Corporate-Level Strategy

Corporate-Level Strategy MANA 5336

Directional Strategies

Directional Strategies Expansion Adaptive Strategy: • Orientation toward growth • Expand, cut back, status quo? • Concentrate within current industry, diversify into other industries? • Growth and expansion through internal development or acquisitions, mergers, or strategic alliances?

Directional Strategies Basic Growth Strategies: Concentration • Current product line in one industry • Vertical Integration • Market Development • Product Development • Penetration Diversification • Into other product lines in other industries

Directional Strategies Expansion of Scope Basic Concentration Strategies: Vertical growth Horizontal growth

Directional Strategies Vertical growth • Vertical integration • Full integration • Taper integration • Quasi-integration • Backward integration • Forward integration

Upstream Downstream Stages in the Raw-Material-to-Consumer Value Chain

Examples: Dow ChemicalUnion CarbideKyocera Examples:IntelSeagateMicron Examples:AppleHpDell Examples:Best BuyOffice Max Distribution Assembly Intermediatemanufacturer Raw materials End user Stages in the Raw-Material-to-Consumer Value Chain in the Personal Computer Industry

Vertical Integration • Integration backward into supplier functions • Assures constant supply of inputs. • Protects against price increases. • Integration forward into distributor functions • Assures proper disposal of outputs. • Captures additional profits beyond activity costs. • Integration choice is that of which value-adding activities to compete in and which are better suited for others to carry out.

Creating Value Through Vertical Integration • Advantages of a vertical integration strategy: • Builds entry barriers to new competitors by denying them inputs and customers. • Facilitates investment in efficiency-enhancing assets that solve internal mutual dependence problems. • Protects product quality through control of input quality and distribution and service of outputs. • Improves internal scheduling (e.g., JIT inventory systems) responses to changes in demand.

Creating Value Through Vertical Integration • Disadvantages of vertical integration • Cost disadvantages of internal supply purchasing. • Remaining tied to obsolescent technology. • Aligning input and output capacities with uncertainty in market demand is difficult for integrated companies.

Directional Strategies Horizontal Growth • Horizontal integration

Directional Strategies Basic Diversification Strategies: • Concentric Diversification • Conglomerate Diversification

Directional Strategies Concentric Diversification • Growth into related industry • Search for synergies

Concentration on a Single Business Southwest Airlines SEARS Coca-Cola McDonalds

Advantages Operational focus on a single familiar industry or market. Current resources and capabilities add value. Growing with the market brings competitive advantage. Disadvantages No diversification of market risks. Vertical integration may be required to create value and establish competitive advantage. Opportunities to create value and make a profit may be missed. Concentration on a Single Business

Diversification • Related diversification • Entry into new business activity based on shared commonalities in the components of the value chains of the firms. • Unrelated diversification • Entry into a new business area that has no obvious relationship with any area of the existing business.

Related Diversification Marriott 3M Hewlett Packard

Unrelated Diversification Tyco Amer Group ITT

Diversification and Corporate Performance: A Disappointing History • A study conducted by Business Week and Mercer Management Consulting, Inc., analyzed 150 acquisitions that took place between July 2000 and July 2005. Based on total stock returns from three months before, and up to three years after, the announcement: • 30 percent substantially eroded shareholder returns. • 20 percent eroded some returns. • 33 percent created only marginal returns. • 17 percent created substantial returns. • A study by Salomon Smith Barney of U.S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquiring firms have, on average, under-performed the S&P stock index by 14 percentage points and under-performed their peer group by four percentage points after the deals were announced.

Directional Strategies Unrelated (Conglomerate) Diversification • Growth into unrelated industry • Concern with financial considerations

Incentives Resources Managerial Motives Reasons for Diversification Reasons to Enhance Strategic Competitiveness • Economies of scope/scale • Market power • Financial economics

Incentives Resources Managerial Motives Reasons for Diversification Incentives with Neutral Effects on Strategic Competitiveness • Anti-trust regulation • Tax laws • Low performance • Uncertain future cash flows • Firm risk reduction

Incentives to Diversify External Incentives: • Relaxation of anti-trust regulation allows more related acquisitions than in the past • Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions • After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments

Incentives to Diversify Internal Incentives: • Poor performance may lead some firms to diversify an attempt to achieve better returns • Firms may diversify to balance uncertain future cash flows • Firms may diversify into different businesses in order to reduce risk

Resources and Diversification • Besides strong incentives, firms are more likely to diversify if they have the resources to do so • Value creation is determined more by appropriate use of resources than incentives to diversify

Reasons for Diversification Incentives Resources Managerial Motives Managerial Motives (Value Reduction) • Diversifying managerial employment risk • Increasing managerial compensation

Managerial Motives to Diversify Managers have motives to diversify • diversification increases size; size is associated with executive compensation • diversification reduces employment risk • effective governance mechanisms may restrict such motives

Bureaucratic Costs and the Limits of Diversification • Number of businesses • Information overload can lead to poor resource allocation decisions and create inefficiencies. • Coordination among businesses • As the scope of diversification widens, control and bureaucratic costs increase. • Resource sharing and pooling arrangements that create value also cause coordination problems. • Limits of diversification • The extent of diversification must be balanced with its bureaucratic costs.

