Corporate-Level Strategy and Long-Run profitability Chapter 7 Corporate-Level Strategy and Long-Run profitability

Corporate-Level Strategy The principle concern: to identify the industry or industries a company should participate in to maximize long-run profitability Several options!!! DS!!!

Concentration on a Single Industry A company chooses to focus its resources and capabilities on competing successfully within the confines of a particular product market Examples of companies that pursue 1 strategy: McDonalds Starbuck’s

Horizontal Integration The process of acquiring or merging with industry competitors to achieve the competitive advantage that comes with large size Merger- an agreement between two companies to pool their resources in a combined operation Acquisition - Occurs when a company uses capital resources to purchase another company. An increase in horizontal integration = an increased level of concentration in an industry

Horizontal Integration Advantages Lowers operating costs Increases product differentiation (can be accomplished through product bundling) Reduces rivalry within an industry Increases bargaining power over suppliers and buyers Disadvantages Problems with merging cultures, managers and operations. Problems with the Federal Trade Commission if a company grows too large

Horizontal Integration: EXERCISE Use the internet to research a company that has implemented Horizontal Integration. What prompted them to do this? Has their profitability increased? By producing more of their own ‘inputs’ has the firm truly reduced costs? Or is there economies of scale in the industry that they cannot capitalize on? Is this true in all industries or is this industry unique?

Outsourcing Functional Activities Outsourcing of non-core functional activities Advantages- specialists,

Vertical Integration Expanding operations into industries that produce inputs or into industries that use, distribute, or sell the company’s product A company can enter a new industry to increase its long-run profitability A company that concentrates on a single business may be missing out on the opportunity to create value through vertical integration

Figures 7.1: Stages in the Raw-Materials-to-Customer Value-Added Chain

Figure 7.2: The Raw-Materials-to-Customer Value-Added Chain in the Personal Computer Industry

Figure 7.3: Full and Taper Integration

Vertical Integration Advantages Disadvantages Enables company to build barriers to new competition Facilitates investments in specialized assets Protects product quality Results in improved scheduling Disadvantages May actually increase cost of inputs Suppliers have less incentive to be efficient Ties a company into old, obsolescent, and high cost technology

Vertical Integration: EXERCISE Use the internet to research a company that has implemented Vertical Integration. What prompted them to do this? Has their profitability increased? By selling products to end users, do you think that they have cannibalized some of their market presence?

Concentration on a Single Industry (cont’d) Advantages Concentrates all resources and capabilities to strengthening its competitive position in one industry Disadvantages Vertical integration may be necessary May miss out on other opportunities to create more value and increase profitability

Related Diversification Exhibit 6.3

“Growth does not always lead a business to build on success “Growth does not always lead a business to build on success. All too often it converts a highly successful business into a mediocre large business.” - Richard Branson “The corporate strategies of most companies have dissipated instead of created shareholder value.” - Michael Porter

Diversification A diversified company is one that operates in two or more industries in order to find ways to use distinctive competencies to increase the value of products in other industries to consumers and to increase long-run profitability A company may choose to diversify when they have excess resources Concept of related diversification and unrelated diversification

Figure 7.5: Sharing Resources at Procter & Gamble

Diversification (cont’d) Diversification can help a company create value in 3 main ways: Permitting superior internal governance Transferring competencies among businesses Realizing economies of scope

Figure 7.4: Transfer of Competencies at Philip Morris

Value-Adding Corporate Parents Envisioning Strategic Intent Central Services and Resources Focus Clarity to external stakeholders Clarity to business units Investment Scale advantages Transferable management capabilities Intervention at Business Level Expertise Monitor performance Action to improve performance Challenge/develop strategic ambitions Coaching/training Develop strategic capabilities Achieve synergies Provide expertise/services Knowledge creation/sharing Leverage Brokering linkages/accessing external networks

Value-Destroying Corporate Parents Bureaucracy Adds cost Hinders responsiveness Buffer from reality Financial safety net Diversity and size Lack of clarity on overall vision Managerial ambition Empire building

Portfolio managers, synergy managers and parental developers Exhibit 6.6

Restructuring Restructuring- implementing strategies for reducing the scope of the company by removing exiting business areas Why restructure? Because the stock of highly diversified companies is often assigned a lower valuation relative to earnings than stocks of less diversified enterprises In an attempt to boost returns to shareholders

Restructuring (cont’d) Restructuring can be beneficial due to diminished advantages of vertical integration or diversification Restructuring can be a reaction to: Managers pursuing too much diversification Diversification for the wrong reasons Failed Acquisition

“The very best takeovers are thoroughly hostile “The very best takeovers are thoroughly hostile. I’ve never seen a really good company taken over. I’ve only seen bad ones.” - James Goldsmith © RoyaltyFree/ Stockdisc/ Getty Images

Exit Strategies Three main exit strategies: Divestment- most favorable Harvest- only works under specific conditions Liquidation- least favorable

Divestment Selling a business unit to the highest bidder A company can sell to: Independent Investors Other Companies

Management Buyout The managers of a business unit may be interested in purchasing it and assuming the high risk associated with the purchase Management often purchases a business unit through the sale of high-yield bonds

Harvest Halting investments in order to maximize short-to-medium term cash flow If employees catch on, morale can sink very quickly and the strategy may fail

Liquidation Shutting down the operation of a business or business unit Least attractive strategy because the company is required to write off its investments in the unit that is shutting down

Further readings and Questions Study the M & A strategies of BP Study the Outsourcing strategies of some good companies such as BP

Corporate Portfolio Management Portfolio balance Markets Organisation’s needs Attractiveness of business units Profitability Growth rates Portfolio ‘fit’ Synergies between business units Synergies with corporate parent

The Growth Share (or BCG) Matrix Exhibit 6.8

Public Sector Portfolio Matrix Source: J.R. Montanari and J.S. Bracker, Strategic Management Journal, vol. 7, no. 3 (1986), reprinted by permission of John Wiley & Sons Ltd. Exhibit 6.9

Indicators of SBU Strength and Market Attractiveness Exhibit 6.10a

Market Attractiveness/SBU Strength Matrix Exhibit 6.10b

Strategy Guidelines Based on Directional Policy Matrix Exhibit 6.10c

International investment opportunities based on the directional policy matrix Source: Harrel, G.D. and R.D. Kiefer (1993), ‘Multinational market portfolio in global strategy development’, International Marketing Review 10 (1); Phillips, C., I. Duole, and R. Lowe, International Marketing Strategy, Routledge 1994, pp. 137–8. Exhibit 6.10d

References Essential of Strategic Management, Chapter 7 Some topics in the last few slides taken from Exploring Corporate Strategy- 7th Edition- Chapter 06