Copyright Guy Harley 2004 Corporate Level Strategy Week 5

Copyright Guy Harley 2004

Corporate Level Strategy

Week 5


Outline

Levels of diversification Reasons for diversification Related diversification Unrelated diversification Diversification: Incentives and resources


What is corporate level strategy?

Strategies that detail actions to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets

What business the firm should be in and how the corporate office should manage its group of business


Corporate Strategy

Developing and implementing multi-business strategies may be necessary for effective use of excess resources, capabilities and core competencies that have value across several businesses.

To enhance strategic competitiveness, & earn above average returns.

How to create value for the corporation as a wholeHow to create value for the corporation as a wholeHow to create value for the corporation as a wholeHow to create value for the corporation as a whole

How to create competitive advantage in each business in How to create competitive advantage in each business in which the company competes, using:which the company competes, using:How to create competitive advantage in each business in How to create competitive advantage in each business in which the company competes, using:which the company competes, using:

Corporate-Level StrategyCorporate-Level Strategy (Companywide Strategy)(Companywide Strategy)

Business-Level StrategyBusiness-Level Strategy (Competitive Strategy)(Competitive Strategy)

– Low costLow cost– DifferentiationDifferentiation– Integrated low cost/Integrated low cost/

differentiationdifferentiation

– Low costLow cost– DifferentiationDifferentiation– Integrated low cost/Integrated low cost/

differentiationdifferentiation

– Focused low costFocused low cost– Focused differentiationFocused differentiation– Focused low costFocused low cost– Focused differentiationFocused differentiation

A Diversified Company has Two Strategy LevelsA Diversified Company has Two Strategy Levels


What businesses should the corporation be in?What businesses should the corporation be in?

How should the corporate office manage the How should the corporate office manage the array of business units?array of business units?

Corporate strategy is what makes the corporate whole Corporate strategy is what makes the corporate whole add up to more than the sum of it business-unit partsadd up to more than the sum of it business-unit parts

Corporate Strategy concerns Two Key Questions:Corporate Strategy concerns Two Key Questions:


Primary Approach

Primary approach to corporate level strategy: Diversification Firms diversify when they have excess

resources, capabilities and core competencies that have multiple uses


Levels of diversification

Firms vary according to Relatedness

Connections between and among business units

Levels of diversification Low Medium High


Low levels of diversification

SingleMore than 95% of revenue comes from dominant business

Dominant Between 70% & 95 % of sales in a single

category eg Cadbury-Schweppes. Tend to be vertically integrated.


Moderate Levels of Diversification

Related-constrained diversification Less than 70% of revenue from dominant

business and Businesses share product, technological and

distribution linkages Related-linked diversification

Less than 70% of revenue comes from dominant business

Only limited links between businesses


High Levels of Diversification

Unrelated diversification Less than 70% of revenue from dominant

business No common links between businesses


Single and Dominant Business Strategies

Advantages (70-95% from single business)

More understanding of competitive dynamics managers develop specialised skills narrower range of business strategies managing synergies

Disadvantages More affected by economic downturn


Diversified Position

Advantages increased economies of scope market power by blocking competitors through

multi-point competition or vertical integration financial economies tax advantages


Sharing: OperationalRelatedness

Corporate Relatedness

High

Low

Low

Related LinkedRelated Linked

Related Constrained

Related Constrained

Operational & Corporate Relatedness

Operational & Corporate Relatedness

UnrelatedUnrelated

Operational & Operational & Corporate Corporate

RelatednessRelatedness

Operational & Operational & Corporate Corporate

RelatednessRelatedness High

Vertical integration

Financial Economies

Economies of Scope

Diseconomies of scope


By developing economies of scope between By developing economies of scope between business units in the firms, which leads to business units in the firms, which leads to synergistic benefitssynergistic benefits

By developing market power, which leads to By developing market power, which leads to greater returnsgreater returns

Diversification most effectively adds value Diversification most effectively adds value by one of two mechanisms:by one of two mechanisms:

