting goals and cultures in sync

Risks of Alliances

Misrepresentation of skills & abilitiesConflicts

Goals (beginning of alliance) Performance metrics (life of alliance) Strategic direction (end of alliance)

Vulnerability of valuable resources -- sharing without full control

Factors Determining Corporate Combination Strategy

SynergyResources

Market Conditions

Type of Synergy Strategy ExampleSequenced: one company completes tasks and passes the results to a partner to do its part

Equity alliance (one company invests in an equity stake in the other)

Bristol-Myers Squibb took a 20% equity stake in ImClone in return for marketing rights to ImClone’s cancer-fighting drug, Erbitux, and 40% of its annual profits.

Pooled: managing own resources and combining results for greater profits

Nonequity alliance

An airline and a hotel chain agree to let hotel guests earn frequent-flyer miles.

Integrated: both firms execute tasks through close knowledge sharing

Acquisition Exxon and Mobil had to boost efficiency throughout their value chains to stay competitive. Combined all assets and functions.

Resources Strategy ExampleMust combine hard resources, (e.g., manufacturing plants) to get desired synergies

Acquisition Home-improvement company Masco quickly scales up its acquired firms’ manufacturing capacity to generate scale economies.

You must combine soft resources (e.g., workforces) to get synergies

Equity alliance

A commercial bank buys an equity stake in a securities firm rather than acquiring it, believing the bank’s culture and compensation structure could drive away key people.

Collaboration will result in extensive redundant resources.

Acquisition When Hewlett-Packard and Compaq merged, they saved$2B eliminating redundancies across every function.

Market Conditions Strategy ExampleThe new entity will face high market uncertainty (e.g., you’re unsure whether consumers or regulators will embrace or support it)

Nonequity or

Equity alliance

Bristol-Myers Squibb lost $650 million when its equity alliance partner ImClone’s drug Erbitrux failed an FDA review. But it would have lost $3.5 billion if it had previously decided to acquire ImClone.

You’ll have rivals for potential partners

Acquisition Pfizer initially allied with Warner-Lambert to make Lipitor, a blockbuster. Pfizer wanted a closer relationship with Warner-Lambert, ultimately acquiring it after other companies expressed interest in it and submitted bids.

Factor Strategy1. Types of Synergies

PooledSequencedIntegrated

Nonequity alliancesEquity alliancesAcquisitions

2. Nature of Resources: Relative value of soft to hard resources

LowLow/MediumHigh

Nonequity alliancesAcquisitionsEquity alliances

3. Extent of Redundant Resources

LowMediumHigh

Nonequity alliancesEquity alliancesAcquisition

4. Degree of Market Uncertainty

LowLow/MediumHigh

Nonequity alliancesAcquisitionsEquity alliances

5. Level of Competition

LowMediumHigh

Nonequity alliancesEquity alliancesAcquisitions

Appendices

Value Building in Multibusiness Companies

Market-related opportunitiesOperating opportunitiesManagement opportunities

Value Building in Multibusiness Companies: Market-related Opportunities

Opportunities to Build Value Potential Competitive Advantage Impediments to Achieving

Enhanced Value

Shared sales force activities or shared sales office, or both

Shared after-sale service and repair work

• Lower selling costs• Better market coverage• Stronger technical advice to

buyers• Enhanced convenience for buyers• Improved access to buyers

• Buyers have different purchasing habits toward the products

• Different salespersons are more effective in representing product

• Some products get more attention

• Lower servicing costs• Better use of service personnel• Faster servicing of customer calls

• Different equipment or different labor skills, or both, needed to handle repairs

• Buyers may do some in-house repairs

Shared brand name

• Stronger brand image and company reputation

• Increased buyer confidence in brand

• Company reputation is hurt if quality of one product is lower

Value Building in Multibusiness Companies: Market-related Opportunities

Opportunities to Build Value Potential Competitive Advantage Impediments to Achieving

Enhanced Value

Shared advertising and promotional activities

Common distribution channels

• Lower costs• Greater clout in purchasing ads

• Appropriate forms of messages are different

• Appropriate timing of promotions is different

• Lower distribution costs• Enhanced bargaining power with

distributors/retailers for shelf space and positioning, stronger push, more dealer attention

• Dealers resist being dominated by a single supplier and turn to multiple sources and lines

• Heavy use of shared channel erodes willingness of other channels to carry firm’s products

Shared order processing

• Lower order processing costs• One-stop shopping for buyer

enhances service and, thus, differentiation

• Differences in ordering cycles disrupt order processing economies

Value Building in Multibusiness Companies: Operating Opportunities

Opportunities to Build Value Potential Competitive Advantage Impediments to Achieving

Enhanced Value

Joint procurement of purchased inputs

Shared manufacturing and assembly facilities

• Lower input costs• Improved input quality• Improved service from suppliers

• Input needs are different in terms of quality or other specifications

• Inputs are needed at different plant locations, and centralized purchasing is not responsive to separate needs of each plan

• Lower manufact/assembly costs• Better capacity utilization (peak

demand for one product correlates with valley demand for other)

• Bigger scale of operation improves access to better technology

• Higher changeover costs in shifting from one product to another

• High-cost special r equipment required to accommodate quality or design differences

Shared inbound or outbound shipping and materials handling

• Lower freight and handling costs• Better delivery reliability• More frequent deliveries, such that

inventory costs are reduced

• Input sources or plant locations, or both, are in different geographic areas

• Needs for frequency and reliability of inbound/outbound delivery differ among businesses

Value Building in Multibusiness Companies: Operating Opportunities

Opportunities to Build Value Potential Competitive Advantage Impediments to Achieving

Enhanced Value

Shared product and process technologies or technology development

Shared administrative support activities

• Lower product or process design costs because of shorter design times and transfer of knowledge from area to area

• More innovative ability, due to scale of effort and attraction of better R&D personnel

• Technologies are the same, but the applications in different business units are different enough to prevent much sharing of real value

• Lower administrative and operating overhead costs

• Support activities are not a large proportion of cost, and sharing has little cost impact (and virtually no differentiation impact)

Value Building in Multibusiness Companies: Management Opportunities

Opportunities to Build Value Potential Competitive Advantage Impediments to Achieving

Enhanced Value

Shared product and process technologies or technology development

• Efficient transfer of a distinctive competence - can create cost savings or enhance differentiation

• Better understanding of key success factors

• More effective development of strategy formulation and implementation

• Technologies are the same, but the applications in different business units are different enough to prevent much sharing of real value