Managing Diversity across Multiple Businesses

Managing Diversity across Multiple Businesses
CORPORATE STRATEGY Managing Diversity across Multiple Businesses

Corporate-Level Strategy
Corporate-Level Strategy should allow a company, or its business units, to perform the value-creation functions at lower cost or in a way that allows for differentiation and premium price. Corporate strategy is used to identify: Businesses or industries that the company should compete in Value creation activities that the company should perform in those businesses Method to enter or leave businesses or industries in order to maximize its long-run profitability Companies must adopt a long-term perspective Consider how changes in the industry and its products, technology, customers, and competitors will affect its current business model and future strategies. Copyright © Houghton Mifflin Company. All rights reserved.

Corporate-Level Strategy: The Multi-Business Model
A company’s corporate-level strategies should be chosen to promote the success of a company’s business model – and to allow it to achieve a sustainable competitive advantage at the business level. A multi-business company must construct its business model at two levels: Business models and strategies for each business unit or division in every industry in which it competes Higher-level multi-business model that justifies its entry into different businesses and industries Copyright © Houghton Mifflin Company. All rights reserved.

Corporate Strategy asks
Two Questions Should we compete in our current business by engaging in closely-related businesses? Should we compete in new related or unrelated businesses ? Copyright © Houghton Mifflin Company. All rights reserved.

How do we manage diversity? How do we manage different businesses?
Corporate Strategy Core Challenge of Corporate Strategy: How do we manage diversity? How do we manage different businesses? (Different businesses may compete in different environments and require different resources and capabilities) Copyright © Houghton Mifflin Company. All rights reserved.

Core question: Relatedness
Closely-related = directly related to a firm’s core business Suppliers Buyers Competitors Related: shares some strategic characteristic with core business Value chain resources, capabilities Unrelated: no logical or complementary relationship to core business Copyright © Houghton Mifflin Company. All rights reserved.

Repositioning and Redefining A Company’s Business Model
Corporate-level strategies are primarily directed toward improving a company’s competitive advantage and profitability in its present business or product line: Horizontal Integration The process of acquiring or merging with industry competitors Vertical Integration Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company’s products Strategic Outsourcing Letting some value creation activities within a business be performed by an independent entity Copyright © Houghton Mifflin Company. All rights reserved.

Related Business Diversification
Horizontal Integration Vertical Integration Strategic Outsourcing Copyright © Houghton Mifflin Company. All rights reserved.

Horizontal Integration Single-Industry Strategy
Horizontal Integration is the process of acquiring or merging with industry competitors in an effort to achieve the competitive advantages that come with large scale and scope. Staying inside a single industry allows a company to: Focus resources Its total managerial, technological, financial and functional resources and capabilities are devoted to competing successfully in one area. ‘Stick to its knitting’ Company stays focused on what it does best, rather than entering new industries where its existing resources and capabilities add little value. Copyright © Houghton Mifflin Company. All rights reserved.

Benefits of Horizontal Integration
Profits and profitability increase when horizontal integration: Lowers the cost structure Creates increasing economies of scale Reduces the duplication of resources between two companies Increases product differentiation Product bundling – broader range at single combined price Total solution – saving customers time and money Cross-selling – leveraging established customer relationships Replicates the business model In new market segments within same industry Reduces industry rivalry Eliminate excess capacity in an industry Easier to implement tacit price coordination among rivals Increases bargaining power Increased market power over suppliers and buyers Gain greater control Copyright © Houghton Mifflin Company. All rights reserved.

Problems with Horizontal Integration
A wealth of data suggests that the majority of mergers and acquisitions DO NOT create value and that many may actually DESTROY value. Implementing a horizontal integration is not an easy task. Problems associated with merging very different company cultures High management turnover in the acquired company when the acquisition is a hostile one Tendency of managers to overestimate the benefits to be had in the merger Tendency of managers to underestimate the problems involved in merging their operations The merger may be blocked if merger is perceived to: Create a dominant competitor Create too much industry consolidation Have the potential for future abuse of market power Copyright © Houghton Mifflin Company. All rights reserved.

