7+ +Strategy+Formulation+ +Corporate+Strategy

STRATEGIC MANAGEMENT & BUSINESS POLICY13TH EDITION

THOMAS L. WHEELEN J. DAVID HUNGER

Prentice Hall, Inc. ©2012 7-2

Corporate strategy - the choice of direction of the firm as a whole. Management of its business or product portfolio concerns:

•Directional strategy – orientation towards growth, stability or retrenchment •Portfolio analysis – coordination of cash flow among units •Parenting strategy – building of corporate synergies through resources sharing and development


Directional strategy (sometimes it is called grand strategy) - Companies must ask 3 questions before taking a directional strategy:

1.Should we expand, cutback or continue our operations unchanged?

2. Should we stay in existing industry or diversify into other industries?

3. If we grow, through internal development, external mergers & acquisitions or strategic alliances?


• Directional strategy - Once having chosen “growth”, managers then select specific strategies such as concentrate on one product one market or diversify into several products several markets.

• Portfolio analysis - industries or markets in which the firm competes through its products and business units

• Parenting strategy - management coordinates activities and transfers resources and cultivates capabilities among product lines and business units


Growth Strategies: Concentration and Diversification

• Companies in expanding industries must grow to survive. Internal growth means increasing in sales, taking advantage of experience curve to reduce per-unit cost thereby increasing profits.

Reduction in cost, if the industry is growing quickly, if competitors engage in price wars to increase market share. Firms not reaching “critical mass” face losses unless they find, fill a small niche where high prices can offset by special product or service features. Larger firms survive longer due to better financial resources, and external tie.

A firm can also grow through externally (M&A) or strategic alliances:

•Merger - a transaction involving two or more corporations in which stock is exchanged. Only one corporation survives. Mergers usually involve between firms of similar size and are usually “friendly”. Allied Corp and Signal formed AlliedSignal.

•Acquisition – the company acquired is completely absorbed by the acquiring corporation. P&G purchased Gillette, usually occurs between firms of different size and can be friendly, or hostile (called takeovers).



Why do companies growth? For 2 reasons:

1. Increased revenue resolves unused resources problems that quickly resolves internal conflicts and problems. Growth also provides cushion for turnaround in case a strategic error is made.

Also, larger companies have bigger bargaining power and are likely to receive support from stakeholders.

2. A growing company offers more opportunities for advancement, promotion, and interesting jobs.

Growth itself is exciting and ego-enhancing for CEOs.

Potential investors see growing company a “winner” or “on the move”. Executives’ compensation tends to get bigger as organizational size increases. Larger companies are also difficult to be acquired and executives’ jobs are secured.



Concentration Strategies

Companies can concentrate on the current product lines and diversify into other product lines or industries.

• Vertical growth - taking over the function previously provided by own suppliers or distributors to reduce costs, gain control over a scarce resource, guarantee quality, or obtain access to potential customers. This can be achieved internally by expanding its operations or externally through acquisitions. Ford’s built River Rouge plant, from iron ore entered the plant to finished automobiles rolling out into a huge parking lot.

• Vertical integration - the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing.

- Backward integration - (going backward on value-chain) assuming a function previously provided by a supplier (upstream)

- Forward integration - (going forward on value-chain) assuming a function previously provided by a distributor (downstream)


• Vertical growth is a strategy for a company in strong competitive position in a highly attractive industry, especially when technology is predictable, and markets are growing. The firm, builds on its distinctive competence by expanding along the industry’s value-chain to gain great competitive advantage.

• Although backward integration is often more profitable than forward integration, because of typical low margins in retailing, and expensive assets may be hard to sell create an exit barrier preventing company to leave the industry, i.e. breweries, when demand drops, no alternative use of the assets.



• Transaction cost economies - vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying on the open market become too great, i.e. $ to buy Zara, H&M?

• Full integration - a firm internally controls 100% of its key suppliers and completely controls its distributors. British Petroleum, owning entire chain from oil rigs, ships and pipelines, refineries, trucks, to franchised gas stations.


