1. 1 Corporate Strategy Lecture 1 Introduction to Corporate Strategy with a Historical Perspective Dr. Olivier Furrer e-mail: o.furrer@fm.ru.nl

2. 2 “Corporate strategy is the way a company creates value through the configuration and coordination of its multimarket activities.” Corporate Level Strategy Collis and Montgomery, 1997, p. 5

3. 3 Corporate Strategy: A Historical Perspective Origins of the Modern Corporation The Multidivisional Corporation Patterns of Diversification on the 1960s and 1970s The Conglomerates Downsizing, Outsourcing, and Refocusing Diversification in Emerging Countries

4. 4 Origin of the Modern Corporation (Chandler, 1977) The company is a recent phenomenon. Even where economies of scale encouraged larger production units, the limited size of local markets constrained the growth of individual firms. With the increasing size of firms, management developed as a specialized and professional activity. The modern corporations utilized administrative hierarchies and standardized systems of decision-making, financial control, and information management. These structures enabled companies to expand the size and scope of their activities. Consolidation through merger and acquisition resulted in the appearance of the first “holding companies” during the late nineteenth century. Beyond the appointment of the subsidiary boards of directors, the parent exercised little strategic or operational influence over the subsidiary companies.

5. 5 The Multidivisional Corporation The multidivisional corporation was a response to the problems posed by increasing size and diversification both for traditional industrial enterprises and the new holding companies. The innovators: DuPont de Nemours and General Motors in the 1920s created separate product divisions, each independently responsible for operations, sales, and financial performance, leaving to the corporate head office the tasks of coordination, strategic leadership, and control (see Chandler, 1962). During the next 30 years, the multidivisional structure became increasingly prevalent in the US and Europe.

6. 6 Patterns of Diversification in the 1960s and 1970s Not only were companies becoming more diversified, but their diversification strategies progressed from closely related to more loosely related businesses, and then towards unrelated businesses (see Wrigley, 1970; Rumelt, 1974). Tools of strategic analysis developed in the 1970s and 1980s permitted standardized yet sophisticated approaches to diversification and resource allocation decisions. These tools included business portfolio analysis (Haspeslaugh, 1983), industry analysis (Porter, 1980), and PIMS models (Buzzel and Gale, 1987). However, the rise of “professional management” had other implications. The separation of ownership from control encouraged salaried top managers to pursue diversification as a means of growth, often at the expense of profitability (Marris, 1964, cf. Agency theory: Jensen and Meckling, 1976, 1986).

7. 7 The Conglomerates By the early 1970s, the emergence of a new type of company with no “core business” and no obvious linkages between their many businesses represented the pinnacle of the diversification trend. The new conglomerates were of particular interest to finance scholars armed with the tools of modern portfolio theory (Sharpe, 1964, Lintner, 1965). If individual investors could spread risk through diversifying their portfolios of securities, what advantages could the conglomerate firm offer? Studies of conglomerates have shown that their risk-adjusted returns to shareholders are typically no better than those offered by mutual funds or by matched portfolios of specialized companies (Levy and Sarnat, 1970; Weston et al., 1972; etc.).

8. 8 Downsizing, Outsourcing, and Refocusing The dominant trends of the last two decades of the twentieth century were “downsizing” and “refocusing,” as large industrial companies reduced both their product scope through focusing on their core businesses and their vertical scope through outsourcing. However, International expansion has continued. These changes coincided with a more turbulent environment: the oil shock of 1973 – 4, the floating of exchange rates in 1972, the invention of the integrated circuit, and the upsurge of international competition. The implication seems to be that during periods of market turbulence, the effectiveness of firms’ internal administrative mechanisms is reduced (Cibin and Grant, 1996). In these circumstances, smaller, more focused firms operating close to their markets can be more efficient and effective.

9. 9 Diversification in Emerging Countries This refocusing trend is less evident in Asia, Eastern Europe, and other emerging market economies than it is in the advanced market economies of North America and Western Europe. A handful of chaebols continue to dominate the South Korean business sector, while in Southeast Asia sprawling conglomerates have even increased in prominence. These geographical differences may be partly explained by lack of efficient, well-developed capital markets outside the US and Western Europe, thus offering internalization advantages to diversified companies (Khanna and Palepu, 1997). Despite the common trends towards diversification and divisionalization across countries identified in the early 1970s, substantial international differences remain in corporate strategies of large companies.

