From Business Strategy to CorporateStrategy: The Scope of the Firm

From Business Strategy to CorporateStrategy: The Scope of the Firm

• Business Strategy is concerned with how a firmcomputes within a particular market

• Corporate Strategy is concerned with where afirm competes the scope of its activities

• The dimensions of scope are

– geographical scope– vertical scope

– product scope

Transactions Costs and the Scope of the Firm

Transactions Costs and the Scope of the Firm

Which is more efficient : several specialist firms linked by markets, or the combination of these specialist firms under common ownership.

VERTICAL PRODUCT GEOGRAPHICAL

AREAS

SINGLE V1 P1 P2 P3 A1 A2 A3

FIRM V2

V3

SEVERAL V1 P1 P2 P3 A1 A2 A3

SPECIALIZED V2

FIRMS V3

Common Issue--- What are TRANSACTION COSTS of markets compared with administrative costs of the firm?

Introduction (cont.)• Types of Diversification

– Vertical integration• Strategy of acquiring control over additional links in value

chain of producing and delivering products/services.

• Backward integration– Moving closer to sources of raw materials by acquiring resource

suppliers or manufacturing the components needed for production of final product.

• Forward Integration– Just the opposite: moving closer to end-user (acquire retail outlets

for distribution, etc.).

Backward Integration

Forward Integration

Engineeringand Design

Purchasing

Assembly andProduction

After-SaleService

Exhibit: Vertical

Integration

Determinants of Changesin Corporate Scope

Determinants of Changesin Corporate Scope

1800 - 1975: Expansion in size & scope of biggest industrial corporations. Administrative costs of firms fell due to• Advances in transportation, information and communication technologies• Advances in management - accounting systems, decision sciences, financial techniques, organizational innovations, scientific management

1975 - 1995: Contraction in size & scope of biggest industrial corporations. Increased market turbulence, more competition, accelerated technological change

Need for speed, flexibility, responsiveness

Large, complex corporations become relatively less efficient

The Costs and Benefits of Vertical Integration: BENEFITS

The Costs and Benefits of Vertical Integration: BENEFITS

• Technical economies from integrating processes e.g. iron and steel production

-- but doesn’t necessarily require common ownership

• Superior coordination

• Avoids transactions costs of market contracts from:

-- small numbers of firms

-- transaction-specific investments

-- opportunism and strategic misrepresentation

-- taxes and regulations on market transactions

Introduction (cont.)

• Advantages of vertical integration – Greater control over costs and supply of

components.– Avoids the transaction costs associated with

dealing with vendors or retailers.– Ability to protect proprietary technology.– Ability to maintain or cultivate a company’s

reputation for outstanding quality or service.

The Costs and Benefits of Vertical Integration: COSTS

The Costs and Benefits of Vertical Integration: COSTS

• Differences in optimal scale of operation between different stages prevents balanced VI

• Strategic differences between different vertical stages creates management difficulties

• Inhibits development of and exploitation of core competencies

• Limits flexibility -- in responding to demand cycles

-- in responding to changes in technology,

customer preferences, etc.(But VI may be conducive to system-wide flexibility)

• Compounding of risk

Introduction (cont.)

• Disadvantages of vertical integration– Higher fixed overhead costs.– Integrated firms must deal with transfer price dilemma

which can create serious morale and other internal problems.

– Demand uncertainty creates problems.• Low demand can lead to underutilization of plant capacity.• High demand can result in dependence on outside suppliers.

– Technological change can leave these firms stuck with old technology.

When is Vertical Integration More Attractive than Outsourcing?

How many firms are available The fewer the companies

to undertake the activities? the more attractive is VI

Is transaction-specific investment If yes, VI more attractive needed?

Does limited information permit VI can limit opportunism cheating?

Are taxes or regulation imposed VI can avoid them on transactions?