Vertical Integration Entering New Industries
A company may expands its operations backward into industries that produces inputs to its products or forward into industries that utilize, distribute or sell it products. Backward Vertical Integration Company expands its operations into an industry that produces inputs to the company’s products. Forward Vertical Integration Company expands into an industry that uses, distributes, or sells the company’s products. Full Integration Company produces all of a particular input from its own operations. Disposes of all of its completed products through its own outlets. Taper Integration In addition to company-owned suppliers, the company will also use other suppliers for inputs or independent outlets in addition to company-owned outlets. Copyright © Houghton Mifflin Company. All rights reserved.

Increasing Profitability Through Vertical Integration
A company pursues vertical integration to strengthen the business model of its original or core business or to improve its competitive position: Facilitates investments in efficiency-enhancing specialized assets Allows company to lower the cost structure or Better differentiate its products Enhances or protects product quality To strengthen its differentiation advantage through either forward or backward integration Results in improved scheduling Makes it easier and more cost-effective to plan, coordinate, and schedule the transfer of product within the value-added chain Enables a company to respond better to changes in demand Copyright © Houghton Mifflin Company. All rights reserved.

Problems with Vertical Integration
Companies may disintegrate or exit industries adjacent to the industry value chain when encountering disadvantages from the vertical integration: Cost structure is increasing. Company-owned suppliers develop a higher cost structure than those of the independent suppliers Bureaucratic costs of solving transaction difficulties The technology is changing fast. Vertical integration may lock into old or inefficient technology Prevent company from changing to a new technology that could strengthen the business model Demand is unpredictable. Creates risk in vertical integration investments. Vertical integration can weaken business model when: Company-owned suppliers lack incentive to reduce costs Changing demand or technology reduces ability to be competitive Copyright © Houghton Mifflin Company. All rights reserved.

Alternatives to Vertical Integration: Cooperative Relationships
Strategic Alliances are long-term agreement between two or more companies to jointly develop new products or processes that benefit all companies concerned. Short-term contracts and competitive bidding May signal a company’s lack of commitment to its supplier Strategic alliances and long-term contracting Enables creation of a stable long-term relationship Becomes a substitute for vertical integration Avoids the problems of having to manage a company located in an adjacent industry Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Outsourcing
Strategic Outsourcing allows one or more of a company’s value-chain activities or functions to be performed by independent specialized companies that focus all their skills and knowledge on just one kind of activity. Company is choosing to focus on a fewer number of value-creation activities In order to strengthen its business model Companies typically focus on noncore or nonstrategic activities In order to determine if they can be performed more effectively and efficiently by independent specialized companies Virtual Corporation Describes companies that have pursued extensive strategic outsourcing Copyright © Houghton Mifflin Company. All rights reserved.

Strategic Outsourcing of Primary Value Creation Functions
Figure 9.4 Copyright © Houghton Mifflin Company. All rights reserved.

Benefits of Outsourcing
Reducing the cost structure The specialist company cost is less than what it would cost to perform the activity internally. Enhanced differentiation The quality of the activity performed by the specialist is greater than if the activity were performed by the company. Focus on the core business Distractions are removed. The company can focus attention and resources on activities important for value creation and competitive advantage. Strategic outsourcing may be detrimental when: Holdup – company becomes too dependent on specialist provider Loss of information – company loses important customer contact or competitive information Copyright © Houghton Mifflin Company. All rights reserved.

Expanding Beyond a Single Industry
Staying inside a single industry allows a company to: Focus its resources  ‘Stick to its knitting’ BUT a company’s fortunes are tied closely to the profitability of its original industry: Can be dangerous if the industry matures and goes into decline May be missing the opportunity to leverage their distinctive competencies in new industries Tendency to rest on their laurels and not engage in constant learning To stay agile, companies must leverage – find new ways to take advantage of their distinctive competencies and core business model in new markets and industries. Copyright © Houghton Mifflin Company. All rights reserved.

