Strategy: A View From the TopChapter 9 - Corporate Strategy: Shaping the Portfolio Group 5: Laura Moore Jeffri Vaughn Grant Gerhardt Patrick Kirkland Chet Visser
Shaping the Portfolio • What exactly is your business strategy? • Single business companies should have a clear, concise answer, and an easy-to-understand answer to this question • For multi-business companies, the answer is a bit more complex, and much less easier to understand.
Multi-business strategies, since they tend to be so complicated, are usually broken down into two to five themes, which makes them much easier to comprehend. • Ex. GE’s Strategic Themes are developing leaders, integrate business on a global scale, and prowess in making skillful acquisitions. • Breaking down a company’s strategy creates a powerful management tool for aligning behaviors and decision making at all levels within the company.
Definitions • Business Unit Strategy - how to compete in a given industry • Corporate Strategy - which business should the company operate in
Economies of Scale and Scope • Economies of Scale- Cost per unit decreases as volume goes up • Ex. Titleist: makes millions of golf balls and therefore can sell them at lower prices because of the sheer volume produced • Provides an advantage to being big, because large plants can often produce products at a much lower cost than smaller plants • Must be large to be able to compete globally, so you can undersell the region’s local competitors and compete with other global companies
Why do costs fall? • From the use of better technologies in the production process • Greater buyer power in large-scale purchasing situations • Finding better ways to perform a given task, thus driving the costs lower • Referred to as: Economics of Learning
Economies of Scope - Cost per unit falls because the asset used is shared with some other activity • Ex. AA using its aircraft to carry mail as well as parcels in extra space in their cargo holds • Three Classes of Economies of Scope • Horizontal • Geographical • Vertical
Horizontal Scope - Concerns choices of product scope • Ex. GE with their many different products: Jet Engines, Medical, Financial, and many other areas • Ex. Virgin with its many different businesses: Airline, Music, and various other things • Geographical Scope - Choices of geographical coverage • Ex. McDonalds and Coke with their operations in 100+ countries • Ex. Southwest with their choice only to operate domestically in the USA, and from 2nd tier airports
Vertical Scope - How the company will link its value chain activities vertically; whether the company manufactures everything themselves or do they buy and re-brand. • Ex. Boeing has a medium vertical strategy. They purchase some of their components from other companies and manufacture other components in-house.
Capitalizing on the Advantages of Scale and Scope • Companies must make investments related to the goal of making their global marketing and distribution organizations function properly, and efficiently. • Timing is critical • First Movers have the best chance to succeed, because challengers face an uphill battle. • First Movers can continue to build their market share and perfect their production process as the challengers work on building their production capacity.
Core • The best starting point for crafting a corporate strategy is to define the core. • The Core is a company’s most valuable products, channels, and distinctive capabilities. • Ex. AA: Maintenance Personnel, Pilots, and Cabin Crew • The challenge is to define the company in a way that is different from all the others so that the company is able to build on its real capabilities and avoid any wishful thinking. • Not choosing a core will result in risking confusion about a company’s positioning in its served markets, and may even make it harder to create value on a sustained basis.
Strategy Traps • Assumption that since their business units are performing well and have reached their limit, and therefore it is not necessary to make any more investments in their core business units • Assumption that there is a greater upside potential in underperforming businesses and making risky investments in these underperforming businesses • Prematurely abandoning core businesses
Ex. Colgate-Palmolive • Invested in its core business and drove it to its full potential. • Resulted in Colgate outperforming GE and generating returns three times of the S&P 500. • Became a leader in their industry. • Ex. Boeing • Bet nearly the entire company’s assets on the development of the 747 airliner. • Resulted in the most successful wide body in aviation history. • Cemented Boeing as the leader in commercial aircraft production.
