Chapter 7 Developing Corporate Strategy

1 2 3 4 5 6 OBJECTIVES Define corporate strategy Understand the roles of economies of scope and revenue-enhancement synergy in corporate strategy 3 Explain the different forms of diversification 4 Understand when it makes sense for a firm to own a particular business 5 Describe the relationship between corporate strategy and competitive advantage 6 Explain the corporate strategy implications of the stable and dynamic perspectives

MITY DIVERSIFICATION Company Diversification process Types of businesses Heavy reliance on acquisition Many seemingly un- related businesses Primarily organic Many businesses clustered in a few related industries MITY Product extensions/ new product lines Few related product lines

THREE CORPORATE STRATEGY DECISIONS THAT ARISE WHEN MAKING ENTRY/EXIT DECISIONS In which business arenas should a com- pany compete? Which vehicles should it use to enter/exit a business? What underlying economic logic makes it sensible to compete in multiple businesses? Also, how do we create synergies between our busi- nesses? 1 2 3

DIVERSIFICATION PROFILES 7 DIVERSIFICATION PROFILES

DIVERSIFICATION PROFILES (Continued) 7 DIVERSIFICATION PROFILES (Continued)

DIVERSIFICATION PROFILES (Continued) 7 DIVERSIFICATION PROFILES (Continued)

EVOLUTION OF DIVERSIFICATION Vertical Integration e.g. General Motors began operating steel plants to ensure supply of raw materials Expansion into related businesses e.g. Dupont moved from gunpowder making onto dynamite, nitro-glycerine, guncotton, and smokeless power Rapid consolidation at turn of the century led to antitrust laws e.g. Standard Oil Wave of conglomerations in 1960s * Unrelated acquisitions expanded the size of companies * Widespread use of portfolio planning (e.g. BCG Matrix – see my research) Corporate Raiders in 1980s broke up many conglomerates New wave of acquisitions in 1990s and 2000s * Mainly related acquisitions

A BRIEF HISTORY AND GENEOLOGY OF A CONGLOMERATE :ITT 2 A BRIEF HISTORY AND GENEOLOGY OF A CONGLOMERATE :ITT 1980: fluid control industry 1995: ITT Industries (auto, defense & electric systems, & fluid-control) The Surviving ITT 1940: Electronics businesses 1979: Begins selling 250 business units, including all telecom businesses 1925: telecom equipment mfr. 1920 International Telephone and Telegraph 1995: ITT Hartford (financial services) Now Hartford Financial Services 1960 Enters auto parts industry 1969: Buys Hartford Insurance 1968: Buys Sheraton Hotels 1995: ITT Corporation (hospitality, entertainment, IT services) Now part of Starwood Hotel & Resorts 1968: Buys Continental Bakery (Hostess) Sold in 1984 to Interstate Bakery

MUST DETERMINE VALUE CREATION 19 MUST DETERMINE VALUE CREATION Geographic diversification Does this create value? Economies of scope? Revenue- enhancement opportunities? Horizontal diversification Vertical diversification

SOURCES OF VALUE FROM DIVERSIFICATION/EXPANSION Economies of scope Lower price of a common resource by combining purchases Share manufacturing capacity to reduce average costs Share distribution to reduce average distribution costs Revenue-enhancement synergies Bundle products to appeal to new customers Cross sell to existing customers Achieve higher valuation from larger, more predictable cash flows

DIVERSIFICATION DOES NOT NECESSARILY CREATE VALUE Non-value generating Value generating Revenue Revenue enhancement No cross-sell opportunities Profit Value Economic of scope Dis-economies of scope Costs Valuation of profit Investor-perceived “quality” No perceived value logic

EXAMPLE OF POOR ECONOMIC LOGIC In 1990s, Diversified from long- distance telephone services into wireless cell phone service and cable TV In 2002, decided to split the company apart

DIVERSIFICATION IS DIFFICULT TO MANAGE

OPPORTUNUTIES TO EXPLOIT POTENTIAL ECONOMIES OF SCOPE Fit among parent- subsidiary resources Fit of parent- subsidiary dominant logic What is a dominant logic?

OTHER REASONS TO DIVERSIFY Risk reduction Empire building Compensation More efficient for investors to diversify themselves Rarely results in higher share- holder value or margins Acquisition motivated by executive pay - a bigger company usually implies a bigger pay check -rarely creates value

FORMS AND SCOPE OF DIVERSIFICATION Wal-Mart expanded into Europe Geographic Horizontal From one market segment to another From one industry to another Coke and Pepsi expanded into water Pulte Homes Inc. created Pulte Mortgage LLC) Vertical

PROFIT POOLS Profit pool analysis helps identify opportunities

WHO SHOULD OWN THE BUSINESS? Two key questions Does the business unit add value to the corporation? 1 ? Does the corporation owning the business unit add more value than alternative ways of linking a business to the corporation? (would an alliance, a joint venture, internal business development or acquisition of a differ-ent business generate more value?) 2

COMPETITIVE ADVANTAGE Resources Implementation Arenas Organi- zational structure Specialized General Systems Processes

Manu-facturing design and Marketing MASCO CORPORATION Independent – unattractive Combined – profitable Cabinets Home depot Home depot Plumbing Manu-facturing design and Marketing Sales Decorative architectural products Lowe’s Lowe’s Specialty products

CORPORATE OWNERSHIP IN A DYNAMIC CONTEXT Economies of scope Revenue enhancement In dynamic markets, diversification can hinder competitiveness This is why Adaptec, Palm, and 3Com spun off businesses Nimbleness Response time

CORPORATE STRATEGY IN STABLE AND DYNAMIC CONTEXTS Stable Contexts Dynamic Collaboration is fluid with networks being created, changed, and disassembled between combinations of owned and alliance businesses Collaboration is solidified through static structural arrangement among wholly-owned businesses Key objectives are growth, maneuverability, and economies of scope Key objectives are the pursuit of economies of scale and scope Top management team emphasizes collaboration among the businesses and the form of that collaboration Top management team emphasizes the creation of a collaborative context that is rich in terms of content and linkages The business units’ roles are to execute their given strategy The business units’ roles are to execute their strategy and seek new collaborative opportunities Business units’ incentives combine business with corporate-level rewards to promote cooperation Business units’ incentives emphasize business-level rewards to promote aggressive execution and collaborative-search objectives Balanced-scorecard objectives emphasize performance against budget and in comparison to within-firm peer unit Balanced-scorecard objectives gauge performance relative to competitors in terms of growth, market share, and profitability

HOW WOULD YOU DO THAT? Walt Disney wants to enter more mature film entertainment (e.g., Kill Bill) Pros Cons What are Walt Disney’s strategic options? Leverage production Damage core brand Leverage distribution Requires producers and directors with different skills ? ?

SUMMARY 1 Define corporate strategy 2 Understand the roles of economies of scope and revenue-enhancement synergy in corporate strategy 2 Explain the different forms of diversification 3 Understand when it makes sense for a firm to own a particular business 4 Describe the relationship between corporate strategy and competitive advantage 5 Explain the corporate strategy implications of the stable and dynamic perspectives 6

EXERCISES Identify the vertical, horizontal and geographical scope of MGM-Mirage of your choice. How similar are the resource requirements (how related is the firm)? Determine if there is a dominant logic connecting the businesses. Design a future corporate strategy for MGM-Mirage.