Corporate Strategy

Plan for a diversified company

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 Diversification and
Corporate Strategy

 A company is diversified when it is in two or

more lines of business that operate in
diverse market environments

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 Diversification and
Corporate Strategy

 Strategy-making in a diversified company is a

bigger picture exercise than crafting a strategy
for a single line-of-business
 A diversified company needs a multi-industry,
multi-business strategy
 A strategic action plan must be developed
for several different businesses competing
in diverse industry environments

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 When Should a Firm Diversify?
 It is faced with diminishing growth prospects in
present business
 It has opportunities to expand into industries
whose technologies and products complement
its present business
 It can leverage existing competencies and
capabilities by expanding into businesses where
these resource strengths are key success factors
 It can reduce costs by diversifying into closely
related businesses
 It has a powerful brand name it can
transfer to products of other businesses to
increase sales and profits of these businesses
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 Why Diversify?

 To build shareholder value!

1+1=3

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 Diversification Parameters

 Diversification is capable of building shareholder value if it

passes three tests:
1. Industry Attractiveness Test—the industry presents
good long-term profit opportunities
2. Cost of Entry Test—the cost of entering is not so
high as to spoil the profit opportunities
3. Better-Off Test—the company’s different
businesses should perform better together than as
stand-alone enterprises, such that company A’s
diversification into business B produces a
1 + 1 = 3 effect for shareholders

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Diversification Will Succeed Only If It
Passes Three Essential Tests
 The attractiveness test:
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 capitalise all future
profits .
 The better-off test :
either the new unit must gain competitive
advantage from its link the corporation or
vice versa.

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How Attractive Is the Industry ?

In the long run the rate of return

available from competing in an
industry is a function of its
underlying structure

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 Industry Attractiveness
Attractive industry
 High ROI
 High entry barriers
 Low bargaining power of
buyers & suppliers
 Few substitute products
 Stable rivalry amongst
existing competition
Unattractive industry
 Structural flaws.
 Large group of
competitors(even state
supported).
 Powerful and price
sensitive buyers.
 Large substitute materials.
 Excessive rivalry caused
by high fixed costs.
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 Companies Tend to Ignore Industry
Attractiveness Test If …...

 Vague belief that the industry “fit” very

closely with their own businesses.
 Low entry cost.
 Many rush into fast growing industries were
burned because they mistook early growth
for long term profit potential.

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 What Is the Cost of Entry ?

 Diversification cannot add shareholder value

if the cost of entry eats up its expected
returns.
 Acquisitions :
take over price < market value.
 Start up:
strive to reduce entry barriers cost.

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 Will the Business Be Better off ?

A corporation must bring in significant

advantage to the new unit , or the new
unit must offer potential for significant
advantage to the corporation.
 Corporate planners tend to ignore this
test or deal with it through arm waving or
trumped up logic rather than hard
strategic analysis.
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 What Is Related Diversification?

 Involves diversifying into businesses whose value

chains possess competitively valuable “strategic
fits” with the value chain(s) of the present
business(es)
 Capturing the “strategic fits” makes related
diversification a 1 + 1 = 3 phenomenon

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 Core Concept: Strategic Fit
 Exists whenever one or more activities in the
value chains of different businesses are
sufficiently similar to present opportunities for
 Transferring competitively valuable
expertise or technological know-how
from one business to another
 Combining performance of common
value chain activities to achieve lower costs
 Exploiting use of a well-known brand name
 Cross-business collaboration to create competitively
valuable resource strengths and capabilities

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 Value Chain
Relationships for Related Businesses

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 Types of Strategic Fits
 Cross-business strategic fits can exist anywhere
along the value chain
 R&D and technology activities
 Supply chain activities
 Manufacturing activities
 Distribution activities
 Sales and marketing activities
 Managerial and administrative support activities
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 Core Concept:
Economies of Scope
 Stem from cross-business opportunities to
reduce costs

 Arise when costs can be cut

by operating two or more businesses
under same corporate umbrella

 Cost saving opportunities can stem

from interrelationships anywhere
along the value chains of different
businesses 17
 What Is Unrelated Diversification?
 Involves diversifying into businesses with
 No strategic fit
 No meaningful value chain
relationships
 No unifying strategic theme
 Basic approach – Diversify into
any industry where potential exists
to realize good financial results
 While industry attractiveness and cost-of-entry
tests are important, better-off test is secondary
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 Value Chains
for Unrelated Businesses

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 Appeal of Unrelated
Diversification
 Business risk scattered over different industries

 Financial resources can be directed to those

industries offering best profit prospects

 If bargain-priced firms with big profit potential are

bought, shareholder wealth can be enhanced

 Stability of profits – Hard times in one industry

may be offset by good times in another industry
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 Diversification and
Shareholder Value

 Related Diversification

 A strategy-driven approach
to creating shareholder value

 Unrelated Diversification

 A finance-driven approach
to creating shareholder value
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 Identifying a
Diversified Company’s Strategy

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 How to Evaluate a
Diversified Company’s Strategy
Step 1: Assess long-term attractiveness of each industry firm
is in
Step 2: Assess competitive strength of firm’s business units
Step 3: Check competitive advantage potential of cross-
business strategic fits among business units
Step 4: Check whether firm’s resources fit requirements of
present businesses
Step 5: Rank performance prospects of businesses and
determine priority for resource allocation
Step 6: Craft new strategic moves to improve overall company
performance

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 Diversification - Strategic Options

 Portfolio management .
 Restructuring .
 Transfer of skills .
 Sharing activities.