Takeaways • A concise description of your corporate strategy • Economies of Scale and Scope and their uses and benefits • Capitalize on Economies of Scope and Scale • Choose a core and invest in it
Growth Strategies • Achieving consistent revenue and profit growth is hard, especially for large companies • A growth strategy that works for one company might not be appropriate for another • May even be disastrous • High percentage of mergers and acquisitions fail to meet expectations • Relying on internal growth to meet revenue targets is risky • Few companies consistently achieve higher-than-GDP growth from internal sources alone
Growth Strategies • To formulate a successful growth strategy, a company must carefully analyze its strengths and weaknesses, how it delivers value to customers, and what growth strategies its culture can effectively support • Selecting the right growth strategy requires a careful analysis of opportunities, strategic resources, and cultural fit
Growth Strategies • A company only has three avenues by which to grow its revenue base • 1. Organic or internal growth • Build: Wal-Mart and Dell • 2. Growth through acquisition • Buy: GE • 3. Growth through alliance-based initiatives • Bond: Amazon and eBay • “Build, Buy, or Bond” paradigm • Growth strategies can also be characterized by using product-market choice as the primary criterion • 1. Concentrated growth • 2. Vertical and horizontal integration • 3. Diversification
Concentrated Growth Strategies • Existing product markets often are attractive avenues for growth • A corporation that continues to direct its resources to the profitable growth of a single product category, in a well-defined market, and possibly with a dominant technology, is said to pursue a concentrated growth strategy
Concentrated Growth Strategies • Most direct way of pursuing concentrated growth is to target increases in market share • This can be done in three ways • 1. Increasing the number of users of the product • 2. Increasing product usage by stimulating higher quantities of use or by developing new applications • 3. Increasing the frequency of the product’s use
Concentrated Growth Strategies • Concentrated growth can be a powerful competitive weapon • A tight product-market focus allows a company to finely assess market needs, develop a detailed knowledge of customer behavior and price sensitivity, and improve the effectiveness of marketing and promotion efforts • High success rates of new products also are tied to avoiding situations that require undeveloped skills
Concentrated Growth Strategies • Four specific conditions favor concentrated growth • 1. The industry is resistant to major technological advancements. This is usually the case in the late growth and maturity stages of the product life cycle and in product-markets where product demand is stable and industry barriers, such as capitalization, are high. • 2. Targeted markets are not product-saturated. Markets with competitive gaps leave the firm with alternatives for growth, other than taking market share away from competitors. • 3. The product-market is sufficiently distinctive to discourage competitors from trying to invade the segment. • 4. Necessary inputs are stable in price and quantity and are available in the amounts and at the times needed.
Concentrated Growth StrategiesSample of corporations that successfully use concentrated growth strategies include:
Vertical and Horizontal Integration • If a corporation’s current lines of business show strong growth potential, two additional avenues for growth – vertical and horizontal integration – are available • Vertical integrationdescribes a strategy of increasing a corporation’s vertical participation in an industry’s value chain • Backward integrationentails acquiring resource suppliers or raw materials or manufacturing components that used to be sourced elsewhere
Vertical and Horizontal Integration • Forward integrationrefers to a strategy of moving closer to the ultimate customer by acquiring a distribution channel or by offering after-sale services • Vertical integration can be valuable if the corporation possesses a business unit that has a strong competitive position in a highly attractive industry – especially when the industry’s technology is predictable and markets are growing rapidly • It can reduce a corporation’s strategic flexibility by creating an exit barrier that prevents the company from leaving the industry if its fortunes decline
Vertical and Horizontal Integration • Decisions about vertical scope are of key strategic importance at both the business unit and corporate levels because they involve the decision to redefine the domains in which the firm will operate • Vertical integration also affects industry structure and competitive intensity • There are four reasons to vertically integrate
Vertical and Horizontal Integration • There are four reasons to vertically integrate • 1. The market is too risky and unreliable and is at risk of “failing.” The typical features of a failed vertical market are (1) a small number of buyers and sellers; (2) high asset specificity, durability, and intensity; and (3) frequent transactions. • 2. A company in an adjacent stage of the industry chain has more market power. Specifically, if one stage of an industry chain exerts market power over another and thereby achieves abnormally high returns, it may be attractive for participants in the dominated industry to enter the dominating industry. Players in weak stages of an industry chain might have clear incentives to move into the powerful stages; however, such a move is not without danger. Existing players in an industry often believe they can enter another business within the chain more easily than can outsiders. The key skills along an industry chain usually differ so substantially that outsiders with analogous skills from other industries often are superior entrants.
