Ch 7. Corporate Strategy Beau Gould - Larry Griffin - Cristian Marsico - Teresita Pinon

Corporate strategy is concerned with where a firm competes whereas business strategy is how a firm competes.

The Scope of the Firm Deciding “What business are we in?” Product Scope - Breadth of the firm’s product range Vertical Scope - Extent of the involvement in the industry value chain

Key Concepts for Analysing Firm Scope Economies of Scope Cost economies is the reduction in average costs that result from an increase in the output of multiple products This exists when using a resource across multiple activities uses less of that resource than when the activities are carried out independently Examples: Tangible - centralized administrative and support services through shared service organizations Intangible - corporate reputation through brand extension Transaction Costs Making a sale or purchase involves search costs, negotiation costs, costs for drawing up a contract, cost of monitoring the deal, and costs for arbitration in the case of a dispute

Key Concepts for Analysing Firm Scope The Cost of Corporate Complexity If a firm extends its scope of operations by directly being involved in additional business activities it may benefit from economies of scope and eliminating transaction costs By doing this firms are incurring additional management costs This in turn leads to the possibility that management costs may exceed the savings from directly engaging in these activities Hence the constant awareness needed to balance corporate activities for overall profitability

Diversification This refers to the expansion of an existing firm into another product line or field of operation Horizontal diversification involves the firm moving into the same stage of production Vertical Diversification occurs when a firm undertakes successive stages in the production of a good or service

The Costs and Benefits of Diversification Growth - Companies are always looking to expand into other industries Risk Reduction - “Don’t put all your eggs in one basket” Value Creation - Is shown by exploiting linkages between different businesses Exploiting Economies of Scope - Brand recognition and company reputation Internal Capital Markets - Keeps cash-flowing internally by eliminating outside borrowing and debt/equity fundraising; Better access to information on their financial prospects Internal Labor Markets - Relies less on hiring/firing but more on internal promotions and employee transfers to different divisions

When Does Diversification Create Value Attractiveness Test - The industries chosen for diversification must be structurally attractive or capable of being made attractive Cost of Entry Test - The cost of entry must not capitalize all the future profits Better-off Test - Either the new unit must gain competitive advantage from its link with the corporation, or vice versa

Diversification Continued Diversification and Performance The performance effects of diversification depend on the mode of diversification. In general, when companies divest diversified businesses and concentrate more on their core businesses, the result is increased profitability and higher stock valuation. Related and Unrelated Diversification Companies can choose to diversify into related or unrelated industries The distinction between what is related and unrelated is not always a fine line Overall it seems likely that diversification into related industries should be more profitable than diversification into unrelated industries

Vertical Integration refers to the firm’s ownership of vertically related activities.

Benefits of Vertical Integration 1. Reduces Risk 2. Cost savings due to the integration of processes 3. Eliminate certain transaction costs 4. Facilitate transaction specific investments 5. Quickly adapt entire value chain

Cons of Vertical Integration 1. The incentive problem 2. Lack of flexibility 3. Compounding risk 4. Shifting assets to non-core competencies 5. Limited scope for economies of scale

Vertical Integration Continued Types of Vertical Relationships Long-term contracts Vendor partnerships Franchising

Recent Trends in Vertical Integration “Hybrid” vertical relationships Long-term sole supplier contracts Supplier networks Outsourcing + competencies Purchasing small stakes in supplier/service network Virtual corporations

Realogy Holdings Corp Examples of Vertical Integration 10/ Spun off from Cendant 07/ Acquired ZipRealty 10/ Acquired Title Resource Group Kent noted, "What we viewed to be a pure play, easy story has turned more complex with acquisitions, tough comps, and charges offsetting improving existing home sales."

CBRE Group Examples of Vertical Integration Sold off from Coldwell Banker 10/ Merged with developer TramwellCrow 02/ Acquired ING’s real estate investment arm 02/ Acquired ING’s listed securities business

CBRE Revenue vs Earnings Growth

Jones Lang Lasalle Examples of Vertical Integration Over 35 mergers and acquisitions since 2007 Recent Acquisitions Propell Valuations in Australia AGL Financial Advisory in Sweden Oak Grove Capital in the US Bill themselves as a professional services firm with a focus in real estate

Portfolio planning allow firms to manage multiple businesses to create the most value possible.

GE/McKinsey Matrix Market Attractiveness: Market size, growth rate, and profitability Cyclicity Inflation recovery International potential Business Unit Strength: Market Share Return on sales (relative to competitors Market position (in terms of quality, technology, manufacturing, distribution, marketing, and cost)

BCG Growth Share Matrix Similar to GE/McKinsey but more limited Uses only market share and market growth rate as defining factors Simplicity makes for ease of use and clear picture of company standing but also masks certain problems BMW: 2% share of world auto market Cow or dog?

Ashridge Portfolio Display Focuses on overall fit between parent company and potential business acquisition Fit (Horizontal Axis) Potential for parent to generate profit through by applying management capabilities, resource sharing, and economies of scale Misfit (Vertical Axis) Potential for value destruction by parent by added costs of corporate overhead or mismatch of management needs/styles Uses subjective criteria, therefore can be more complicated to use Extremely important, given today’s complex business environment

What Does This Mean for ? The GE/McKinsey matrix helps to identify which businesses to grow and which to harvest based on market and business analysis The BCG growth matrix allows the company to easily classify existing business to determine strategies moving forward The Ashridge Portfolio Display helps to analyze potential businesses and assist with selecting the ones that would be a proper fit

In Summary Analyzing a firm’s scope is imperative for creating a diversification strategy that reduces risk and creates value Trends have shifted to corporate networks but traditional vertical integration can still be a valuable tool Portfolio planning, through the use of various charts and matrixes, helps companies to develop the optimal mix of businesses and investments