Do the two stages have similar Greater the similarity, the optimal scale of operation? more attractive is VI

Are the two stages strategically Greater the strategic similar? similarity ---the more

attractive is VI

How uncertain is market demand? Greater the unpredictability ----the more costly is VI

Does VI increase risk? If heavy investment required and risks between stages are inter-related----VI increases risk.

Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical

Integration

Designing Vertical Relationships: Long-Term Contracts and Quasi-Vertical

Integration

• Intermediate between spot transactions and vertical integration are several types of vertical relationships

---such relationships may combine benefits of both market transactions and internalization

• Key issues in designing vertical relationships

-- How is risk allocated between the parties?

-- Are the incentives appropriate?

Recent Trends in Vertical RelationshipsRecent Trends in Vertical Relationships

• From competitive contracting to supplier partnerships, e.g. in autos

• From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services).

• Diffusion of franchising• Technology partnerships (e.g. IBM- Apple; Canon- HP)• Inter-firm networks

General conclusion:- boundaries between firms and markets becoming increasingly blurred.

Different Types of Vertical Relationship

Different Types of Vertical Relationship

Spot sales/ purchases

Long-term contracts

Agency agreements

Franchises

Vertical integration

Joint ventures

Informal supplier/ customer

relationshipsSupplier/ customer

partnerships

Low Degree of Commitment High

Low

High

Fo

rmal

izat

ion

The Internationalization of Industries The Internationalization of Industries

The Process of InternationalizationThe Process of Internationalization

International Global Industries Industries --aerospace --automobiles --military hardware --oil --diamond mining --semiconductors --agriculture --consumer electronics

Domestic Multinational/ Industries Multidomestic --railroads Industries --laundries/dry cleaning --retail banking --hairdressing --hotels --milk --consulting

Inte

rnat

ion

al

Tra

de

Foreign Direct Investment

LO

W

LOW

HIG

H

HIGH

Implications of Internationalizationfor Industry Analysis

Implications of Internationalizationfor Industry Analysis

INDUSTRY STRUCTURE

• Lower entry barriers around national markets

• Increased industry rivalry --- lower seller concentration

--- greater diversity of competitors

• Increased buyer power: wider choice for dealers & consumers

COMPETITION

• Increased intensity of competition

PROFITABILITY

• Other things remaining equal, internationalization tends to reduce an industry’s margins & rate of return on capital

Analyzing Competitive Advantage within an International Context: The Basic FrameworkAnalyzing Competitive Advantage within an International Context: The Basic Framework

COMPETITIVE ADVANTAGE

THE INDUSTRY ENVIRONMENT

Key Success Factors

FIRM RESOURCES & CAPABILITIES

-- Financial resources

-- Physical resources

-- Technology

-- Reputation

-- Functional capabilities

-- General management capabilities

THE NATIONAL ENVIRONMENT-- National resources and capabilities (raw materials;

national culture; human resources; transportation, communication & legal infrastructure

-- Domestic market conditions

-- Government policies

-- Exchange rates

-- Related and supporting industries

National Influences on Competitiveness: The Theory of

Comparative Advantage

National Influences on Competitiveness: The Theory of

Comparative Advantage

A country is relatively efficient in the production of those products which make intensive use of resources which are relatively abundant within the country. E.g.

• Philippines relatively more efficient in the production of footwear, apparel, and assembled electronic products than in the production of chemicals and automobiles.

• U.S. is relatively more efficient in the production of

semiconductors and pharmaceuticals than shoes or shirts.

When exchange rates are well-behaved, comparative advantage emerges as competitive advantage.

Porter’s Competitive Advantage of Nations

Porter’s Competitive Advantage of Nations

Extends and modifies traditional theory of comparative advantage to take account of the following factors:

• Competitive advantage is about companies --- the importance of the national environment is providing a home base for the company.

• Sustained competitive advantage depends upon dynamic factors-- innovation and the upgrading of firm’s resources and capabilities

• The critical role of the national environment is its influence upon the dynamics of innovation and upgrading.

