1. Chapter 7: Corporate Strategy
Foundations of Strategy
Team 4

2. Scope [the range of product and marketing activities the firm undertakes]
Product Scope
how specialized the firm is in terms of the range of products it supplies
Vertical Scope
the range of vertically linked activities the firm encompasses
Geographical Scope
the geographical spread of activities for the firm

3. Tesco
Global grocery and general merchandise retailer headquartered in London
3rd largest retailer in the world
Over 472,000 employees with 4,811 stores in 14 countries

4. Tesco Founded by Jack Cohen in 1919
Market stall in the East End of London
Labels from tea shipments from T.E. Stockwell
TES + CO
Acquisitions in 1950’s and 1960’s
“piling it high and selling it cheap”

5. Tesco Downmarket image, low price, middling quality
Consumers want better quality and more sophistication by the 1970’s Jack Cohen steps down
Leslie Porter and Ian McLaurin take over, introduce:
Tesco Extra (out of town hypermarkets)
Tesco Express (neighborhood convenience stores)
New systems and technology
Appeal to a wider range of market segments and expand the company through acquisition

6. Tesco
First UK supermarket to introduce loyalty cards with its “Clubcard” and points system
Gives Tesco valuable information about who you are and what you buy for their database
Segment customer base more accurately and target promotions and cross selling

7. Tesco
Terry Leahy took over in 1997 and though the company was doing good, realized they were reaching limits
Added online non-food retail in 1998 through joint venture with Grattan, a mail order company
Online grocery delivery, discount clothing, electronics, DVDs
Tesco Direct, a printed catalougue, everything in house (pictures, publishing)

8. Tesco Diversification into personal finances Tesco Personal Finance
50-50 banking joint venture with the Royal Bank of Scotland
Credit cards, savings accounts, insurance
Sheer size of market and knowledge of shoppers personally through the Tesco database
Had capital requirement necessary for a banking license
Customers are already familiar with Tesco
Synergy and innovation

9. Tesco
During 2008 financial crisis, they acquired RBS’s shares in Tesco Personal Finance to become a wholly owned subsidiary of Tesco
Customer disillusionment with traditional banks led the way for alternative financial service providers

10. Tesco Pulling back from this ambitious plan
Different core competencies from store and bank
Need to develop differently
Customers reluctant to switch financial providers, too complicated and daunting
Customers may view Tesco with disdain, if it does certain bank acts (such as repossessing a house)

11. Tesco Trading profits up 13%
Customer accounts across all products at 6.2 million
Watch to see how far Tesco can extend its product portfolio

12. The scope of the firm “What business are we in?”
Starting point of strategy and basis for deciding firm’s identity
Range of scope
Scope of a firm’s business is likely to change over time
Ex: Phillip Morris, now Altria Group
Ex: Microsoft
Vertical integration
Now, trend is outsourcing and de-integration
Ex: Pharmaceutical companies

13. Key concepts for analyzing firm scope
Firm’s extend or reduce their scope because they perceive this to be in the firm’s best interest
Economies of scale
Reduction in average costs that result from an increase in the output of a single product
Economies of scope
Cost economies from increasing the output of multiple products
Creates potential for multi-business firms to gain cost advantages over more specialized business

14. Key concepts for analyzing firm scope
Tangible resources
Distribution networks, info technology systems, sales force, labs
Offer economies of scope by eliminating duplication between businesses through creating a single shared facility
Ex: cable TV companies and telephone companies
Shared services organizations
Intangible resources
Brands, reputation, technology
Offer economies of scope from the ability to extend them to additional businesses at low marginal cost
Ex: Starbucks
Brand extension

15. Key concepts for analyzing firm scope
Organizational capabilities
Transfer capabilities between businesses within the diversified company
Once developed, can typically be replicated in a new business at a fraction of the cost of the initial creation
General management capabilities are very important
Ex: General Electric

16. Transaction Costs Market Mechanism Administrative Mechanism Examples
search costs, cost of negotiating and drawing up a contract, the cost of monitoring the other party’s side of the contract

17. The Scope of a Firm: Specialization vs. Integration
Single Integrated Firm
Vertical Scope
Product Scope
Geographical Scope
Several Specialized Firms
“ The dominant trends of the past three decades 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.”