Relationship Between Diversification and Performance Performance Dominant Business Related Constrained Unrelated Business Level of Diversification

Restructuring:Contraction of Scope • Why restructure? • Pull-back from overdiversification. • Attacks by competitors on core businesses. • Diminished strategic advantages of vertical integration and diversification. • Contraction (Exit) strategies • Retrenchment • Divestment– spinoffs of profitable SBUs to investors; management buy outs (MBOs). • Harvest– halting investment, maximizing cash flow. • Liquidation– Cease operations, write off assets.

Why Contraction of Scope? • The causes of corporate decline • Poor management– incompetence, neglect • Overexpansion– empire-building CEO’s • Inadequate financial controls– no profit responsibility • High costs– low labor productivity • New competition– powerful emerging competitors • Unforeseen demand shifts– major market changes • Organizational inertia– slow to respond to new competitive conditions

The Main Steps of Turnaround • Changing the leadership • Replace entrenched management with new managers. • Redefining strategic focus • Evaluate and reconstitute the organization’s strategy. • Asset sales and closures • Divest unwanted assets for investment resources. • Improving profitability • Reduce costs, tighten finance and performance controls. • Acquisitions • Make acquisitions of skills and competencies to strengthen core businesses.

Adaptive Strategies Maintenance of Scope Enhancement Status Quo

Market Entry Strategies • Acquisition:a strategy through which one organization buys a controlling interest in another organization with the intent of making the acquired firm a subsidiary business within its own portfolio • Licensing:a strategy where the organization purchases the right to use technology, process, etc. • Joint Venture:a strategy where an organization joins with another organization(s) to form a new organization

Learn and develop new capabilities Reshape firm’s competitive scope Overcome entry barriers Increase diversification Acquisitions Cost of new product development Increase speed to market Increase market power Lower risk compared to developing new products Reasons for Making Acquisitions

Reasons for Making Acquisitions: Increased Market Power • Factors increasing market power • when a firm is able to sell its goods or services above competitive levels or • when the costs of its primary or support activities are below those of its competitors • usually is derived from the size of the firm and its resources and capabilities to compete • Market power is increased by • horizontal acquisitions • vertical acquisitions • related acquisitions

Reasons for Making Acquisitions: • Barriers to entry include • economies of scale in established competitors • differentiated products by competitors • enduring relationships with customers that create product loyalties with competitors • acquisition of an established company • may be more effective than entering the market as a competitor offering an unfamiliar good or service that is unfamiliar to current buyers • Cross-border acquisition Overcome Barriers to Entry

Reasons for Making Acquisitions: • Significant investments of a firm’s resources are required to • develop new products internally • introduce new products into the marketplace • Acquisition of a competitor may result in • lower risk compared to developing new products • increased diversification • reshaping the firm’s competitive scope • learning and developing new capabilities • faster market entry • rapid access to new capabilities

Reasons for Making Acquisitions: Lower Risk Compared to Developing New Products • An acquisition’s outcomes can be estimated more easily and accurately compared to the outcomes of an internal product development process • Therefore managers may view acquisitions as lowering risk

Reasons for Making Acquisitions: Increased Diversification • It may be easier to develop and introduce new products in markets currently served by the firm • It may be difficult to develop new products for markets in which a firm lacks experience • it is uncommon for a firm to develop new products internally to diversify its product lines • acquisitions are the quickest and easiest way to diversify a firm and change its portfolio of businesses

Reasons for Making Acquisitions: Reshaping the Firms’ Competitive Scope • Firms may use acquisitions to reduce their dependence on one or more products or markets • Reducing a company’s dependence on specific markets alters the firm’s competitive scope

Reasons for Making Acquisitions: Learning and Developing New Capabilities • Acquisitions may gain capabilities that the firm does not possess • Acquisitions may be used to • acquire a special technological capability • broaden a firm’s knowledge base • reduce inertia

Resulting firm is too large Inadequate evaluation of target Managers overly focused on acquisitions Acquisitions Large or extraordinary debt Too much diversification Integration difficulties Inability to achieve synergy Problems With Acquisitions

Problems With Acquisitions Integration Difficulties • Integration challenges include • melding two disparate corporate cultures • linking different financial and control systems • building effective working relationships (particularly when management styles differ) • resolving problems regarding the status of the newly acquired firm’s executives • loss of key personnel weakens the acquired firm’s capabilities and reduces its value

Problems With Acquisitions • Evaluation requires that hundreds of issues be closely examined, including • financing for the intended transaction • differences in cultures between the acquiring and target firm • tax consequences of the transaction • actions that would be necessary to successfully meld the two workforces • Ineffective due-diligence process may • result in paying excessive premium for the target company Inadequate Evaluation of Target

Problems With Acquisitions • Firm may take on significant debt to acquire a company • High debt can • increase the likelihood of bankruptcy • lead to a downgrade in the firm’s credit rating • preclude needed investment in activities that contribute to the firm’s long-term success Large or Extraordinary Debt

Problems With Acquisitions • Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately • Firms experience transaction costs (e.g., legal fees) when they use acquisition strategies to create synergy • Firms tend to underestimate indirect costs of integration when evaluating a potential acquisition Inability to Achieve Synergy

Corporate-Level Strategy