STRATEGY

Dr. Humam AL-Jazaeri

Syrian Virtual UniversityMBAP Course Winter 2010

Session Six

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Part One

Strategy:

Conceptual & Analytical Framework

2

Corporate Level Strategy

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Samsung: Business Portfolio

Semicoductor

38% Telecom Networks

22%

Digital Media

27%

Home Appliances & Others

13%

Chart (1)Business Portfolio of Samsung, (%) of

Net Sales, (2000)

Semiconductor81%

Telecommunication

Networks11%

Digital Media

6%Home

Appliances & Others

2%

Chart (2)Business Portfolio in Samsung, (%) of

Operating Profits, (2000)

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Portfolio Management

During the 1970s and early 1980s, several leading consulting firmsdeveloped the concept of portfolio management to achieve a betterunderstanding of the competitive position of an overall portfolio ofbusinesses.

Objectives

Suggest strategic alternatives for each of the businesses;

Identify priorities for the allocation of resources; and

Assist a firm in achieving a balanced portfolio of businesses.

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The Boston Consulting Group (BCG) Portfolio Matrix

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STARS

Business units competing in high-growth industries with relatively high marketshares. These firms have long-term growth potential and should continue toreceive substantial investment funding.

QUESTION MARKS

Business units competing in high-growth industries but having relatively weakmarket shares. Resources should be invested in them to enhance theircompetitive positions.

CASH COWS

Business units with high market shares in low-growth industries. These unitshave limited long-run potential but represent a source of current cash flows tofund investments in ‘stars’ and ‘question marks’

DOGS

Business units with weak market shares in low-growth industries. Because theyhave weak positions and limited potential, most analysts recommend that theybe divested.

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ROYAL PHILIPS ELECTRONICS started making lightbulbs in Eindhoven in theNetherlands in 1891. In the first half of the 20th century it produced X-ray machines and radio equipment, and in the 1970s it moved into therecord business. By 2007, it employed 122,000 people in 60 countriesin its diversified businesses.

Until recently, however, Philips wasn’t like most big companies. It was a huge, unwieldyconglomerate that made everything from lightbulbs, consumer electronics, mobile phones,microprocessors, and electric shavers to less-well-known products such as defibrillators and MRImachines. In fact, at one time Philips was even in the music business. Not surprisingly, the companyeven confused analysts. ‘Can You Tell What It Is?’ asked Citigroup’s Simon Smith in a report onPhilips, describing the company as ‘one of the last great misunderstood conglomerates of Europe’.

In recent years, Philips has been undergoing an endless round of restructuring in an effort to makeit more competitive. Things came to a head in the 2001 recession when the company suffered hugelosses and had to shed 55,000 jobs – about one-fourth of its workforce. Thirty separate divisionswere reduced to only five – domestic appliances, lighting, medical, consumer electronics, andsemiconductors. A net loss of $4.2 billion in 2002 turned into a net profit of $3.6 billion by 2004.

Philips has continued its effective divestment strategy. It has been steadily exiting electronicsmarkets where it doesn’t hold a first- or second-place position – most notably divesting its mobilephones operations after being eclipsed by Nokia Group. The streamlined company’s goal is now torefocus on its fastest-growing and most profitable sectors, such as medical systems. Philips becomesa much more focused company. Its 2006 earnings hit $7 billion on revenues of $35 billion/

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The Role of Diversification

• Diversification strategies play a major role in the behavior of largefirms.

• Product diversification concerns:

The scope of the industries and markets in which the firmcompetes.

How managers buy, create and sell different businesses tomatch skills and strengths with opportunities presented to thefirm.

Business-Level Strategy VS. Corporal Level Strategy

• BUSINESS-LEVEL STRATEGY Competitive

Each business unit in a diversified firm chooses a business-levelstrategy as its means of competing in individual productmarkets.

• CORPORATE-LEVEL STRATEGY Companywide

Specifies actions taken by the firm to gain a competitiveadvantage by selecting and managing a group of differentbusinesses competing in several industries and product markets.

Corporate-Level Strategy

Core Questions

Why do some diversification efforts pay off and others producedisappointing results?

What businesses should a corporation compete in?

How should these businesses be managed to jointly create morevalue than if they were freestanding units?

Failed and Successful Diversification Initiatives

Failed Diversification Initiatives: Examples

o AOL paid $114 billion to acquire Time Warner in 2001. Over the next two years, AOL Time Warner lost $150 billion in market valuation.

o Sony acquired Columbia Pictures in 1989 for $4.8 billion although it had no competencies in movie production. Five years later, Sony was forced to take a $2.7 billion write-off on the acquisition.

Successful Diversification: Example

The Renault-Nissan alliance, under CEO Carlos Ghosn’s leadership, has led to a quadrupling of its collective market capitalization – from $20.4 billion to $84.9 billion – by the end of 2006

Diversification

Diversification initiatives – whether through mergers and acquisitions,strategic alliances and joint ventures, or internal development – must bejustified by the creation of value to shareholders.

BUT this is not always the case! Acquiring firms typically pay highpremiums when they acquire a target firm (the case of Kraft/Cadbury).

WHY THEN COMPANIES SHOULD EVEN BOTHER WITH DIVERSIFICATION INITIATIVES?

The answer is SYNERGY*

* Derived from the Greek word Synergos: ‘WORKING TOGETHER’

What does Synergy means in Business Terms?

I. A corporation may diversify into Related Businesses.

Primary potential benefits come from HORIZONTAL RELATIONSHIP.