18. Transaction Costs at Tesco
Grocery retailer
What transaction costs would a grocery retailer have?
Search for potential suppliers
Bargaining with these suppliers
Drawing up a legal contract
Monitor the suppliers’ performance
Enforce the contract and seek damages if need be
What role does time play in the transaction costs of a company?

19. The Costs of Corporate of Corporate Complexity
Organizational Complexity
Three concepts
Economies of scope
Transaction cost of managing complexity
Provide important insights into corporate strategic decisions and we next use these ideas to explore strategic decisions with regard to product scope and vertical scope

20. Diversification
The expansion of an existing firm into another product line or field of operation
Related (Concentric) or Unrelated (Conglomerate)
Horizontal diversification
Vertical diversification

21. The Benefits and Costs of Diversification
Why do companies strive to diversify?
Growth
Risk reduction
Value creation

22. Exploiting Economies of Scope
Licensing
Branding
Franchising

23. Internal Capital Markets
The corporate allocating of capital between the different businesses through the capital expenditures budget
By maintaining a balance portfolio of cash-generating and cash-using businesses, diversified firms can avoid the costs of using the external capital market, including the margin between borrowing and lending the heavy costs of issuing new debt and equity

24. Internal Labor Markets
A diversified corporation has a pool of employees and can respond to the specific needs of any one business through transfer from elsewhere within the corporation
As college students, we look for the entry-level position which we can use as a springboard. Diversified companies such as Siemens, General Electric, Unilever, and Nestle are high sought after due to the immense opportunity to have an enriched career

25. When does diversification create value?
The attractiveness test
The industries chosen for diversification must be structurally attractive or capable of being made attractive
The Cost-of-Entry test
The cost of entry must not capitalize all the future profit
The Better-Off test
Either the new unit must gain competitive advantage from its link with the corporation, or vice versa

26. The attractiveness and cost-of-entry tests
A key feature of Porters’ essential test is that the industry attractiveness is sufficient on its own
Pharmaceuticals, corporate legal services, and defense contracting offer above-average profitability precisely because of barriers to entry
The only ways to enter are to acquire and established player or establish a new corporate venture

27. The better-off test Addresses the basic issue of competitive advantage
If two businesses producing different products are brought together under the ownership and control of a single enterprise, is there any reason why they should become any more profitable?
In most diversification decisions, it is the better-off test that dominates

28. Diversification and Performance
High levels of diversification associated with low profitability
Diversification is good when exhausted growth has occurred and emerge external opportunities
Moderately diversified companies more profitable than specialized firms doesn’t necessarily mean they are more profitable but maybe firms diversify their cash flow investments
Companies who diversify seem to have more profitability (a good happy medium seems to be the answer; take in what you can handle)

29. Related and Unrelated Diversification
Diversification in related industries should be more profitable than justification into unrelated industries.
Several factors may be confusing the relationship
Related diversification offers greater potential benefits than unrelated diversification which creates greater management complexity.
Distinction between “related” and “unrelated” is not always clear, it may depend upon the strategy and characteristics of individual firms.

30. Recent Trends in Diversification
Conglomerate firms are highly diversified companies created from multiple, unrelated acquisitions and have almost disappeared as a distinctive corporate form.
The divestment trend among large US companies meant that between 1980 and 1990, the average index of diversification for the Fortune 500 declined from one 1.00 to 0.67.
Highly diversified business groups dominate the industrial sectors of many emerging companies.
There are also signs that diversification may be making a come back in advanced industrial nations.
In the technology sector, digitisation is tending to break down conventional market boundaries.
Complementarities are becoming more important between different products
As the rate at which technologies and products become obsolete increases and competitive advantages in core businesses erodes, so firms are finding it desirable to create “growth options” in other industries.

31. Defining vertical integration
Definition; a firms ownership vertically related activities
the extent of vertical integration is indicated by the ratio of a firms value added to its sales revenue
Vertical integration can be:
Backward: where the firm acquires ownership and control over the production of its own inputs.
Forward: Where the firm acquires ownership and control of activities previously undertaken by it customers.
Vertical integration may be full or partial.