• Taper integration - a firm internally produces less than 50% of its own requirements and buy the rest from outside suppliers. Apple’s sales go through national chain store such as Best Buy and independent dealers.

• Quasi-integration - a company does not control key supplies but purchases most of its requirements from outside suppliers that are under its partial control. Bristol-Meyers Squibb purchased 17% of ImClone to gain access to new drug products developed through biotechnology.


• Long-term contracts – Agreements between 2 firms to provide goods and services to each other for a specific period of time. It is not “really” vertical integration unless the agreements are exclusive.

The recent trend is moving away from vertical growth strategies toward cooperative contractual relationships with suppliers, even with competitors. The relationships include outsourcing, strategic alliances which includes technology licensing, partnerships, JVs. Toshiba alliances with GE, Siemens, Motorola, Ericsson …


• Horizontal growth - expansion into other geographic locations and/or increasing the range of products and services offered to current markets. Firms that grow horizontally by broadening product lines have higher survival rate.

• Horizontal integration - the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value-chain. P&G introduces additional sizes, variations to its existing product lines, and to different regions, i.e. introduced Heads & Shoulders, Crest, Olay to the Chinese market.

• Horizontal growth is achieved through internal development, acquisitions, strategic alliances.

Delta Airlines acquired Northwest Airlines to obtain Northwest’s Asian markets and those US markets that Delta was not serving. Wal-Mart, Carrefour, Tesco expanded horizontally throughout the world.

This type of growth can be achieved internationally through different strategies:



International Entry Options for Horizontal Growth

• Exporting – minimize risk and gain experience to market the products. Company handles critical functions itself or through an exporting company. Popular among small businesses because of current technologies (i.e. internet) reduce the costs of going international.

• Licensing – grant rights to another firm in the host

country to sell and/or produce a product with a fee for technical expertise provided. Useful if the trademark or brand name is well known but lacks fund to go international directly. >>>

Anheuser-Busch used this strategy to produce and market Budweiser beer in the UK, Japan, Israel, Australia… This strategy is also important if the host country makes entry either difficult or impossible.

• Franchising – grant the right to another company to open a retail store using franchiser’s name and operating system for a royalty based on sales. Franchising gives an opportunity for a firm to establish a presence in countries where population or per capita is not justified for expansion.

Franchising accounts for 40% of retail sales in the US.


• Joint Venture – combine the resources and expertise needed to develop new products or technologies. A quick way to obtain local management, reduce risks of harassment by host country that restricts foreign ownership. A company can enter into a country with fewer assets at stake and thus lower risks.

India (did not) permit foreign retailers owning more than 51% of shops selling single-brand products or to sell to others on a wholesale basis, Wal-Mart’s formed an equal partnership with Bhartia to start wholesale operation in India.


• Acquisitions – A quick way to go int’l, by purchasing another co. operating in that area. Synergistic benefits if acquired company has strong complementary product lines and good distribution network. Belgium’s InBev acquired Anheuser-Busch for the profitable North American beer market. However, acquisitions could be difficult for lack of information about potential candidates and government restriction.

• Green-Field Development – build its own product lines and distribution system. Co. with high level of technology, multinational experience and diverse product lines prefer GFD. Honda, Nissan and Toyota built their own factories in the UK.


• Production Sharing – Peter Drucker said this means “combining the high labor skills and technology in developed countries with the low-cost labor available in developing countries.” “outsourcing” - many companies have moved its data centers, customer services to India, Singapore where English is spoken, wages lower, and telecommunications are in place.

• Turn-key Operations – contracts for the construction of operating facilities for a fee. The facilities are transferred back to the host country government or a firm upon completion. Customers are usually a government agencies, the operators are industrial equipment suppliers.


• BOT Concept – “Build-operate-transfer” the firm operates for a fixed period during which it earns back its investment before turning it over to the government at little or no cost to the host country.

• Management Contracts – a firm can use its management talents to assist a firm in a host country for a specific fee and period of time. The contracts allow the firm to continue to earn some income from its investment and keep the operation going until local government is trained.



