Chapter 9 New Business Development Copyright © 2004 McGraw Hill Companies, Inc. All rights reserved.

The Process of New Business Development Source: Adapted from Robert, “A Model of the Interaction of Strategic Behavior, Corporate Context and the Concept of Strategy.” Academy of Management Review, 8, (1983), pp. 61–70. Figure 9.1

Process of New Business Development New business ideas frequently come from lower and middle management (e.g., salespeople and engineers). The ideas are assessed by top management who are influenced by the organizational dimensions of strategy execution. Accepted new business ideas alter the concept of corporate strategy. The new concept of corporate strategy shifts the parameters of strategy execution and how new ideas will be assessed in the future.

Motivations for Diversification Common motivations to diversify: To escape a highly competitive industry or market To acquire a new source of revenues and earnings. To respond to an emerging market that is threatening a core business. To employ underutilized assets to produce a new products in new markets.

Motivations for Diversification (cont’d) Questions of strategic fit: What is the new business going to do for the parent company? What is the parent company going to do for the new business?

Contributions of the New Venture to the Parent Company Reducing business risk Risk reduction example: earnings volatility Should not be a primary motivation for diversification as capital markets are more efficient at diversifying risk. Adding to corporate growth in revenues and earnings Dependent on success of new business Helping in repositioning of other businesses in the parent firm Dependent on viability of new business

Contributions of the Parent Company to the New Venture Financial capital Backing of the parent company Resources Brand recognition, distribution channels, locations, and technology Capabilities Skills in logistics, service, operations, and technology development Management skills Entrepreneurial: assistance in growing the startup. General management skills: continuing guidance in managing the venture through shakeout and maturity.

Financial Capital Firms on average cannot be more efficient than external capital markets in allocating financial resources to businesses This disadvantage is reduced when: The value chains of the businesses are highly related. The firm invests in businesses that are relatively small and have high growth potential.

Resources Firms share resources among business units in order to improve their market positions through: Improved value (e.g., brand). Lower costs (economies of scale and scope). The contribution of the shared resource to a business unit should be benchmarked against market alternatives.

Capabilities Capabilities transferred to a business unit should contribute to its market position (through higher value or lower cost). A paradox: codified capabilities are easier to transfer but also more observable and imitable. This problem is acute for firms diversifying for the first time.

Entrepreneurial Management Firms can transfer managerial expertise in innovation and capacity expansion to a new business. The transferred expertise frequently involves building scale-driven value and cost drivers. Expertise transfers can also involve knowledge about how to manage the unit’s boundaries as it grows.

General Management Supplying existing management expertise helps a new business unit achieve a sustainable competitive advantage during shakeout and maturity. When a firm frequently specializes in achieving a value or cost advantage: Managers across business units benefit from the knowledge and shared practices. Corporate executives have a more homogeneous portfolio of business units in the major drivers of their market positions (value or cost).

Core Competence In contrast to common usage, the original meaning of core competence was: The existence of a technology platform from which many applications could be developed (e.g., flat screen technology by Sharp, specialty adhesives by 3M). An entrepreneurial capability to commercialize applications. Enhanced application development as a function of the experience gained from the application-based startups.

New Market Characteristics Characteristics of industries that are attractive to firms seeking to diversify: Large ultimate demand A high growth rate in demand A future industry structure in which the startup will have a favorable position based in part on the resources and capabilities of the parent corporation. Every diversification event is an entry event.

Managing New Ventures Major challenges: Differentiation Separating the new venture from existing businesses so that it can tailor its investments more closely to its market’s requirements. Integration Tying the new venture to existing businesses so that it can benefit from their resources and capabilities.

New Venture Governance to Achieve Effective Differentiation and Integration Multiple perspectives on business unit valuation across the firm Separate resource allocation mechanisms for existing and startup business units Different management incentive schemes for existing and startup businesses Alternative formal and informal mechanisms for interunit coordination and control

Carve-Outs Spinning off part of the equity in a startup to outside investors: Improves estimates of venture’s value. Allows the entrepreneur and management team to own shares in venture. Allows parent firm to benefit from owning shares.

Diversification in Different Nations Industry-to-industry diversification patterns differ significantly across countries Technological relatedness from existing to new businesses is the same across countries. Opportunities for diversification from one industry to another vary according to national institutions such as: Regulation Industry associations Labor involvement Corporate networks of directors and owners