Porter’s National Diamond FrameworkPorter’s National Diamond Framework

1. FACTOR CONDITIONS. “Home grown” resources and capabilities more important than natural endowments.

2. RELATED AND SUPPORTING INDUSTRIES. Competitive advantage occurs in “industry clusters” (e.g. semiconductors-computers-software in the U.S.).

3. DEMAND CONDITIONS. Discerning domestic customers drive quality and innovation (e.g. Japanese camera industry)

4. STRATEGY, STRUCTURE, RIVALRY. E.g. domestic rivalry drives innovation and upgrading.

FACTOR CONDITIONS

DEMAND CONDITIONS

RELATING ANDSUPPORTINGINDUSTRIES

STRATEGY, STRUCTURE,AND RIVALRY

Consistency Between Strategy and National Conditions

Consistency Between Strategy and National Conditions

In globally-competitive industries, firm strategy needs to take account of national conditions:

– U.S. textile manufacturers must compete on the basis of advanced process technologies and focus on high quality, less price-sensitive market segments

– Malaysian semiconductor manufacturers can be competitive in high volume, less technologically advanced items (e.g. memory chips)

– Dispersion of value chain to exploit different national environments (e.g. Nike: R&D in U.S., components in Korea and Taiwan, assembly in China, Thailand and India, marketing in Europe and North America)

International Location of ProductionInternational Location of Production

3 considerations:

– National resource conditions: What are the major resources which the product requires? Where are these available at low cost?

– Firm-specific advantages: to what extent is the company’s competitive advantage based upon firm-specific resources and capabilities, and are these transferable?

– Tradability issues: Can the product be transported at economic cost? If not, or if trade restrictions exist, then production must be close to the market.

International Location of Industrial Activities within the Value Chain

International Location of Industrial Activities within the Value Chain

The optimal locationof activity X considered

independently

WHERE TO LOCATE

ACTIVITY X?

The importance of linksbetween activity X and

other activities of the firm

Where is the optimal locationof X in terms of the cost and

availability of inputs?

What government incentives/ penalties affect the location decision?

What internalresources and capabilities does the firm

possess in particular locations?

What is the firm’s business strategy (e.g. cost vs. differentiation

advantage)?

How great are the benefits of linkages through proximity?

Overseas Market Entry: Alternative Modes

Overseas Market Entry: Alternative Modes

TRANSACTIONS DIRECT INVESTMENT

Exporting: Exporting: Exporting: Licensing Franchising Joint Wholly owned

Spot Long-term with foreign technology venture subsidiary

trans- contract distributor/ and Marketing & Fully Marketing Fully

actions agent trademarks distribution integral- & sales integral-

only ted only ted

Key issues:• Is the firm’s competitive advantages based upon firm-specific or

country-specific resources and capabilities?• Is the product tradable and what are the barriers to/ costs of

trade?• Does the firm possess the full range of resources and capabilities

needed to serve the overseas market?

Introduction (cont.)• Global diversification

– Usually motivated by desire to grow (Boeing, Kellogg’s, Caterpillar).

– Simplest route is exporting.– Others include licensing or franchising.– Most complex route is to establish wholly-owned

subsidiaries.

Introduction (cont.)

– Challenges in global diversification:• Most difficult challenge is to appreciate the unique

cultures and customs of foreign markets.– Need for products to be adapted to accommodate these

markets.

Alliances and Joint Ventures: Management Issues

Alliances and Joint Ventures: Management Issues

• Benefits: ability to combine different resources and capabilities of separate partners, ability to learn from one another.

• Problems: management differences between the two partners. Conflict potential greatest where the partners are also competitors.

• Collaborating with competitors: benefits seldom shared equally. Determinants of distribution of benefits:

– Strategic intent of the partners- which partner has the clearer vision of the purpose of the alliance?

– Appropriability of the contribution-- which partner’s resources and capabilities can more easily be captured by the other?

– Absorptive capacity of the company-- which partner is the more receptive learner?