Corporate-Level Strategy of Diversification
Diversification Strategy is the company’s decision to enter one or more new industries (that are distinct from its established operations) to take advantage of its existing distinctive competencies and business model. Types of diversification: Related diversification Unrelated diversification Methods to implement a diversification strategy: Internal new ventures Acquisitions Joint ventures Copyright © Houghton Mifflin Company. All rights reserved.

A Company as a Portfolio of Distinctive Competencies
Reconceptualize the company as a portfolio of distinctive competencies rather than a portfolio of products: Consider how those competencies might be leveraged to create opportunities in new industries Existing competencies versus new competencies that would need to be developed Existing industries in which a company competes versus new industries Copyright © Houghton Mifflin Company. All rights reserved.

Establishing a Competency Agenda
Figure 10.1 Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright © 1994 by Gary Hamel and C. K. Prahalad. All rights reserved. Copyright © Houghton Mifflin Company. All rights reserved.

Increasing Profitability Through Diversification
A diversified company can create value by: Transferring competencies among existing businesses Leveraging competencies to create new businesses Sharing resources to realize economies of scope Using product bundling Managing rivalry by using diversification as a means in one or more industries Exploiting general organizational competencies that enhance performance within all business units Managers often consider diversification when their company is generating free cash flow – with resources in excess of those needed to maintain competitive advantage. Copyright © Houghton Mifflin Company. All rights reserved.

2 Types of Diversification
Related diversification Entry into a new business activity in a different industry that: Is related to a company’s existing business activity or activities and Has commonalities between one or more components of each activity’s value chain Based on transferring and leveraging competencies, sharing resources, and bundling products Unrelated diversification Entry into industries that have no obvious connection to any of a company’s value-chain activities in its present industry or industries Based on using only general organizational competencies to increase profitability of each business unit Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.
“Fit between a parent and its businesses is a two-edged sword: a good fit can create value, a bad one can destroy it.” - Andrew Campbell, Michael Gould & Marcus Alexander Copyright © Houghton Mifflin Company. All rights reserved.

Commonalities Between Value Chains of Three Business Units

Disadvantages and Limits of Diversification
Conditions that can make diversification disadvantageous: Changing Industry and Firm-Specific Conditions Future success of this strategy is hard to predict. Over time, changing situations may require businesses to be divested. Diversification for the Wrong Reasons Must have clear vision as to how value will be created. Extensive diversification tends to reduce rather than improve profitability. Bureaucratic Costs of Diversification Costs are a function of the number of business units in a company’s portfolio, and the Extent to which coordination is required to gain the benefits. Copyright © Houghton Mifflin Company. All rights reserved.

Coordination Among Related Business Units

Choosing a Strategy The choice of strategy depends on a comparison of the benefits of each strategy versus the cost of pursuing it: Related diversification When company’s competencies can be applied across a greater number of industries and Company has superior capabilities to keep bureaucratic costs under control Unrelated diversification When functional competencies have few useful applications across industries and Company has good organizational design skills to build distinctive competencies Web of corporate level strategy May pursue both related and unrelated diversification As well as other strategies that improve long-term profitability Copyright © Houghton Mifflin Company. All rights reserved.

Sony’s Web of Corporate-Level Strategy

Diversification That Dissipates Value
Diversifying to pool risks Stockholders can diversify their own portfolios at lower costs than the company can. This represents an unproductive use of resources as profits can be returned to shareholders as dividends. Research suggests that corporate diversification is not an effective way to pool risks. Diversifying to achieve greater growth Growth on its own does not create value. Business cycles of different industries are inherently difficult to predict. Based on a large number of academic studies: Extensive diversification tends to reduce, rather than improve, company profitability. Copyright © Houghton Mifflin Company. All rights reserved.

