Lecture 1 © Furrer Corporate Strategy Fall 2008 Lecture 1 Introduction to Corporate Strategy with an Historical Perspective Dr. Olivier Furrer Office: TvA , Phone: Office Hours: only by appointment

Lecture 1 © Furrer Discussion Themes 1.Introduction (See Collis and Montgomery, 1997, Ch. 1) –The Need for Corporate Strategy –What is Corporate Strategy? –A Framework for Corporate Strategy 3.Corporate Strategy Analytical Tools (See Collis and Montgomery, 1997, A1) –Organization Structure and Diversification –Portfolio Planning –Value-Based Strategy –Generic Corporate Strategies –Resource-Based View 2.An Historical Perspective (See Grant, 2002) –Origins of the Modern Corporation –The Multidivisional Corporation –Postwar Patterns of Diversification –The Conglomerates –Downsizing, Outsourcing, and Restructuring –Diversification in Emerging-Market Economies –Beyond the Trends

Lecture 1 © Furrer “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

Lecture 1 © Furrer The Need for Corporate Strategy Most industrial activity in developed countries is carried out by large corporations which compete in more than one market. In the United States, 60% of assets are controlled by multibusiness companies (Villalonga, 2003). In Europe, the percentage is about the same (Pedersen and Thomsen, 1997). On average these firms engaged in over 10 different lines of business. Due to the dominant role these firms play in economic activity, it is likely that most of you, regardless of their chosen career paths, will at some point either work for, advise, or compete with a multibusiness corporation.

Lecture 1 © Furrer The Need for Corporate Strategy The nature of these large corporations has undergone enormous change in the last forty years, affecting both their scope and their structure. The merger and acquisition booms of the sixties and eighties extended the scope of existing multibusiness corporations. More recently, capital market pressures forced every corporation to reassess its portfolio of businesses, level of overhead, and the way it coordinates and controls its multibusiness activities. New forms of corporate organization, such has the LBO partnerships of the eighties, provoked a debate about the efficacy of corporate hierarchies. In addition, new institutional arrangements, such as joint ventures, alliances and franchising have come to prominence.

Lecture 1 © Furrer The Need for Corporate Strategy In response, normative prescriptions for corporate strategy have been varied as the challenges multibusiness corporations have faced. From an emphasis on financial performances and EPS growth in the sixties, through managing the corporation as a ‘portfolio’ of SBU’s, and searching for ‘synergy’ between business units in the seventies; to the emphasis on ‘free cash flow’ and its corollary ‘shareholder value analysis’ in the eighties, recommendations, such as the strident call to break up corporate organizations or ‘stick to the knitting,’ have pulled CEO’s in many conflicting directions. Not surprisingly, only a few corporations have made through the last forty years intact. Of the Fortune 500 in 1950, only 262 firms were still on the list in 1980.

Lecture 1 © Furrer s: Little –Growth at any cost –Weak rivals –Fragmented, passive shareholders –Ineffective boards 1980s: Increasing –Restructuring pathological portfolios –Takeover premiums increase Pressure for Shareholder Value 1990s: Intense –Active shareholders –Active boards –Global product markets –Global capital markets 2000s: Rethinking –Accounting scandals –Corporate governance (Sarbanes-Oxley Act) –Global markets retreat Ref.: Collis and Montgomery, 2005

Lecture 1 © Furrer Corporate-Level Strategy What is Corporate Strategy?

Lecture 1 © Furrer low cost - differentiation - integrated low cost/differentiation - focused low cost - focused differentiation How to create value for the corporation as a whole 2 A Diversified Company has 2 Levels of Strategy How to create competitive advantage in each business in which the company competes Corporate-Level Strategy (Company-wide Strategy) Business-Level Strategy (Competitive Strategy)

Lecture 1 © Furrer What businesses should the corporation be in? How should the corporate office manage the array of business units? Corporate Strategy is what makes the corporate whole add up to more than the sum of it business unit parts 2 Corporate Strategy Concerns 2 Key Fundamental Questions:

Lecture 1 © Furrer “Corporate strategy is the way a company creates value through the configuration and coordination of its multimarket activities” (Montgomery and Collis, 1997, p. 5) Definition This definition has 3 important aspects: Value Creation as the ultimate purpose of corporate strategy. The focus on the multimarket scope of the corporation (Configuration), including its product, geographic, and vertical boundaries. The emphasis on how the firm manages the activities and businesses that lie within the corporate hierarchy (Coordination).

Lecture 1 © Furrer 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 and Montgomery (1997, 2005)

Lecture 1 © Furrer Corporate Strategy: An Historical Perspective Origins of the Modern Corporation The Multidivisional Corporation Postwar Patterns of Diversification The Conglomerates Downsizing, Outsourcing, and Restructuring Diversification in Emerging-Market Economies Beyond the Trends Grant, R.M. (2002), “Corporate Strategy: Managing Scope and Strategy Content,” In Handbook of Strategy and Management, A. Pettigrew, H. Thomas, and R. Whittington (eds.), London, Sage, pp

Lecture 1 © Furrer 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 19th century. Beyond the appointment of the subsidiary boards of directors, the parent exercised little strategic or operational influence over the subsidiary companies.

Lecture 1 © Furrer 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 increasing prevalent within the US and Europe.

Lecture 1 © Furrer Young Strategy and Structure Growth Pattern Maturity Age of Organization Size of Organization Small Large Coordination and Control Problems Simple Structure Functional Structure Multi- divisional Structure Matrix Structure Network Structure Ref.: Adapted from Greiner, 1972; Churchill and Lewis, 1983

Lecture 1 © Furrer ProductionFinanceR&DAccounting Sales & Marketing Human Resources Chief Executive Officer Functional Structure

Lecture 1 © Furrer Division ProductionFinanceEngineeringAccounting Sales & Marketing Human Resources Strategic Planning Corporate Finance Corporate R&D Corporate Marketing Corporate Human Resources Chief Executive Officer Multi-Divisional Structure

Lecture 1 © Furrer Postwar Patterns of Diversification 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).

Lecture 1 © Furrer Pattern of Diversification Core Business Closely related businesses Increasingly unrelated businesses Source: Collis and Montgomery (2005)

Lecture 1 © Furrer 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

Lecture 1 © Furrer Firms Vary by Degree of Diversification Ref.: Rumelt, 1974 Unrelated Business Related Business Dominant- Unrelated Dominant Business Single Business 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.

Lecture 1 © Furrer The BCG Matrix Ref: Adapted from The Boston Consulting Group, Inc., Perspectives, No. 66, “The Product Portfolio.” 1970.

Lecture 1 © Furrer Porter’s (1980) Five Forces Model of Competition Threat of Substitute Products Threat of New Entrants Rivalry Among Competing Firms in Industry Bargaining Power of Buyers Bargaining Power of Suppliers Ref.: Porter, Michael (1980). Competitive Strategy. New York: The Free Press.

Lecture 1 © Furrer 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 investor 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.)

Lecture 1 © Furrer Downsizing, Outsourcing, and Restructuring The dominant trends of the last two decades of the 20th 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. International expansion has continued however. These changes coincided with a more turbulent environment: the oil shock of , 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.

Lecture 1 © Furrer Diversification in Emerging-Market Economies 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.

Lecture 1 © Furrer 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 and Montgomery (1997, 2005)

Lecture 1 © Furrer Next Session: Text Discussion 1 Justification for the Multibusiness Firm –Presentations: Williamson (1991); Teece (1982); Montgomery and Hariharan (1991); Jensen (1989). –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?