1. Chapter 7
Corporate Strategy

2. Learning objectives
By the time you have completed this topic you will:
be familiar with the concepts of economies of scope, transaction costs and the costs of managing complexity, and understand how these ideas help explain firm boundaries and shifts over time;
understand the rationale behind multi-business activity and the potential benefits and costs of extending the horizontal or vertical scope of a firm;
be able to evaluate the advantages and disadvantages of changing a firm’s scope and the different ways of exploiting opportunities for value creation;
appreciate the trends in diversification and vertical integration over time and understand mergers, acquisitions and alliances;
be familiar with the techniques of portfolio analysis and be able to apply them to corporate strategic decisions.
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3. Structure of the session
the scope of the firm
key concepts for analysing firm scope
economies of scope
transaction costs
the costs of corporate complexity
diversification
vertical integration
strategic manoeuvring
managing the corporate portfolio
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4. Building an empire Empire Company Ltd. is based in Nova Scotia.
Their subsidiary Sobeys owns or franchises over 1500 stores across Canada under the names Sobeys, IGA, Thrifty Foods, Foodland, Lawtons drug stores, and FreshCo.
$17 billion sales, 47,000 employees
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5. Empire’s diversification strategy
In previous decades, Empire acquired groceries, drug stores, industrial products, movie theaters, and real estate - product scope.
Now Empire is concentrating on food retailing and real estate - geographic and vertical scope.
In 2013, Empire purchased the Canadian Subsidiary of Safeway for $5.8 billion cash.
Safeway had 213 stores, 199 pharmacies, 62 gas stations, 12 manufacturing facilities, and 4 distribution centres.
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6. The scope of the firm
Product scope – How wide a range of products does the firm supply? Vertical scope – What range of vertically linked activities does the firm encompass? Geographical scope – What is the geographical spread of the firm’s activities? Does it compete locally or globally?
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7. Key concepts for analyzing firm scope
Economies of scope: cost economies from spreading costs of over multiple products.
Transaction costs: the costs of market transactions. When the costs of administering transactions within the firm are lower than the costs of market transactions, the firm grows in size and scope.
The costs of corporate complexity: impose limits to the firm’s growth in size and scope.
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8. The scope of the firm: specialization vs. integration
In the integrated firm there is an administrative interface between the different vertical units (V), product units (P), and country units (C). Where there is specialization, each unit is a separate firm linked by market interfaces. Which arrangement is more efficient depends upon economies of scope, transaction costs and costs of complexity.
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9. Transaction costs at Empire
Most supermarkets are neither fully vertically integrated, nor wholly reliant on the open market.
Empire chose a middle ground of long-term contractual relationships with a small number of suppliers.
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10. The benefits and costs of diversification
Growth: A powerful motive for managers—but growth without profitability does not create value for shareholders. Growth through acquisition a major destroyer of shareholder value.
Risk spreading: Diversification tends to reduce fluctuations in profits; but this does not necessarily create value for shareholders.
Value creation: For diversification to create shareholder value it must exploit some linkage (“synergy”) between the different businesses, e.g., by:
exploiting economies of scope,
operating an efficient internal capability market,
operating an internal labour market.
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11. When does diversification create value?
Porter’s “three essential tests”
The attractiveness test: The 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 capitalize all the future profits.
The better-off test: Either the new unit must gain competitive advantage from its link with the corporation, or vice versa.
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12. Did Empire’s diversification create value?
The attractiveness test: Western Canada is the fastest growing region. The cost-of-entry test: Acquisition of Safeway avoided “greenfield” costs and saved Empire $200 million per year. The better-off test: Empire sold 68 Safeway properties for $990 million.
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13. Diversification and performance
How do diversified firms perform relative to specialized firms?
Does related diversification outperform unrelated diversification?
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14. Diversification and performance
In North America and Western Europe…
When companies divest diversified businesses and concentrate on their core business, the result is typically increased profitability and higher stock valuation.
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15. Vertical integration: benefits and costs
Sources of benefits
technical economies from integrating processes
avoids transactions costs in vertical exchanges; especially where there are:
small numbers of firms,
transaction-specific investments,
limited information.
superior coordination
Sources of costs
differences in optimal scale between different
incentive problems
limits flexibility—e.g., in responding to changes in demand and in technology. (however, may enhance system-wide flexibility)
compounding of risk
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16. The vertical chain for steel cans
Question: Why do market contracts predominate between some
stages and vertical integration between others?
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17. Different types of vertical relationships
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19. MANAGING THE CORPORATE PORTFOLIO
The GE/McKinsey portfolio planning matrix
THE GE/MCKINSEY PORTFOLIO PLANNING MATRIX
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20. Managing the corporate portfolio: the BCG growth-share matrix
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21. MANAGING THE CORPORATE PORTFOLIO: THE ASHRIDGE PORTFOLIO DISPLAY
Source: Ashridge Strategic Management Centre
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22. CopyRIGHT
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