Entry Strategies to Implement Multibusiness Model
Various entry strategies may be employed based on the company’s competencies and capabilities: Internal New Ventures Company has a set of valuable competencies in its existing businesses. Competences leveraged or recombined to enter new business areas. Acquisitions Company lacks important competencies to compete in an area. Company can purchase an incumbent company that has those competencies at a reasonable price. Joint Ventures Company can increase the probability of success by teaming up with another company with complementary skills. Joint ventures are preferred when risks and costs of setting up a new business unit are more than company can assume. Copyright © Houghton Mifflin Company. All rights reserved.

 Pitfalls of New Ventures
Scale of entry Large-scale entry is initially more expensive than small scale entry, but it brings higher returns in the long run. Commercialization Technological possibilities should not overshadow market needs and opportunities. Poor implementation Demands on cash flow Need clear strategic objectives Anticipate time and costs Copyright © Houghton Mifflin Company. All rights reserved.

Scale of Entry and Profitability

 Guidelines for Successful Internal New Venturing
Structured approach to managing internal new venturing: Research aimed at advancing basic science and technology Development research aimed at finding and refining commercial applications for the technology Foster close links between R&D and marketing; between R&D and manufacturing Selection process for choosing ventures Monitor progress Copyright © Houghton Mifflin Company. All rights reserved.

 The Attractions of Acquisition
Acquisitions are the principal strategy used to implement horizontal integration: Used to achieve diversification when the company lacks important competencies Enable a company to move quickly Perceived as less risky than internal new ventures An attractive way to enter a new industry that is protected by high barriers to entry Copyright © Houghton Mifflin Company. All rights reserved.

 Acquisition Pitfalls
There is ample evidence that many acquisitions fail to create value or to realize their anticipated benefits: Integrating the acquired company Difficulty in integrating value-chain and management activities High management and employee turnover in acquired company Overestimating the economic benefits Overestimate the competitive advantages and value-added that can be derived from the acquisition Pay too much for the target company The expense of acquisitions Premium paid for publicly traded companies Premium cancels out the prospective value-creating gains Inadequate preacquisition screening Weaknesses of acquisitions’ business model are not clear Copyright © Houghton Mifflin Company. All rights reserved.

 Guidelines for Successful Acquisition
Target identification and preacquisition screening for: Financial position Distinctive competencies and competitive advantage Changing industry boundaries Management capabilities Corporate culture Bidding strategy Avoid hostile takeovers and speculative bidding. Encourage friendly takeover with amicable merger. Integration Eliminate duplication of facilities and functions. Divest unwanted business units included in acquisition. Learning from experience Conduct post-acquisition audits. Copyright © Houghton Mifflin Company. All rights reserved.

 Joint Ventures Attractions: Helps avoid the risks and costs of building a new operation from the ground floor Teaming with another company that has complementary skills and assets may increase the probability of success Pitfalls: Requires the sharing of profits if the new business succeeds Venture partners must share control – conflicts on how to run the joint venture can cause failure Run the risk of giving critical know-how away to joint venture partner Copyright © Houghton Mifflin Company. All rights reserved.

“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 Copyright © Houghton Mifflin Company. All rights reserved.

Corporate Structure What if diversification doesn’t work? Restructuring: alter portfolio by Divesting businesses Exiting industries Restructuring is the process of divesting businesses and exiting industries to focus on core distinctive competencies in order to increase company profitability. Copyright © Houghton Mifflin Company. All rights reserved.

Restructuring Why restructure? Diversification discount: investors see highly diversified companies as less attractive Complexity and lack of transparency in financial statements Too much diversification Diversification for the wrong reasons Response to failed acquisitions Innovations in strategic management have diminished the advantages of vertical integration or diversification Copyright © Houghton Mifflin Company. All rights reserved.

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