Session 7: Corporate Strategy: Integration and Diversification

Corporate Level Strategy

• the decisions and actions taken to gain and sustain a comp adv in several industries and markets simultaneously

• the overarching plan that defines the scope and direction of a business

• outlines the industries, products/services, and geographic markets where a company will compete

• the fundamental essence of corporate strategy is choosing where to compete, while business strategy focuses on how to compete within our clients chosen industry

• to maintain a competitive edge, a corporate strategy must reinforce a firm’s strategic position, whether its through differentiation, cost leadership, or a blend of both

• revolves around three key questions:

  • 1. Which industries should we compete in?

  • 2. How can we add value to our Strategic business units?

  • 3. Will diversifying or entering new industries bolster our competition in existing ones?

• WHERE to compete along three dimensions

  • Industry Value Chain: Vertical Integration (stages of industry value chain)

  • Products and Services: Horizontal Integration (make vs buy)

  • Geographic scope

Why Do Firms Need to Grow

• Increase profits

  • results in shareholder returns

• Lower costs

  • growth enables efficiency

• Increase market power

  • fewer competitors, more bargaining power, higher profitability

• Reduce risk

  • low performance in one SBU can be compensated by another

• Motivate management

  • job security

Transaction Cost Economies

• costs associated with economic exchange

• can be within or external to a firm

• External Transaction Costs

  • searching for a firm to contract with

  • negotiating, monitoring, and enforcing the contract

• Internal Transaction Costs

  • recruiting and retaining employees

  • paying salaries and benefits

  • setting up a shop floor

  • providing office space and computers, etc

Make vs Buy

• transaction cost economics help managers decide what activities to do in house (make) vs what p/s to obtain from an external market (buy)

• if in house costs are less then market cost, Vertical Integration may be the way to go, taking control of input production or distribution channels

• If Costs in-house < Costs market 

  • firm's should consider vertical integration

  • own production of the inputs (and/or)

  • own output distribution channels

  However, if market costs are lower, purchasing from the market may be the best option, economically speaking.

  If Costs market < Costs in-house

  • firm should consider purchasing instead of making

Alternatives to Make vs Buy Dilemma

there are other alternatives that we can recommend to our client other than the make vs. buy option

Strategic Alliances

• Short Term Contracts:

  • firms send out a Request for Proposal (RFP), competitive bidding ensues, the buying firm can often demand lower prices.

• Long Term Contracts:

  • licensing enables firms to commercialize intellectual property, and franchising enables use of trademarks, brands, and goods & services in exchange for a lump sum paid up-front & a percent of revenues

• Equity Alliances:

  • one partner takes a partial (financial) ownership of another partner

• Joint Ventures:

  • two or more partners jointly create & own a new organization

• Parent-Subsidiary Relationships:

  • This is the most integrated alternative to performing work in-house. The corporate parent owns the subsidiary and can direct it via command and control. However, this can result in political turf battles and competition for resources.

Vertical Integration

• When pursuing vertical integration, a firm gets involved in new portions of the value chain.

  • This approach can be very attractive when a firm’s suppliers or buyers have too much power over the firm and are becoming increasingly profitable at the firm’s expense.

  • By entering the domain of a supplier or a buyer, executives can reduce or eliminate the leverage that the supplier or buyer has over the firm.

  • Considering vertical integration alongside Porter’s Five Forces model highlights that such moves can create greater profit potential.

  • Firms can pursue vertical integration on their own or through a merger or acquisition

• Oil companies are among the most vertically integrated firms.

  • can be involved in all stages of the value chain, including crude oil exploration, drilling for oil, shipping oil to refineries, refining crude oil into products such as gasoline, distributing fuel to gas stations, and operating gas stations.

• Vertical integration also creates risks.

  • Venturing into new portions of the value chain can take a firm into very different businesses. A lumberyard that started building houses, for example, would find that the skills it developed in the lumber business have very limited value to home construction. Such a firm would be better off selling lumber to contractors.

• Vertical integration can also create complacency.

  • Consider, for example, a situation in which an aluminum company is purchased by a can company. People within the aluminum company may believe that they do not need to worry about doing a good job because the can company is guaranteed to use their products. Some companies try to avoid this problem by forcing their subsidiary to compete with outside suppliers, but this undermines the reason for purchasing the subsidiary in the first place.

• Benefits:

  • lower costs, improves quality, facilitates scheduling and planning, secures critical supplies and distribution channels

  • Risks:

    • Increase in costs, reduction in quality, reduced flexibility, inc in the potential for legal repercussior

• 
  

Backward Integration

• A backward vertical integration strategy involves a firm moving back along the value chain and entering a supplier’s business.

  • Some firms use this strategy when executives are concerned that a supplier has too much power over their firms. In the early days of the automobile business, Ford Motor Company created subsidiaries that provided key inputs to vehicles such as rubber, glass, and metal. This approach ensured that Ford would not be hurt by suppliers holding out for higher prices or providing materials of inferior quality.

  • Although backward vertical integration is usually discussed within the context of manufacturing businesses, such as steelmaking and the auto industry, this strategy is also very popular among major retailers. Consider the next time you shop at Publix or Target and see THEIR brand on the shelf next to the national brand.  