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 Portfolio Management

Primarily diversification through

acquisition.
Acquiring sound attractive
companies with competent
managers.
Acquired units need not be in the
same business as existing units.

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 Portfolio Management

New units are treated as

autonomous .
Parent units provide capital and
infuses professional management .
Top management provides
objectives and dispassionate review
of business results.

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Success of Portfolio Management
Depends on...
Companies must locate strong , but
undervalued units , where parent
company can provide resources
(funds,professional management).
The style of operating through highly
autonomous business units must
develop sound business strategies and
motivate managers.

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 Portfolio Management - Pitfalls

Limited candidates available for

acquisition.
Benefit of giving complete autonomy is
also questionable now.
Strong need for industry specific
knowledge for parent company to
effectively handle a diverse portfolio.

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Portfolio Management - Recent Views

A strong sense of Corporate identity

is as important as slavish adherence
to Business unit financial results

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 Restructuring

Corporation seeks underdeveloped,

sick or threatened companies or
industries on the threshold of a
significant change.
 Active involvement of parent
company in turnaround operations at
all levels.

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 Restructuring

Parent company changes

management team,shifts
strategy,infuses new technology.
 Parent co may make follow up
acquisitions to build critical mass.

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Restructuring Success Depends on …..

Requires corporate management team with

the insight to spot undervalued companies or
positions in industries ripe for transformation.
 Strong capabilities for turnaround
management.

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 Restructuring - Pitfalls

 Mistaking rapid growth of ‘HOT’ industry as

evidence for restructuring.

 Best companies realise they are not just

acquiring companies but restructuring an
industry.

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Purpose of portfolio management and
restructuring is to create value
through a company’s relation ship with
each autonomous unit .
The corporation’s role is to be a selector,
a banker , and an intervener.
 Last two strategic options transfer of
skills and synergy exploit the
interrelationships between businesses.
 Transfer of Skills

 Starting point is value chain and synergy.

 Depends on company’s capability to transfer
skills or expertise among similar value
chains.
 Transfer of expertise from existing units to
new operations.

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Success of Transfer of Skills Depends
on ….
 Activities involved in businesses are similar
enough that sharing expertise is meaningful.
 The transfer of skills involves activities
important to competitive advantage.
 The skills transferred represent a significant
source of competitive advantage for the
receiving unit. The expertise or skills to be
transferred are both advanced and
proprietary enough to be beyond the
capabilities of competitors.

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 Sharing of Activities

 Sharing activities in the value chains among

business units .
 Ability to share activities is potent basis for
lowering cost and raise differentiation.
 Cost benefit analysis of prospective sharing
to check synergy.
 Economies of scale should drive costs lower.
 Coordination costs must not outweigh
sharing benefits.

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 Action Plans

Identifying the interrelationships among

already existing business units.
 Selecting the core business that will be
the foundation of corporate strategy.
 Creating horizontal organisational
mechanisms that will facilitate future
related diversification.

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 Action Plans

 Pursuing diversification opportunities

that allow shared activities.
 Pursuing diversification through
transfer of skills.
 Pursuing strategy of restructuring if this
fits the skills of management.
Portfolio management as last option.

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 Vertical Integration Strategies
 Vertical integration extends a firm’s
competitive scope within same industry
 Backward into sources of supply
 Forward toward end-users of final
product

Internally Activities, Costs,

Activities,
Performed & Margins of Buyer/User
Costs, &
Activities, Forward Channel Value
Margins of
Costs, & Allies & Chains
Suppliers
Margins Strategic Partners
 Vertical Integration Strategies

 Can aim at either full or partial integration

Internally Activities, Costs,

Activities,
Performed & Margins of Buyer/User
Costs, &
Activities, Forward Channel Value
Margins of
Costs, & Allies & Chains
Suppliers
Margins Strategic Partners
Competitive Strategy Principle

A vertical integration strategy has

appeal ONLY if it significantly
strengthens a firm’s competitive
position!
Pros and Cons of Vertical Integration
 The appeal of a vertical integration strategy
depends on
 Its ability to enhance performance of
strategy-critical activities by
 Lowering costs or
 Increasing differentiation
 Its impact on
 Resource requirements
 Flexibility and response times
 Administrative overhead of coordination
 Its ability to create a competitive advantage
 Appeal of Backward Integration

 Generates cost savings only if volume

needed is big enough to capture efficiencies
of suppliers
 Potential to reduce costs exists when
 Suppliers have sizable profit margins
 Item supplied is a major cost component
 Resource requirements are easily met
 Appeal of Backward Integration

 Can produce a differentiation-based

competitive advantage when it results in a
better quality part
 Reduces risk of depending on suppliers of
crucial raw materials / parts / components
 Appeal of Forward Integration

 Advantageous for a firm to establish its own

distribution network if
 Undependable distribution channels
undermine steady production operations
 Appeal of Forward Integration

 Integrating forward into distribution and

retailing
 May be cheaper than going through
independent distributors
 May help achieve stronger product
differentiation, allowing escape from price
competition
 May provide better access to users
 Strategic Disadvantages of
Vertical Integration
 Poses problems of balancing
capacity at each stage of value
chain
 May require radically different skills
/ capabilities
 Reduces manufacturing flexibility,
lengthening design time and ability
to introduce new products
 Strategic Disadvantages of
Vertical Integration
 Boosts resource requirements
 Locks firm deeper into same
industry
 Results in fixed sources of
supply and less
flexibility in accommodating
buyer demands for
product variety