10. 10

11. 11 Firms Vary by Degree of Diversification Single-business > 95% of revenues from a single business unit Low Levels of Diversification Dominant-business Between 70% and 95% of revenues from a single business unit Related-Diversified <70% of revenues from a single business unit Moderate to High Levels of Diversification Businesses share product, techno-logical or distribution linkages Unrelated-Diversified Business units not closely related High Levels of Diversification Ref.: Rumelt, 1974

12. 12 Firms Vary by Degree of Diversification Source: Rumelt, 1974 Unrelated Business Related Business Dominant- Unrelated Dominant Business Single Business 1.0 0.95 0.7 0.0 1.0 0.7 0.0 Specialization Ratio Related Ratio Specialization Ratio: Proportion of a firm’s revenues derived from its largest single business. Related Ratio: Proportion of a firm’s revenues derived from its largest single group of related businesses.

13. 13 Types of Diversification Strategies Source: adapted from Rumelt, 1974 Low Levels of Diversification Moderate to High Levels of Diversification Very High Levels of Diversification A A B A B C A B C A B C Single Business Dominant Business Related constrained Related linked Unrelated

14. 14 Pattern of Diversification Core business Closely related businesses Increasingly unrelated businesses Source: Collis and Montgomery, 2005

15. 15 ANIMATED FEATURE FILMS THEME PARKS Family Motion Pictures Cable Television Network Television Programming Books and Educational Materials Consumer Products Records and Music Television Stations Direct Marketing Retail Stores Real Estate Development Resort Hotels Adult Motion Pictures

16. 16 Reasons for Diversification Motives to Enhance Strategic Competitiveness Economies of Scope Market Power Financial Economies Resources Managerial Motives Incentives Incentives and Resources with Neutral Effects of Strategic Competitiveness Anti-Trust Regulation Tax Laws Low Performance Uncertain Future Cash Flows Firm Risk Reduction Tangible Resources Intangible Resources Managerial Motives Causing Value Reduction Diversifying Managerial Employment Risk Increasing Managerial Compensation Source: Hoskisson and Hitt, 1990

17. 17 Summary Model of the Relationship between Firm Performance and Diversification Resources Capital Market Intervention and Market for Managerial Talent Diversification Strategy Firm Performance Internal Governance Strategy Implementation Incentives Managerial Motives Source: Hoskisson and Hitt, 1990

18. Lecture 1 © Furrer 2002-201218 A Framework for Corporate Strategy CA = ƒ (quality of elements, internal & external consistency, mutually reinforcing) RESOURCES VISION GOALS & OBJECTIVES BUSINESSES ROLES OF CORPORATE OFFICE STRUCTURESYSTEMSPROCESSES CORPORATE ADVANTAGE (CA) Source: Collis & Montgomery (1997, 2005)

19. 19 Alternative Diversification Strategies Efficient Internal Capital Market Allocation Transferring Core Competencies Sharing Activities Restructuring Related Diversification Strategies Unrelated Diversification Strategies 1 2 3 4 Efficient Internal Capital Market Allocation

20. 20 Sharing Activities Key Characteristics Sharing Activities often lowers costs or raises differentiation. Sharing Activities can lower costs if it: Example: Using a common physical distribution system and sales force such as Procter & Gamble’s disposable diaper and paper towel divisions. * Achieves economies of scale * Boosts efficiency of utilization * Helps move more rapidly down Learning Curve. Example: General Electric’s costs to advertise, sell, and service major appliances are spread over many different products.

21. 21 Sharing Activities Key Characteristics Sharing Activities can enhance potential for or reduce the cost of differentiation. Example: Shared order processing system may allow new features customers value or make more advance remote sensing technology available. Must involve activities that are crucial to competitive advantage Example: Procter & Gamble’s sharing of sales and physical distribution for disposable diapers and paper towels is effective because these items are so bulky and costly to ship.

22. 22 Sharing Activities Assumptions Strong sense of corporate identity Clear corporate mission that emphasizes the importance of integrating business units Incentive system that rewards more than just business unit performance   

23. 23 Transferring Core Competencies Key Characteristics  Exploits Interrelationships among divisions  Start with Value Chain analysis Identify ability to transfer skills or expertise among similar value chains Exploit ability to share activities Two firms can share the same sales force, logistics network or distribution channels

24. 24 Assumptions Activities involved in the businesses are similar enough that sharing expertise is meaningful Transfer of skills involves activities which are important to competitive advantage The skills transferred represent significant sources of cooperative advantage for the receiving unit    Transferring Core Competencies Transferring Core Competencies leads to competitive advantage only if the similarities among business units meet the following conditions:

25. 25 Key Characteristics Firms pursuing this strategy frequently diversify by acquisition: Acquire sound, attractive companies Acquired units are autonomous Acquiring corporation supplies needed capital Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs Add professional management & control to sub-units Sub-unit managers compensation based on unit results Efficient Internal Capital Market Allocation