Business units sharing intangible resources (e.g. core competencies such asmarketing) and tangible resources (e.g. production facilities and distributionchannels). Example: Procter & Gamble.

II. A corporation may diversify into Unrelated Businesses.

Primary potential benefits come from HIERARCHICAL RELATIONSHIPS.

Business units share few similarities in the product they make or theindustries in which they compete, whilst value creation is derived from thecorporate office. Example General Electric.

Levels of Diversification: Low Level

Dominant Business

Between 70% and 95% of revenue comes from a single business.

A

A

B

Single BusinessMore than 95% of revenue comes

from a single business.

Levels of Diversification: Moderate to High

• Related Constrained

Less than 70% of revenuecomes from a singlebusiness and all businessesshare product, technologicaland distribution linkages.

• Related Linked: Mixed Related &

Unrelated

Less than 70% of revenuecomes from the dominantbusiness, and there are onlylimited links betweenbusinesses.

C

A

BC

A

B

Levels of Diversification: Very High Levels

• Unrelated Diversification

Less than 70% of revenue comes from the dominant business, and there are no common links between businesses.

CB

A

Related Diversification

Economies of Scope

Cost savings that occur when a firm transfers capabilities and competencies developed in one of its businesses to another of its businesses.

Value is created from economies of scope through:

Operational relatedness in sharing activities.

Corporate relatedness in transferring skills or corporate core competencies among units.

Operational Relatedness in Sharing Activities

Created by sharing either a primary activity such as inventorydelivery systems, or a support activity such as purchasing.

Activity sharing requires sharing strategic control over businessunits.

Activity sharing may create risk because business-unit tiescreate links between outcomes.

Corporate Relatedness in Transferring Competencies

• Corporate Relatedness

Using complex sets of resources and capabilities to link differentbusinesses through managerial and technological knowledge,experience, and expertise.

• Creates value in two ways:

Eliminates resource duplication in the need to allocate resourcesfor a second unit to develop a competence that already exists inanother unit.

Provides intangible resources (resource intangibility) that aredifficult for competitors to understand and imitate.

• A transferred intangible resource gives the unit receiving itan immediate competitive advantage over its rivals.

Related Diversification: Market Power

• Market power exists when a firm can:

Sell its products above the existing competitive level and/or

Reduce the costs of its primary and support activities below thecompetitive level.

• Multipoint Competition

Two or more diversified firms simultaneously compete in thesame product areas or geographic markets.

• Vertical Integration

Backward integration—a firm produces its own inputs.

Forward integration—a firm operates its own distributionsystem for delivering its outputs.

1. Is the company satisfied with the quality and the price that its presentsuppliers and distributors are providing?

2. Are there activities in the industry value chain presently beingoutsourced or performed independently by others that are a viablesource of future profits?

3. Is there a high level of stability in the demand for the organization’sproducts?

4. How high is the proportion of additional production capacity actuallyabsorbed by existing products or by the prospects of new and similarproducts?

5. Does the company have the necessary competencies to execute thevertical integration strategy?

6. Will the vertical integration initiative have potential negative impacts onthe firm’s stakeholders?

Vertical Integration: Important Considerations

Unrelated Diversification

• Restructuring creates financial economies

A firm creates value by buying and selling other firms’ assets inthe external market.

• Resource allocation decisions may become complex, so successoften requires:

Focus on mature, low-technology businesses.

Focus on businesses not reliant on a client orientation.

YALE ENDOWMENT FUND: Asset AllocationsSeeking the least correlated assets in Financial Portfolio Management Funds

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External Incentives to Diversify

• Antitrust laws in 1960s and 1970sdiscouraged mergers that createdincreased market power (vertical orhorizontal integration.

• Mergers in the 1960s and 1970s thustended to be unrelated.

• Relaxation of antitrust enforcement resultsin more and larger horizontal mergers.

• Early 2000: antitrust concerns seem to beemerging and mergers now more closelyscrutinized.

Anti-trust Legislation

External Incentives to Diversify

• High tax rates on dividends cause a

corporate shift from dividends to

buying and building companies in high-

performance industries.

• 1986 Tax Reform Act (U.S.)

Reduced individual ordinary income tax

rate from 50 to 28 percent.

Treated capital gains as ordinary

income.

Thus created incentive for shareholders

to prefer dividends to acquisition

investments.

Anti-trust Legislation

Tax Laws

Internal Incentives to Diversify

• High performance eliminates the needfor greater diversification.

• Low performance acts as incentive fordiversification.

• Firms plagued by poor performanceoften take higher risks (diversificationis risky).

Low Performance

Internal Incentives to Diversify

• Diversification may be defensivestrategy if:

Product line matures.

Product line is threatened.

Firm is small and is in mature ormaturing industry.

Low Performance

Uncertain Future

Cash Flows

Internal Incentives to Diversify

• Synergy exists when the value created bybusinesses working together exceeds thevalue created by them workingindependently

• … but synergy creates jointinterdependence between business units.

• A firm may become risk averse andconstrain its level of activity sharing.

• A firm may reduce level of technologicalchange by operating in more certainenvironments.

Low Performance

Uncertain Future Cash

Flows

Synergy & Risk

Reduction

Keywords

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Portfolio Diversification

Synergy Merger

Acquisition Relatedness

Scope Motives

Incentives Integrated

Horizontal Vertical

Incentive Performance

Internal External

Core Reference:

Dess, Gregory G. et al. (2008). Strategic Management: Text and Cases.(4th Edition), McGraw-Hill Irwin, N.Y., U.S.

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End of Session Six

Take Care..!

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