Vertical and Horizontal Integration • 3. Vertical integration also makes strategic sense when used to create or exploit market powers by raising barriers to entry or allowing price discrimination across customer segments. • Barriers to entry. When most competitors in an industry are vertically integrated, it can be difficult for nonintegrated players to enter. Potential entrants might have to enter all stages to compete. This increases capital costs and the minimum efficient scale of operations, thus raising barriers to entry. • Price discrimination. Forward integration into selected customer segments can allow a company to benefit from price discrimination.
Vertical and Horizontal Integration • 4. When an industry is young, companies sometimes forward integrate to develop a market. This is successful only when the downstream business possesses proprietary technology or a strong brand image prevents imitation by “free rider” competitors. It is futile to develop new markets if a company cannot capture the economic gains for at least several years.
Vertical and Horizontal Integration • Three important questions with respect to vertical and horizontal integration (PIMS Ch. 6): • 1. Are highly integrated businesses in general more or less profitable than less integrated ones? • 2. Under what circumstances is a high level of vertical integration likely to be most profitable? • 3. Apart from its influence on overall profitability, what are the principal benefits and risks associated with vertical integration strategies?
Vertical and Horizontal Integration • Answers: • The study found that for both industrial and consumer manufacturing businesses, backward integration generally raised ROI but forward integration did not, whereas partial integration generally hurt ROI. • The impact of vertical integration on profitability varies with the size of the business. Larger businesses tend to benefit to a greater extent than smaller ones. This suggests that vertical integration might be a particularly attractive option for businesses with a substantial market share in which further backward integration has the potential for enhancing competitive advantage and increasing barriers to entry.
Vertical and Horizontal Integration • What other factors should be considered, (1) alternatives to ownership, such as long-term contracts and alliances, should actively be considered; (2) vertical integration almost always requires substantial increases in investment; (3) projected cost reductions do not always materialize; and (4) vertical integration sometimes results in increased product innovation. • *Although useful as a general guide to crafting strategy, some of these findings might need to be validated before applying them to a specific industry
Vertical and Horizontal Integration • Horizontal integration involves increasing the range of products and services offered to current markets or expanding the firm’s presence into a wider number of geographic locations • Horizontal integration strategies often are designed to leverage brand potential • In recent years, strategic alliances have become an increasingly popular way to implement horizontal growth strategies
Diversification • The term diversification has a wide range of meanings in connection with many aspects of business activity. • In a strategic context, diversification is defined as a strategy of entering product markets different from those in which a company is currently engaged. • Berkshire Hathaway is a good example of a company engaged in diversification.
Berkshire Hathaway • Examples of Berkshire’s Diversity: • Acme Brick • Ben Bridge Jewelers • Fruit Of The Loom • GEICO Auto Insurance • NetJets • See’s Candy • Star Furniture
Fortune Brands • Jim Beam, Sauza, Maker’s Mark, Cruzan, Canadian Club, Courvoisier • Moen, Master Lock, Master Brands, Simonton • Titleist, FootJoy, Cobra, Pinnacle, Scotty Cameron
Diversification Strategy • Diversification strategies pose a great challenge to corporate executives. • In the 1970s, many US companies, facing stronger competition from abroad and diminished growth prospects in a number of traditional industries, moved into industries in which they had no particular competitive advantage.
Diversification Strategy • Believing that general management skill could offset knowledge gained from experience in an industry, executives thought that because they were successful in their own industries, they could be just as successful in others. • A depressing number of their subsequent experiences showed that these executives overestimated their relevant competence and, under these circumstances, bigger was worse, not better.