26. 26 Assumptions Managers have more detailed knowledge of firm relative to outside investors Firm need not risk competitive edge by disclosing sensitive competitive information to investors Firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own    Efficient Internal Capital Market Allocation

27. 27 Portfolio Planning under the Boston Consulting Group (BCG) matrix: –Identifying the Strategic Business Units (SBUs) by business area or product market. –Assessing each SBU’s prospects (using relative market share and industry growth rate) relative to other SBUs in the portfolio. –Developing strategic objectives for each SBU. Portfolio Planning

28. 28 The BCG Matrix Source: Adapted from The Boston Consulting Group, Inc., Perspectives, No. 66, “The Product Portfolio.” 1970.

29. 29 The Strategic Implications of the BCG Matrix Stars –Aggressive investments to support continued growth and consolidate competitive position of firms. Question marks –Selective investments; divestiture for weak firms or those with uncertain prospects and lack of strategic fit. Cash cows –Investments sufficient to maintain competitive position. Cash surpluses used in developing and nurturing stars and selected question mark firms. Dogs –Divestiture, harvesting, or liquidation and industry exit.

30. 30 Limitations on Portfolio Planning Flaws in portfolio planning: –The BCG model is simplistic; it considers only two competitive environment factors: relative market share and industry growth rate. –High relative market share is no guarantee of a cost savings or competitive advantage. –Low relative market share is not always an indicator of competitive failure or lack of profitability. –Multifactor models (e.g., the McKinsey matrix) are better, though imperfect.

31. 31 The McKinsey Matrix

32. 32 Restructuring Key Characteristics Seek out undeveloped, sick, or threatened organizations or industries. Frequently sell unit after making one-time changes since parent no longer adds value to ongoing operations. Parent company (acquirer) intervenes and frequently: - Changes sub-unit management team - Shifts strategy - Infuses firm with new technology - Divests part of firm - Makes additional acquisitions to achieve critical mass - Enhances discipline by changing control systems

33. 33 Assumptions Requires keen management insight in selecting firms with depressed values or unforeseen potential Must do more than restructure companies Need to initiate restructuring of industries to create a more attractive environment    Restructuring

34. 34 External Incentives Relaxation of Anti-Trust regulation allows more related acquisitions than in the past Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions Incentives to Diversify After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments

35. 35 Diversification and Firm Performance Performance Level of Diversification Dominant Business Unrelated Business Related Constrained Source: Palich, Cardinal, & Miller, 2000

36. 36

37. 37 Incentives to Diversify Poor performance may lead some firms to diversify to attempt to achieve better returns. Firm may diversify into different businesses in order to reduce risk. Internal Incentives Firms may diversify to balance uncertain future cash flows. Managers often have incentives to diversify in order to increase their compensation and reduce employment risk, although effective governance mechanisms may restrict such abuses.

38. 38 What Resources, Capabilities and Core Competencies do we possess that would allow us to outperform competitors? Is it possible to leapfrog competitors? What Core Competencies must we possess to succeed in a new product or geographic market? Will diversification break up capabilities and competencies that should be kept together? Will we only be a player in the new product or geographic market or will we emerge as a winner? What can the firm learn through its diversification? Is it organized properly to acquire such knowledge? Issues to Consider Prior to Diversification

39. 39 Alternative Diversification Strategies Efficient Internal Capital Market Allocation Transferring Core Competencies Sharing Activities Restructuring Related Diversification Strategies Unrelated Diversification Strategies 1 2 3 4 Efficient Internal Capital Market Allocation

40. 40 How Parents Create Value Stand-alone influence Linkage influence Central functions and services Corporate development Source: Goold, Campbell, & Alexander, 1994

41. 41 Summary Model of the Relationship between Firm Performance and Diversification Resources Capital Market Intervention and Market for Managerial Talent Diversification Strategy Firm Performance Internal Governance Strategy Implementation Incentives Managerial Motives Source: Hoskisson & Hitt, 1990

42. 42 198019902000 Focused = 95% or more of sales within main industry. Dominant Business = Between 80% and 95% of sales within main industry. Diversified = Between 20% and 40% of sales outside main industry. Highly Diversified = More than 40% of sales outside main industry. Source: Franko, 2004 Level of Diversification

43. 43 Next Session: Text Discussion 1 Justification for the Multibusiness Firm –Presentations: Williamson (1991); Teece (1982); Montgomery & Hariharan (1991); Jensen (1989); Fliegstein (1985). –Write: One-page write-up by group. –Key Questions: What is corporate strategy? What are the rationales for the multibusiness firms? What are the disadvantages for a corporation to be in multiple businesses?