1. Modern Competitive Strategy 3 rd Edition Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reservedMcGraw-Hill/Irwin

2. Chapter 11 Managing the Multi-business Firm 11-2

3. Shift from Functional to Product Structure Alfred Chandler’s Strategy and Structure describes the rationale and process of this shift Two parts to the rationale: Organizing functional activities under a product division manager lowers coordination costs within the product line Resource allocation across product lines is improved by establishing a general office at the corporate level 11-3

4. Tasks of Corporate Management Allocate resources across business units Manage the portfolio of businesses Organize and manage relationships among businesses Centralize activities across businesses Develop top-down initiatives Develop corporate infrastructure 11-4

5. Resource Allocation In efficient financial markets, diversified firms with unrelated businesses typically incur a diversification discount: The firm’s market value is lower than the aggregate value of its businesses calculated as if they were independent How can the firm mitigate (but not overcome) this effect? The development of corporate management expertise (e.g., Hanson Trust) The allocation of financial resources to financially constrained businesses in high growth markets 11-5

6. Explaining a Diversification Discount The multibusiness firm performs poorly and cannot improve by adding more businesses The firm buys good businesses and degrades their performance through poor integration and post integration management The firm is out-performed by focused firms in each of the industries it competes in All of these may be true, but only one is necessary 11-6

7. When is an Internal Capital Market Superior to External Capital Markets? The business units receiving capital should be capital constrained, i.e., have difficulty getting capital from external sources Given a capital constraint, the firm may benefit when: It has proprietary information about the business that improves investment decisions The business has trade secrets that the demands of external funding might expose The business has an irregular funding pattern that might be difficult to satisfy in external capital markets 11-7

8. Managing a Portfolio of Businesses A portfolio consists of businesses in more or less attractive industries and with varying degrees of competitive strength in their markets Resources provided by strong firms in mature industries are used to fund development of new ventures in growing industries. When startups become dominant and survive the competitive shakeout, they become the new sources of funding for new businesses. 11-8

9. Figure 10.1 Boston Consulting Group Growth-Share Matrix 11-9

10. BCG Matrix Assumptions Cash cows have lower costs than industry competitors, based on efficiencies based on having progressed down a learning curve Cash cows generate higher cash flows but have fewer investment opportunities than other businesses in the portfolio The excess funds of cash cows are allocated into investments in new businesses to promote their growth 11-10

11. BCG Matrix Assumptions (cont’d) The firm has the entrepreneurial capability to grow a startup to dominance in its market The firm has the general management talent to sustain the startup’s superior market position as its industry matures New cash cows are sufficiently large to support a new round of business development 11-11

12. Problems with the BCG model All of the assumptions must be valid for the model to be effective The model applies poorly to firms with value-driven businesses The model focuses on transfers of financial resources not operating resources or capabilities BUT: The problem of growing the multibusiness firm through managing its portfolio of businesses remains very important 11-12

13. Alternatives to the BCG Model Portfolio analysis tools typically have two dimensions: Industry factors Business unit factors The dimensions are composed of relevant industry and business unit characteristics 11-13

14. Industry Characteristics Growth rate in revenues and volume Rates of change in growth rates Average profitability Distribution of profitability Trends in profitability – average and distribution Key value and cost drivers across firms Industry structure/ strategic groups/intensity of competition Regulatory constraints and trends Entry barriers Buyer and supplier power Trend in viability of substitutes Trend in viability of complements 11-14

15. Unit Characteristics Key value drivers Key cost drivers Defendability of unit resources and capabilities Interdependence of the unit with other units in the firm 11-15

16. Figure 10.2a Segment Annual Revenues and Contributions to IBM Corporate Revenue 11-16

17. Figure 10.2b Segment Annual Gross Profits and Contributions to IBM Gross Profit 11-17

18. Figure 10.2c Segment Annual Gross Margins and Contribution to IBM Corporate Gross Margin 11-18

19. Organize and Manage Relationships Among Businesses Take the perspective of the internal unit on the receiving end of the transfer Focus on dimensions of control: Pricing Internal supplier investments Product design Quality Service Other value drivers 11-19

20. Transfer Pricing Mandated market price More appropriate when internal buyer competes on value Mandated full cost More appropriate when internal buyer competes on cost Dual pricing Combination of market price (for internal supplier) and full cost (for internal buyer) Typically unstable Exchange autonomy No policy of vertical integration Units negotiate terms 11-20

21. Centralized Activities Centralized activities are typically structured to support one type of business strategy: Value-based Cost-based As more activities are centralized, the firm moves towards becoming a single business This shift may be muted if the centralized activity is designed as a profit center, selling to external customers Conflicts arise when the centralized unit’s position in external markets is inconsistent with the requirements of the internal businesses 11-21

22. Centralizing Technology Development Reasons for centralizing technology development in a multibusiness firm: Scale economies in research and development Scope economies in research and development Shared process innovation 11-22

23. Top-down Initiatives Jack Welch’s nine initiatives at GE: Reduce bureaucratic behavior Define markets globally Develop managers as leaders Promote sharing across business units Set very aggressive goals Build service businesses Implement six sigma quality programs Identify and remove underperforming managers Force all businesses to implement e-commerce strategies 11-23

24. Figure 10.3 Source: Adapted from Steven Kerr, personal communication, March, 2000. The Common Business Template at GE in the 1990s 11-24

25. Corporate Infrastructure Dimensions of corporate infrastructure same as strategy execution: Control and coordination, e.g.: Business unit definition: strategic business units Global organization: worldwide product structure Compensation and incentives Promote sharing of innovation Reduce conflict in transfers Improve acceptance of centralized activities Culture Promote risk taking and openness to learning 11-25

26. Control and Coordination Organize by strategic business units Manager’s responsibility consists of Management of key resources and capabilities Control over strategic decisions Worldwide product structure Global functional and country units report to global product managers Benefits: Cost reduction through centralized functions – scale and scope Flexibility to focus on unique regional or country requirements, e.g., China 11-26

27. Compensation and Incentives Major objectives in choosing performance metric for divisional reporting: Enable effective decision making by unit manager Allow effective management performance appraisal Result in the improvement in corporate economic performance Secondary objectives include: Communicate in simple yet effective language Allows comparison of units against competitors Applicable to a wide range of investment types 11-27

28. Compensation and Incentives (cont’d) Return on investment (ROI) Advantage: Comprehensive since ratio captures factors affecting financial statements Easy to understand, calculate and apply to any profit making unit Cab be used to evaluate and compare the performance of competitors Disadvantage: Can induce managers to make decisions contrary to the benefit of shareholders 11-28

29. Compensation and Incentives (cont’d) Residual income Allows investment in a project only if its residual income is positive Net income generated – capital charge (WACC) = % of capital invested 11-29

30. Project Choice Figure 10.5 Source: Adapted from Sudhakar Balachandran, “How does residual income affect investment? The role of prior performance measures,” Management Science, forthcoming, 2006. 11-30

31. Comparison of ROI and Residual Income Figure 10.6 11-31

32. Culture Essential for the long-term competitive advantage of business units Willingness to take risk Willingness to learn openly 11-32