Diversification Strategy • Diversification strategies can be motivated by a variety of factors, including the desire to create revenue growth, increase profitability through shared resources and synergies, reduce the company’s overall exposure to risk by balancing the business portfolio, or an opportunity to exploit underutilized resources. • Diversifying • Relatedness or the potential for synergy is a major consideration in formulation diversification strategies. • Relatedness or synergy can be defined in a number of ways…
Relatedness or Synergy • The most common interpretation defines relatedness in terms of tangible linksbetween business units. • A second form of relatedness among business unities is based on common intangible resources, such as knowledge or capabilities. • A third form of relatedness concerns the ability of a business unity to jointly gain or exercise market power. • A forth form is strategic relatedness. It is defined in terms of the similarity of the strategic challenges faced by different business units.
Relatedness • A well-known study links a company’s performance to the degree of relatedness among its various businesses. It identifies three categories of relatedness based on a firm’s specialization ratio, defined as the proportion of revenues derived from the largest single group of related businesses: dominant business companies, related business companies, and unrelated business companies.
Risks of Diversification Strategy • What can the company do better than any of its competitors in its current markets? • What strategic assets are needed to succeed in the new market? • Can the firm catch or leapfrog competitors? • Will diversification break up strategic assets that need to be kept together? • Will our firm simply be a player in the new market or will it be a winner? • What can the corporation learn by diversifying, and is it organized to learn it?
Tests • Attractiveness Test • Is the industry the company is about to enter fundamentally attractive from a growth, competitive, and profitability perspective, or can the company create such favorable conditions? • Cost of Entry Test • Are the costs of entry reasonable? Is the time horizon until the venture becomes profitable acceptable? Are risk levels within accepted tolerances? • Better-Off Test • Does the overall portfolio’s competitive position and performance improve as a result of the diversification move?
Diversification • Diversification is a powerful weapon in a corporation’s strategic arsenal. It is not a panacea for rescuing corporations with mediocre performance, however. If done carefully, diversification can improve shareholder value, but it needs to be planned carefully in the context of an overall corporate strategy.
Mergers and Acquisitions • A mergersignifies that two companies have joined to form one company. • An acquisition occurs when one firm buys another. • In acquisitions, the management team of the buyer tends to dominate decision making in the combined company. • Acquisitions are generally more expensive.
Six Themes of Acquisition • Successful acquisitions are usually part of a well-developed corporate strategy. • Diversification through acquisition is an ongoing, long-term process that requires patience. • Successful acquisitions usually result from disciplined strategic analysis, which looks at industries first before it targets companies, while recognizing that good deals are firm-specific.
Six Themes con’t • An acquirer can add value in only a few ways, and before proceeding with an acquisition, the buying company should be able to specify how synergies will be achieved and value created. • Objectivity is essential, even though it is hard to maintain once the acquisition chase continues. • Most acquisitions flounder on implementation; strategies for implementation should be formulated before the acquisition is completed and executed quickly after the acquisition deal is closed.
Attractive Key Drivers • Risk sharing—prioritize strategic interests and balance them according to risk • Funding limitations—to compete in the global arena, companies must incur immense fixed costs with a shorter payback period and at a higher level of risk • Market access—customers benefit because the gaps in product lines are filled with quality products • Technology access—partnering with technologically compatible companies to achieve the prerequisite level of excellence is often essential
Cooperative Strategy • Cooperative strategies—joint ventures, strategic alliances, and other partneringarrangements—have become increasingly popular in recent years. • For many corporations, cooperative strategies capture the benefits of internal development and acquisition while avoiding the drawbacks of both. • Other reasons to pursue a cooperative strategy are a lack of particular management skills; an inability to addvalue in-house; and a lack of acquisition opportunitiesbecause of size, geographical, or ownership restrictions. • The airline industry provides a good example of some of the drivers and issues involved in forging strategic alliances.
The Strategic Logic of Alliances • Each business has its own, “unique alliance drivers.” • Key drivers in the early growth stage • Product innovation • Credibility • Access to capital • External value, market and customer reach are the most important factors in the Rapid Growth and Consolidation phases.
Stability Stage • Reduced cost • Value-chain strengthening • Product extension • Alliance Models-Booz Allen Hamilton, Inc. • Franchise • Portfolio • Cooperative • Constellation