Forward Integration

• A forward vertical integration strategy involves a firm moving further down it's industry value chain to enter a buyer’s business. Disney has pursued forward vertical integration by operating more than three hundred retail stores that sell merchandise based on Disney’s characters and movies. This allows Disney to capture profits that would otherwise be enjoyed by another store. 

  • Forward vertical integration also can be useful for neutralizing the effect of powerful buyers. Rental car agencies are able to insist on low prices for the vehicles they buy from automakers because they purchase thousands of cars. If one automaker stubbornly tries to charge high prices, a rental car agency can simply buy cars from a more accommodating automaker. It is perhaps not surprising that Ford purchased Hertz Corporation, the world’s biggest rental car agency, in 1994. This ensured that Hertz would not drive too hard of a bargain when buying Ford vehicles. By 2005, selling vehicles to rental car companies had become less important to Ford and Ford was struggling financially. The firm then reversed its forward vertical integration strategy by selling Hertz.

Taper Integration

• alternative to vertical integration

• Involves either:

  • backward integration and relying on others for supplies

  • Forward integration and relying on others for distribution

Strategic Outsourcing

• Moving one or more internal value chain activities outside the firm's boundaries to other firms in the industry value chain

• Example: Off-shoring

• Most active sectors of off-shoring:

  • Banking & financial services

  • IT

  • Health Care

Corporate Diversification: 4 main types

1. Single Business 

• A single-business firm derives 95 percent or more of its revenues from one business.

  • Examples: Coca-Cola, Google, Meta

2. Dominant Business 

• A dominant-business firm derives between 70 and 95 percent of its revenues from a single business, but pursues at least one other business activity.

  • Examples: Harley Davidson, Nestle, UPS

3. Related Diversification

• occurs when a firm moves into a new industry that has important similarities with the firm’s existing industry or industries.

• Some firms that engage in related diversification aim to develop and exploit a core competency to become more successful.

  • A core competency is the result of the combination of a firms resources + organizational capabilities which results in a deeply embedded strength; it should also be difficult for competitors to imitate, be leveraged in different businesses, and contribute to the benefits enjoyed by customers within each business.

• A firm follows a related diversification strategy when it derives less than 70 percent of its revenues from a single business activity, but obtains revenues from other lines of business that are linked to the primary business activity. Choices within a related diversification strategy can be related-constrained or related-linked.

• Related Constrained: Examples include firms like Exxon Mobile and Nike

• Related Linked: Examples include firms like Amazon and Disney

4. Unrelated Diversification

• A firm follows an unrelated diversification strategy when less than 70 percent of its revenues come from a single business, and there are few, if any, linkages among its businesses.

• These new ventures are often unrelated to the core business.

• Most unrelated diversification efforts, however, do not have happy endings.

Does corporate diversification lead to superior performance

• yes mainly if its related diversification

  • share synergies, leveraged core compentencies

  • moderate level of diversification

Boston Consulting Groups Matrix (BCG Matrix)

So how do we measure the success between SBU's, especially if they are in different industries? Boston Consulting group's product portfolio matrix (BCG matrix)

• it helps a firm manage their long-term strategic planning, to helps firms consider growth opportunities by reviewing its portfolio of products to decide where to invest, and it helps firms decide whether they should discontinue a line or develop new products.

• The firm plots its SBUs into one of four categories in the matrix: dog, cash cow, star, and question mark. Each category warrants a different investment strategy. All four categories shape the firm’s corporate strategy.

DOGs: easy to identify: They are the underperforming businesses. Dogs hold a small market share in a low-growth market; they have low and unstable earnings, combined with neutral or negative cash flows. The strategic recommendations are either to divest the business or to harvest it.

CASH COW:, in contrast, are SBUs that compete in a low-growth market but hold considerable market share. Their earnings and cash flows are high and stable. The strategic recommendation is to invest enough into cash cows to hold their current position and to avoid having them turn into dogs.

 STAR: holds a high market share in a fast-growing market. Their earnings are high and either stable or growing. The recommendation for the corporate strategist is to invest sufficient resources to hold the star’s position or even increase investments for future growth.

QUESTION MARKS: These SBU's typically have high growth prospects but a low market share. They consume a lot of cash but bring little in return, at least at the start. In the end, question marks, also known as "problem children," lose money. However, since these business units are growing rapidly, they have the potential to turn into stars. Companies are advised to invest in question marks if the product has the potential for growth, or to sell if it does not.

 

In essence, the BCG Matrix is a framework for evaluating the different components of a business’s portfolio, guiding strategic decisions on whether to invest, divest, or develop products and services.

Limitations to the BCG Matrix

Although portfolio planning is a useful tool, this tool has important limitations:

1. Portfolio planning oversimplifies the reality of competition by focusing on just two dimensions when analyzing a company’s operations within an industry. Many dimensions are important to consider when making strategic decisions, not just two.

2. Portfolio planning can create motivational problems among employees. For example, if workers know that their firm’s executives believe in the BCG matrix and that their subsidiary is classified as a dog, then they may give up any hope for the future. Similarly, workers within cash cow units could become dismayed once they realize that the profits that they help create will be diverted to boost other areas of the firm.

3. Portfolio planning does not help identify new opportunities. Because this tool only deals with existing businesses, it cannot reveal what new industries a firm should consider entering.