Multinational Strategies: Globalization versus National differentiation

Multinational Strategies: Globalization versus National differentiation

The case for a global strategy:• National preferences in decline-- possible to view the

world becoming a single, if segmented, market.• Access to global scale economies--cost savings in purchasing,

manufacturing, product development and marketing.• Strategic strength from global positioning-- but

locating in multiple national markets, by locating in multiple national markets, the global competitor can cross-subsidize to attack nationally focused rivals.

Need to access market trends and technological

developments in each of the world’s major economic

centers- N. America, Europe, EastAsia.

Hamel &PrahaladThesis

Kenichi Ohmae’s“Triad Power”

Thesis

Ted Levitt

“Global--izationThesis”}

Strategy and Organization of the MNC:The Evolution of Multinational Strategies

and Structures : (1) Pre 2nd WW: Era of the Europeans

Strategy and Organization of the MNC:The Evolution of Multinational Strategies

and Structures : (1) Pre 2nd WW: Era of the Europeans

The European MNC as Decentralized Federation :• National subsidiaries self-sufficient and autonomous• Parent control through appointment of subsidiaries senior

management• Organization and management systems reflect conditions of

transport and communications at the time e.g. Unilever, Phillips, Courtaulds, Royal Dutch/Shell.

Strategy and Organization of the MNC: The Evolution of Multinational

Strategies and Structures: (2) Post 2nd WW: U.S. Dominance

Strategy and Organization of the MNC: The Evolution of Multinational

Strategies and Structures: (2) Post 2nd WW: U.S. Dominance

American MNC’s as Coordinated Federations :• National subsidiaries fairly autonomous

• Dominant role as U.S. parent-- especially in developing new technology and products

• Parent-subsidiary relations involved flows of technology and finance, and appointment of top management.e.g.

Ford, GM, Coca Cola, IBM

Strategy and Organization of the MNC: The Evolution of Multinational Strategies

and Structures: (3) 1970’s and 1980’s: The Japanese Challenge

Strategy and Organization of the MNC: The Evolution of Multinational Strategies

and Structures: (3) 1970’s and 1980’s: The Japanese Challenge

The Japanese MNC as Centralized Hub• Pursuit of global strategy from home base

• Strategy, technology development, and manufacture concentrated at home

• National subsidiaries primarily sales and distribution companies with limited autonomy. e.g. Toyota, NEC, Matsushita

Matching Global Strategies and Structures to Industry ConditionsMatching Global Strategies and

Structures to Industry Conditions

Degree of globalization depends upon the benefits of global

integration versus the benefits of national differentiation.

Key issue: --How important are global scale economies?

--How different are customer requirements between countries?

Benefits of national differentiation

Benefitsof

global integration

• Jet engines

• Consumer electronics

• Cement

• Telecommunicationsequipment

• Packaged grocery products

Marketing Global Strategies and Situations to Industry Conditions: Firm

Success in Different Industries

Marketing Global Strategies and Situations to Industry Conditions: Firm

Success in Different Industries

Consumer Electronics Branded, Packaged Telecommunications

Consumer Goods Equipment

- Global industry - Substantial national - Requires both global

- Matsushita the most differentiation, few global integration and national

successful scale economies differentiation.

- Philips the survivor - Kao has limited success - NEC only partially

- GE sold out outside Japan successful - Unilever and P&G most - ITT sold out

successful - Ericsson most successful

local responsiveness local responsiveness local responsiveness

glo

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teg

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Matsushita

Philips

General Electric

Kao

P&G

Unilever

NEC

Erickson

ITT

Reconciling Global Integration with National Differentiation: The Transnational

Corporation

Reconciling Global Integration with National Differentiation: The Transnational

Corporation

The Transnational: an integrated network of distributed interdependent resources and capabilities.

– Each national unit and source of ideas, skills and capabilities that can be harnessed to benefit whole corporation.

– National units become world sources for particular products, components, and activities.

– Corporate center involved in orchestrating collaboration through creating the right organizational context.

Tight complex controls and coordination and a

shared strategic decision process.

Heavy flows of technology, finances, people, and materials

between interdependent units.