Diversification Strategies

• Richard Rumelt proposes diversifications occur when an industry consolidates, becomes mature, and the surviving firms have reached the limit of growth using vertical and horizontal strategies. Unless companies can expand internationally into less mature markets, they have to diversify into different industries if they want to continue growing. The 2 basic diversification strategies are related (concentric) and unrelated (conglomerate) diversifications.

• Concentric (Related) Diversification - growth into a related industry when a firm has a strong competitive position but in industry relatively attractive (see pp 263). Company can put good use of its product knowledge, manufacturing capabilities, and marketing skills when it diversified.

The point is to find synergy where two businesses will generate more profits together than they could separately, if they have similar technology, customer usage, distribution, managerial skills or products.



• Conglomerate (Unrelated) Diversification - growth into an unrelated industry, where current industry is unattractive, and the firm lacks abilities or skills that it could easily transfer to related products or services in other industries. Managers who use this strategy are concerned with uneven seasonal financial cash flow, risk reduction or they can transfer own excellent management system into less-well-managed firms.

Berkshire Hathaway holds interests in furniture retailing, razor blades, paper, airlines, soft drinks, publishing and broadcasting


Controversies in Directional Strategies

• Is vertical growth better than horizontal growth?• Is concentration better than diversification?• Is concentric diversification better than conglomerate

diversification?

• Growth - into related areas of current product lines generally more successful than into unrelated areas. Success in order of: vertical 80%, horizontal 50%, concentric 35%, conglomerate 28% >>>

Therefore, companies should exploit their own assets and capabilities before exploring for new ones, but they should also diversify their portfolio of products.

•Diversification strategy - the relationship between relatedness and performance is inverted U-shape curve. If the new business is very similar to the acquiring firm, it adds little, improved performance marginally. If completely different, there is no synergy, if the new business provides new resources and capabilities in a different, but similar business, significant performance improvement is high.



•Internal and external growth – can add capabilities, expand geographically. But firms growing

through acquisitions do not perform financially as well as firms grow internal means. The reasons are that

acquiring firms paid too high premium to earn their cost of capital or tend to spend less on R&D. And 50%

of the customers of a merged firm are less satisfied with the combined company’s service.

Neither strategy is best, some combinations of strategies is better than using one or the other.

• What can improve acquisition performance?

Acquisition should be linked to strategic objectives and support corporate strategy. It should identify many candidates and conduct due diligence. Cisco uses 3 criteria to judge whether a company is a suitable candidate for takeover:

- relatively small before going to larger ones

- comparable in organizational culture

- physically close to one of the existing affiliates



Stability Strategies – no significant change in direction. Popular with small business owners who have a niche and are happy with their success and the manageable size of their firms.

•Pause/Proceed with caution strategy – Take a rest before continuing growth or retrenchment strategy. A firm may wait until the environment becomes hospitable or enables them to consolidate its resources after rapid growth.

Banks frozen lending in 2008 and awaiting a rescue package from the government.


• No change strategy – continue current operations and policies. Stability, created by the firm’s modest competitive position, lack of significant change, little growth potential, making only small adjustments for inflation in its sales and profit objectives.

• Profit Strategies - to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary. Blaming the problems on a hostile environment, management defers investments/cut expense to stabilize profits, it may even sell one of its products lines for cash-flow benefits. But this strategy helps temporary or boost value before going public (IPO).


Retrenchment strategies - When the firm has a weak competitive position in some or all of its product lines from poor performance – sales are down and profits becoming losses.

•Turnaround strategy - emphasizes the improvement of operational efficiency, 2 method are:

a. Contraction - effort to quickly “stop the bleeding” across-the-board cut in size and costs, especially cutting manpower costs

b. Consolidation - reducing unnecessary overhead and make functional activities cost-justified. This is a crucial time for the organization. If this period is not conducted in a positive manner or overdone it would be counter-productive, hurt performance, best people may leave the company.

If, however, all employees get involved in productivity improvements, firm can emerge as a better-organized and more competitive and once again expand the business later.



Captive Company Strategy - company gives up independence in exchange for security, desperately in search of an “angel” which guarantees the company’s existence and long-term contract. This way, company can reduce its activities, thus significantly reducing costs.