Adding Value by DiversificationAdding Value by Diversification


Alternative Diversification StrategiesAlternative Diversification Strategies

Related Diversification StrategiesRelated Diversification Strategies

Unrelated Diversification StrategiesUnrelated Diversification Strategies

Sharing ActivitiesSharing Activities11

Transferring Core CompetenciesTransferring Core Competencies22

Efficient Internal Capital Market AllocationEfficient Internal Capital Market Allocation33

RestructuringRestructuring44


1. - Sharing Activities Sharing activities often lowers costs or raises Sharing activities often lowers costs or raises

differentiationdifferentiation Sharing activities can lower costs if it:Sharing activities can lower costs if it:

Achieves economies of scaleAchieves economies of scale Boosts efficiency of utilisationBoosts efficiency of utilisation Means more rapid movement through learning curveMeans more rapid movement through learning curve

Sharing activities can enhance potential for or reduce the Sharing activities can enhance potential for or reduce the cost of differentiationcost of differentiation

Sharing activities must involve activities that are crucial Sharing activities must involve activities that are crucial to competitive advantageto competitive advantage


Sharing Activities - Assumptions

Strong sense of corporate identityStrong sense of corporate identity Clear corporate mission that emphasises the Clear corporate mission that emphasises the

importance of integrating business unitsimportance of integrating business units Incentive system that rewards more than just Incentive system that rewards more than just

business-unit performancebusiness-unit performance


2. - Transferring Core Competencies

Exploits interrelationships among divisionsExploits interrelationships among divisions Starts with value chain analysis:Starts with value chain analysis:

Identify ability to transfer skills or expertise Identify ability to transfer skills or expertise among similar value chainsamong similar value chains

Exploit ability to share activitiesExploit ability to share activities E.g. Two firms can share the same sales force, E.g. Two firms can share the same sales force,

logistics network or distribution channelslogistics network or distribution channels


2. - Transferring Core Competencies

AssumptionsAssumptions Transferring core competencies leads to competitive Transferring core competencies leads to competitive

advantage only if the similarities among business units advantage only if the similarities among business units meet the following conditions:meet the following conditions:

Activities involved in the businesses are similar enough Activities involved in the businesses are similar enough for expertise sharing to be meaningfulfor expertise sharing to be meaningful Transfer of skills involves activities that are important Transfer of skills involves activities that are important

to competitive advantageto competitive advantage The skills transferred represent significant sources of The skills transferred represent significant sources of

competitive advantage for the receiving unitcompetitive advantage for the receiving unit


3. - Efficient Internal Capital Market Allocation3. - Efficient Internal Capital Market Allocation

Firms pursuing this strategy frequently diversify by Firms pursuing this strategy frequently diversify by acquisition:acquisition: Acquire sound, attractive companiesAcquire sound, attractive companies Acquire units that are autonomousAcquire units that are autonomous Acquire corporation to supply needed capitalAcquire corporation to supply needed capital

Portfolio managers transfer resources from units that Portfolio managers transfer resources from units that generate cash to those with high growth potential and generate cash to those with high growth potential and substantial cash needssubstantial cash needs Add professional management and control to sub-Add professional management and control to sub-

unitsunits Sub-unit managers’ compensation is based on unit Sub-unit managers’ compensation is based on unit

resultsresults


3. - Efficient Internal Capital Market Allocation3. - Efficient Internal Capital Market Allocation

AssumptionsAssumptions Managers have more detailed knowledge of a Managers have more detailed knowledge of a

firm relative to outside investorsfirm relative to outside investors The firm need not risk competitive edge by The firm need not risk competitive edge by

disclosing sensitive competitive information to disclosing sensitive competitive information to investorinvestor

The firm can reduce risk by allocating resources The firm can reduce risk by allocating resources among diversified businesses, although among diversified businesses, although shareholders can generally diversify more shareholders can generally diversify more economically on their owneconomically on their own