32. The Benefits & Cost of Vertical Integration
For most of the 20th century, the prevailing wisdom was that vertical integration was generally beneficial because it allowed superior coordination and reduced risk.
There has been a change of opinion during the last 25 years that outsourcing enhances flexibility and allows firms to focus on their core competencies.
On the positive side, vertical integration can produce cost savings due to the physical integration of processes, eliminate certain transaction cost and facilitate transaction specific investments.
On the negative side, vertical integration may restrict a firms ability to benefit from scale economies and may reduce flexibility and increase risk.

33. Technical Economies from the Physical Integration of Processes
Analysis of the benefits of vertical integration has traditionally emphasized the technical economies of vertical integration; cost savings that arise from the physical integration of processes.

34. Transaction Costs in Vertical Exchanges
Where a single supplier negotiates with a single buyer, there is no market price; it all depends on relative bargaining power.
Such bargaining is likely to be costly; the mutual dependency of the two parties is likely to give rise opportunism and strategic misrepresentation as each company seeks to both enhance and exploit it bargaining power at the expense of the other.
The more technically complex the integrated circuit and hence the greater the need for the designer and fabricator to invest in technical collaboration and adapt processes to the needs of the other, the better the relative performance of integrated producers.

35. The Incentive Problem
High Powered incentives: Where a market interface exists between a buyer and a seller, profit incentives insure that the buyer is motivated to secure the most best possible deal and the seller is motivated to pursue efficiency and service in order to attract and retain the buyer.
One approach to creating stronger performance incentives within vertically integrated companies is to open internal divisions to external competition.

36. Flexibility
Where the required flexibility is rapid responsiveness to uncertain demand, there may be advantages in market transactions.
Vertical integration may also be disadvantages in responding quickly to new product development opportunities that require new combinations of technically capabilities.
Where system-wide flexibility is required vertical integration may allow for speed and coordination in achieving simultaneous adjustment throughout the vertical chain.

37. Compounding Risk
To the extent to the vertical integration ties a company to its internal suppliers, vertical integration represents a compounding of risk insofar as problems at any one stage of production threaten production and profitability at all other stages.

38. Designing Vertical Relationships
Vertical business relationships exist when two people interact that are on different positional levels within an organization. 
These relationships often involve an employee relating to his direct supervisor. It can also involve relationships that stretch across two or more levels of hierarchy within the organization. 

39. Different Types of Vertical Relationships
Long Term Contracts:
Series of transactions over a period of time and specify the terms and responsibilities for each party.
Spot Contracts:
Market transactions or normal purchases
Relational Contracts:
A contract whose effect is based upon a relationship of trust between the parties.
Franchise:
A Contractual agreement between the owner of a business system and a trademark.

40. Vertical integration vs. Outsourcing
Throughout the years companies have done less outsourcing and more vertical integration.
Companies in essence have “maxed out” on outsourcing
Vertical integration allows more control and less risk.

41. Dominating the supply chain

42. Managing the corporate portfolio
Opportunities exist to create value through diversification or vertical integration
“How do we manage a multi-business firm in ways that generate as much value as possible?”

43. Portfolio Planning
Represent graphically the individual businesses of a multi-business company in terms of key strategic variables that determine their potential for profit
Relate to attractiveness of their market and competitive advantage in that market

44. GE/McKinsey matrix
Industry attractiveness axis combines market size, growth rate, profitability, international potential
Business unit competitive advantage combines market share, return on sales relative to competitors; and relative position with regard to quality, technology, manufacturing, distribution, marketing, and cost

45. Boston Consulting Group’s growth-share matrix
Uses single indicator as a proxy for each of these dimensions: industry attractiveness is measured by rate of market growth, competitive advantage by relative market share
Simplicity is both limitation and usefulness

46. The Ashridge portfolio display
The value-created potential of a business within a company’s business portfolio depends not just on the characteristics of the business, but also on the characteristics of the parent
Focus on fit between business and parent company

47. Portfolio Planning Models
Portfolio planning models can aid managers to make sense of the complexity and to start to develop a degree of consistency in the firm’s activities to produce coherence and fit

48. Questions???