•Sell-out strategy - management get a good price for its shareholders and the employees keep their jobs. The hope is that the buyer has the resources and determination to turnaround the company, i.e. Northwest bought by Delta in 2008.


• Divestment - sale of a division with low growth potential. An example is Ford sold Jaguar , Land Rover to Tata Motors in 2008, hoping to use the cash from the sale to help Ford reach profitability.

• Bankruptcy - management giving up to the courts in return for settlement of the corporation’s obligations.

Deliphi filed Chapter 11 only for its US operations which employed 32,000 high-wage union workers, but not for its low–wage foreign factories.

• Liquidation - management terminates the firm. When the industry is unattractive, too weak to be sold as a going concern, it may choose to sell assets for cash, and distributed to the shareholders after obligations are paid.

The benefit of this to bankruptcy is the board and the management make decisions and not courts which may ignore shareholders interest completely.

A company needs a strong board who, to safeguard shareholders’ interest, tell the management when to quit.



Portfolio analysis – companies with so many product lines and business units, the question is how much resources managers spend on best products or on developing new costly products? Portfolio analysis is also used to evaluate the contribution of alliances to company or business units. Popular portfolio analysis techniques include:

•BCG Growth-Share Matrix•GE Business Screen


BCG Growth-Share Matrix (Boston Consulting Group)

• BCG is a portray of each of the product lines, business units plotted on the matrix according to the growth rate and its relative competitive position.

- Relative Competitive position - company’s market share divided by that of the largest competitor. A relative market share > 1 is the market leader

- Growth rate - the % by which a product’s sales has increased and that a growing market is attractive

- The line separating high or low competitive position is 1.5 times. > 1.5 is “star” “cash cow”, < 1 is “dog”

- Each product line or unit is represented by a “circle”. The area of the circle is the relative significance of each business unit or product line to the assets or sales of the corporation.


• Question marks - new products with the potential for success but require a lot of cash for development. If it gains enough market share to become market leader and thus a star, money has to be taken away from mature products and spent on the question mark?

This is a “fish or cut bait” decision. After years fruitlessly experimenting with an electric car, GM decided in 2006 to take a chance on developing the Chevrolet Volt.


• Stars - market leaders at the peak of their product cycle, generate enough cash to maintain their high market share and contribute to the company’s profits.

HP’s printer business is “crown jewel” or a “star”. It has 41% in printer market share in printers, and it controls the cartridge market, accounted for over 50% of HP’s operating profit.

When a star’s market growth rate slows, it becomes a cash cow.



• Cash cows - products that bring more cash than is needed to maintain market share. In this declining stage of cycle, products are “milked” for cash and be invested in “question marks”. Advertising and R&D expenses are reduced. Panasonic’s VCRs moved to this category as DVD replaced them, then quickly moved to become “dogs”

• Dogs - products with low market share and have no potential generate much cash. IBM sold its PC business to Lenovo.


BCG Matrix and its Limitations

• BCG is the concept of experience curve. It assumes the key to success is market share. Firms with high market share tend to have a cost leadership position based on economies of scale. Then they sell new products at a price low enough to gain market share, to make them a “star”, reaching very profitable stage.

• Using BCG, companies can project its future positions, assuming no change in strategy. The goal is always to be self-sufficient in cash, and harvest mature products to support new products in growing industries

• BCG is quantifiable and easy to use.

Limitations of BCG:

1. Use of highs/lows to form 4 categories is too simplistic

2. Link between market share and profitability is questionable. Low market share can be profitable.

3. Growth rate is only one aspect of industry attractiveness. Market share is only one aspect of overall competitive position

4. Product lines or business units are considered only in relation to the market leader. Small competitors with fast-growing market share are ignored.