4. - Restructuring

Seek out undeveloped, sick or threatened organisations Seek out undeveloped, sick or threatened organisations or industriesor industries

Parent company (acquirer) intervenes and frequently:Parent company (acquirer) intervenes and frequently: Changes sub-unit management teamChanges sub-unit management team Shifts strategyShifts strategy Infuses firm with new technologyInfuses firm with new technology Enhances discipline by changing control systemsEnhances discipline by changing control systems Divests part of firmDivests part of firm Makes additional acquisitions to achieve critical massMakes additional acquisitions to achieve critical mass

Unit will often be sold after one-time changes are made, Unit will often be sold after one-time changes are made, since parent no longer adds value to ongoing operationssince parent no longer adds value to ongoing operations


4. - Restructuring

AssumptionsAssumptions Requires keen management insight in selecting Requires keen management insight in selecting

firms with depressed values or unforeseen firms with depressed values or unforeseen potentialpotential

Must do more than restructure companies:Must do more than restructure companies: Need to initiate restructuring of industries to Need to initiate restructuring of industries to

create a more attractive environmentcreate a more attractive environment


ResourcesResources

DiversificationDiversificationStrategyStrategy

IncentivesIncentives

ManagerialManagerialMotivesMotives

Summary Model of the Relationship between Summary Model of the Relationship between Firm Performance and DiversificationFirm Performance and Diversification


Incentives Economies of scope

Sharing of activities Transferring core competencies

Market Power Blocking competitors Vertical integration

Financial economies Efficient internal capital allocation Business restructuring


Resources & Incentives

Incentives & Resources with neutral effects Anti-trust regulation Tax laws Low performance Uncertain future cash flows Risk reduction Tangible resources Intangible resources


Incentives to Diversify

Internal Incentives Poor performance may lead some firms to Poor performance may lead some firms to

diversify in an attempt to achieve better returnsdiversify in an attempt to achieve better returns To balance uncertain future cash flowsTo balance uncertain future cash flows In order to reduce riskIn order to reduce risk


Reasons for diversification

Managerial motives Diversifying managerial employment risks Increasing managerial compensation

Effective governance mechanisms may restrict Effective governance mechanisms may restrict such abusessuch abuses


Perf

orm

an

ce

Level of Diversification

Diversification and Firm PerformanceDiversification and Firm PerformanceDiversification and Firm PerformanceDiversification and Firm Performance

Unrelated Business

Related Constrained

Dominant Business


Summary Model of the Relationship Summary Model of the Relationship between Firm Performance and between Firm Performance and

DiversificationDiversification

ResourcesResources


FirmFirmPerformancePerformance




Summary Model of the Relationship between Summary Model of the Relationship between Firm Performance and DiversificationFirm Performance and Diversification

ResourcesResources


FirmFirmPerformancePerformance

InternalInternalGovernanceGovernance

StrategyStrategyImplementationImplementation

Capital Market Capital Market Intervention and Intervention and

Market for Market for Managerial TalentManagerial Talent




Issues to Consider Prior to DiversificationIssues to Consider Prior to Diversification

What resources, capabilities and core competencies do What resources, capabilities and core competencies do we possess that would allow us to outperform we possess that would allow us to outperform competitors?competitors?

What core competencies must we possess in order to What core competencies must we possess in order to succeed with a new product or geographical market?succeed with a new product or geographical market?

Is it possible to leapfrog competitors?Is it possible to leapfrog competitors? Will diversification break up capabilities and Will diversification break up capabilities and

competencies that should be kept together?competencies that should be kept together? Will we only be a player in the new product or Will we only be a player in the new product or

geographical market, or will we emerge as a winner?geographical market, or will we emerge as a winner? What can the firm learn through its diversification? What can the firm learn through its diversification? Is it organised properly to acquire such knowledge?Is it organised properly to acquire such knowledge?