GE Business Screen (Mckinsey & Co)

• Include 9 cells based on long-term industry attractiveness and business strength and competitive position

• Attractiveness include market growth rate, industry profitability, size, pricing practices, and other opportunities and threats. Business strength/competitive position include market share, technological position, profitability and size, and other strengths and weaknesses

• Individual product lines or business units are identified by a Letter and plotted as circles on the Business Screen

• The area of each circle represents market size

• The pie size within the circles represents the market shares of the product lines or business units


• GE Business Screen – 4 steps

1. Select criteria to rate the industry for each business unit or product line. Assess attractiveness ranging from 1 (very unattractive) to 5 (very attractive)

2. Select key factor needed for success for each business unit or product line. Assess strength/competitive position, ranging from 1 (very weak) to 5 (very strong)

3. Plot current position on a matrix

4. Plot future portfolio, assuming strategies unchanged. If there a gap between projected and desired portfolio. If so find the gap! (i.e. missing objectives, strategies, policies)


GE Business Screen Limitations

1. Complex and cumbersome

2. Numerical estimates of industry attractiveness and business strength/competitive position give the appearance of objective, but are actually subjective judgments that can vary from person to person

3. Cannot effectively depict the positions of new products and business units in developing industries



Advantages and Limitations of Portfolio Analysis

Advantages:

1. Encourages top management to evaluate each of the businesses individually and to set objectives and allocate resources for each

2. Stimulates the use of externally oriented data to supplement management’s judgment

3. Raises the issue of cash-flow availability to use in expansion and growth

4. Graphic facilitates communications


Limitations:

1. Defining product/market segments is difficult2. Suggest the use of standard strategies that can miss

opportunities or be impractical3. Provides an illusion of scientific rigor when in reality

positions are based on objective judgments4. Value-laden terms such as cash cow and dog can

lead to self-fulfilling prophecies5. Lack of clarity on what makes an industry attractive

or where a product is in its life cycle6. Naively following a portfolio model may be

inappropriate, and reduce profits. A old product can have a new life.


Managing a Strategic Alliance Portfolio

• Managing strategic alliances is primarily the job of business units, however, units’ decisions may escalate to the corporate level. Toman Corp. has 195 international JVs and 422 alliance partners. A study found 4 tasks that are necessary for successful alliance portfolio management:

1. Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing alliances. Every new alliance is checked against corporate policy, corporate value, corporate strategy

2. Monitoring the alliance portfolio. Each alliance is measured against achievement of objectives, financial measures, contributed resource in quantity and quality, and the overall relationship with the corporation.

3. Coordinating the portfolio to obtain synergies and avoid conflicts among alliances. Because the interdependencies among alliances within business unit are usually greater than at the corporate level, the need for coordination is greater at the business level.


4. Establishing an alliance management system to support other tasks of multi-alliance management.

Many companies set up centers of competence for alliance management, often a department within corporate development at the corporate level. In other companies, specialized positions are set up only at the business unit level.



Corporate parenting - views a corporation in terms of resources and capabilities that can be used to create business unit value as well as generate synergies across business units

•Generates corporate strategy by focusing on the core competencies of the parent corporation and the value created from the relationship between the parent and its businesses

•GE under CEO Jack Welsh, imposed tough standards of profitability and disseminating knowledge and best practices quickly in GE empire


Developing a Corporate Parenting Strategy

1. Examine each business unit in terms of its strategic factors, and establish centers of excellence throughout the organization

2. Examine each business unit in terms of areas in which performance can be improved. The corporate parent could transfer people from one unit to another to improve performance of business units

3. Analyze how well the parent corporation fits with the business unit, must be aware of its own strengths and weaknesses in resources, skills and capabilities


Horizontal Strategy and Multipoint Competition

• Horizontal strategy - cuts across business unit boundaries to build synergy across business units and to improve competitive position in one of more business units

• Multipoint competition - large multi-business corporations compete against other large multi-business firms in a number of markets, i.e. P&G, Scott Paper, Kimberly-Clark, and Johnson & Johnson compete one another in paper products.


1. How does horizontal growth differ from vertical growthas a corporate strategy? From concentric diversification?

2. What are the tradeoffs between an internal and an externalgrowth strategy? Which approach is best as an internationalentry strategy?

3. Is stability really a strategy or just a term for no strategy?4. Compare and contrast SWOT analysis with portfolio

analysis.5. How is corporate parenting different from portfolio analysis?

How is it alike? Is it a useful concept in a global industry?

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