Acquisition and restructuring strategies


Outline

Mergers, acquisitions and takeovers Reasons for acquisitions Effective acquisitions Restructuring

downsizing downscoping leveraged buyouts restructuring outcomes


Merger Merger

Two firms agree to integrate operations on a relatively equal basis because they have resources and capabilities that create stronger competitive advantage

AcquisitionA transaction where one firm buys another firm with the intent of more effectively using a core competency by making the acquired firm a subsidiary within its portfolio of businesses

TakeoverAn acquisition where the target firm did not solicit the bid.


Reasons for Acquisitions Increased market power

An acquisition intended to reduce the competitive balance of the industry

Overcome barriers to entryAcquisitions overcome costly barriers to entry that may make ‘start-ups’ economically unattractive

Costs\risks of new product developmentBuying established businesses reduces the risk involved in start-up ventures


Reasons for Acquisitions (cont.) Increased speed to market

Closely related to barriers to entry … allows market entry in a more timely fashion

DiversificationA quick way to move into businesses when a firm lacks experience and depth in an industry

Avoiding excessive competitionFirms may acquire businesses in which competitive pressures are less intense than in their core business


Poor Performance of Acquisitions

Integration difficultiesDiffering cultures can make integration of firms problematic

Inadequate evaluation of targetWinners curse’ bid causes acquirer to overpay for firm

Large or extraordinary debtCostly debt can create onerous burden on cash outflows


Poor Performance of Acquisitions (cont.) Inability to achieve synergy

Justifying acquisitions can increase estimate of expected benefits

Too much diversificationThe acquirer does not have the expertise required to manage unrelated businesses

Managers overly focussed on acquisitionsManagers lose track of the core business by expending too much effort on acquisitions

Combined firm becoming too largeLarge bureaucracy reduced innovation and flexibility


Effective Acquisitions

Assets are complementaryBuying firms with assets that meet current needs to build competitiveness

Careful selection ProcessDeliberate evaluation and negotiations are more likely to lead to easy integration and building synergies Targets are selected and ‘groomed’ prior to acquisition etc.

Acquisition is friendlyFriendly deals make integration go more smoothly


Effective Acquisitions (cont.) Maintain Financial Slack

Provide enough additional financial resources so that profitable projects are not foregone

Low to Moderate DebtMerged firm maintains financial flexibility

FlexibilityFirm has experience at managing change and is flexible and adaptable. Both firms are adaptable

InnovationContinue to invest in R&D as part of the firm’s overall strategy


Restructuring

Changes in the composition of the firms set of businesses and/or financial structure

Often in response to poor performance and over-diversification

Forms Downsizing- reduce costs by laying off employees or

eliminating operating units Downscoping- reduce the level of unrelatedness in

the firm –leads to greater focus Leveraged buyout


Leveraged BuyoutsLeveraged Buyouts Purchase involving mostly borrowed funds Generally occurs in mature industries where R&D and

innovation are not central to value creation High debt load commits cashflows to repay debt,

creating strong discipline for management Increases concentration of ownership Focuses attention of management on shareholder value Greater oversight by ‘active investor’ board members Leads to more value-based decision making


Outcomes of restructuring

Downsizing reduces labour costs, but also leads to loss of human capital and lower performance?

Downscoping reduces debt costs and reestablishes emphasis on strategic controls resulting in higher performance

Leveraged buyouts provide emphasis on strategic controls but increased debt costs, long term result is increased performance but greater risk

Downsizing

Downscoping

Leveraged

Buyout

Reduced Labour Costs

Reduced Debt Costs

High Debt Costs

Loss of Human Capital

Lower Performance

Higher Risk

AlternativesAlternatives Short-Term Short-Term OutcomesOutcomes

Long-Term Long-Term OutcomesOutcomes

Restructuring and OutcomesRestructuring and OutcomesRestructuring and OutcomesRestructuring and Outcomes

Emphasis on Strategic Controls

Higher Performance

Documents

Copyright Guy Harley 2004 Corporate Level Strategy Week 5