MGT 3830 LSU Exam 3

Corporate Strategy

The decisions that senior management makes and the goal-directed actions it takes to gain and sustain competitive advantage in several industries and markets simultaneously

Answers question of where to compete

Determines the boundaries along three dimensions: vertical integration, diversification, and geographic scope

Vertical Integration

The firm's ownership of its production of needed inputs or of the channels by which it distributes its outputs.

In what stages of the industry value chain should the company participate?

Industry value chain

Depiction of the transformation of raw material into finished goods and services along distinct vertical stages, each of which typically represents a distinct industry in which a number of different firms are competing.

Also called vertical value chains

Diversification

An increase in the variety of products and services a firm offers or markets and the geographic regions in which it competes

What range of products and services should the company offer?

Geographic scope

Where should the company compete geographically in terms of regional, national, or international markets?

Business Strategy

concerns the question of how to compete in a single product market

-Increase profits

-Lower costs

-Increase market power

-Reduce risk

-Motivate management

Why do firms need to grow?

Increase Profits

Allows businesses to provide a higher return for their shareholders

If firms fail to achieve their growth target, their stock price often falls and comes to a lower overall market capitalization

Lower costs

Firms are also motivated to grow in order to lower their cost.

A larger firm may benefit from economies of scale, thus driving down average costs as their output increases.

Firms need to grow to achieve minimum efficient scale, and thus stake out the lowest-cost position achievable through economies of scale.

Economies of scale

factors that cause a producer's average cost per unit to fall as output rises

Core competencies

Unique strengths embedded deep within a firm that allow a firm to differentiate its products and services from those of its rivals, creating higher value for the customer or offering products and services of comparable value at lower cost

minimum efficient scale (MES)

the lowest level of output at which a firm can minimize long-run average total cost

Increase market power

Firms might be motivated to achieve growth to increase their market share and with it their market power.

Firms often consolidate industries through horizontal mergers and acquisitions (buying competitors) to change the industry structure in their favor

Fewer competitors generally equates to higher industry profitability. Moreover, larger firms have more bargaining power with suppliers and buyers

Reduce risk

Firms might be motivated to grow in order to diversify their product and service portfolio through competing in a number of different industries.

The rationale behind these diversification moves is that falling sales and lower performance in one sector might be compensated by higher performance in another

Motivate management

Firms need to grow to motivate management.

Growing firms afford career opportunities and professional development for employees.

Firms that achieve profitable growth can also pay higher salaries and spend more on benefits such as health care insurance for its employees and paid parental leave, among other perks.

Resource-based view

According to the ___________________ of the firm, a firm's boundaries are delineated by its knowledge bases and core competencies

Economies of scope

Savings that come from producing two (or more) outputs at less cost than producing each output individually using the same resources and technology

For example, Amazon can offer a large range of different product and service categories at a lower cost than it would take to offer each product line individually

Transaction costs

All internal and external costs associated with an economic exchange, whether it takes place within the boundaries of a firm or in markets

Enables managers to answer the question of whether it is cost-effective for their firm to expand its boundaries through vertical integration or diversification.

Transaction cost economics

A theoretical framework in strategic management to explain and predict the boundaries of the firm, which is central to formulating a corporate strategy that is more likely to lead to competitive advantage

External transaction costs

Costs of searching for a firm or an individual with whom to contract, and then negotiating, monitoring, and enforcing the contract

Internal transaction costs

Costs pertaining to organizing an economic exchange within a hierarchy

Also called administrative costs

Firms vs. Markets: Make or Buy

-Must decide which activities a firm should pursue in-house ("make") vs which goods and services to obtain externally ("buy")

-If C'in-house is less than C'market then vertically integrate by owning production of the inputs or own output distribution channels

-When firms are more efficient than the market, vertically integrate

Ex) Google in house programmers

Advantages of firms

- command and control

——fiat and hierarchical lines of authority

- coordination

- transaction-specific investments

- community of knowledge

Advantages of markets

-High powered incentives

-Flexibility

Disadvantages of firms

- Administrative costs

- Low-powered incentives

- Principal-agent problem

Disadvantages of markets

- Search costs

- Opportunism by other parties

——Hold up

- Incomplete contracting

——Specifying and measuring performance

——Information asymmetries

- Enforcement of contracts

Principal-Agent Problem

Situation in which and agent performing activities on behalf of a principal pursues his or her own interests

Information asymmetry

Situation in which one party is more informed than another because of the possession of private information

Caveat emptor

buyer beware

Hold-up problem

A situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns that they may give the other party increased bargaining power, and thereby reduce their own profits.

Alternatives on the Make-or-Buy Continuum

- Short term contracts

- Strategic alliances

——long term contracts (licensing, franchising)

——equity alliances

——joint ventures

-Parent-subsidiary relationships

requests for proposals

When engaging in short-term contracting, a firm sends out ___________________ to several companies, which initiates competitive bidding for contracts to be awarded with a short duration, generally less than one year

Strategic alliances

Voluntary arrangements between firms that involve the sharing of knowledge, resources, and capabilities with the intent of developing processes, products, or services

Licensing

A form of long-term contracting in the manufacturing sector that enables firms to commercialize intellectual property

Long-term contracts

Agreements between two firms that are for greater than one year

Franchising

A long-term contract in which a franchisor grants a franchisee the right to use the franchisor's trademark and business processes to offer goods and services that carry the franchisor's brand name

Equity alliances

A partnership in which at least one partner takes partial ownership in the other partner

Credible commitment

A long-term strategic decision that is difficult and costly to reverse

Joint ventures

A stand-alone organization created and jointly owned by two or more parent companies.

Parent-subsidiary relationship

The most-integrated alternative to performing an activity within one's own corporate family.

The corporate parent owns the subsidiary and can direct it via command and control.

Backward and Forward Integration Along an Industry Value Chain

Upstream Industries ^ Stage 1) Raw Materials

Backward Integration. | Stage 2) Components and

| Intermediate Goods

| Stage 3) Final Assembly

| and Manufacturing

| Stage 4) Marketing and

Forward Integration | Sales

Downstream Industries Stage 5) After-Sales Service

and Support

Raw Materials

the basic material from which a product is made.

Ex) chemicals, ceramics, metals, etc.

Components and Intermediate Goods

Ex) integrated circuits, displays, touchscreens, cameras

HTC's Backward and Forward Integration along the Industry Value Chain in the Smartphone Industry

Backward Vertical ^ Stage 1) Design (apple/google)

Integration | Stage 2) Manufacturing (HTC)

| Stage 3) Marketing and

| Sales (Apple/ HTC)

HTC| Stage 4) After-Sales Service

Forward Vertical | and Support (AT&T)

Integration

Backward vertical integration

Changes in an industry value chain that involve moving ownership of activities upstream to the originating (inputs) point of the value chain

Forward vertical integration

Changes in an industry value chain that involve moving ownership of activities closer to the end (customer) point of the value chain

Benefits of Vertical Integration

-Securing critical supplies and distribution channels

-Lowering costs

-Improving quality

-Facilitating scheduling and planning

-Facilitating investments in specialized assets

Risks of Vertical Integration

- Increase in costs

- Reduction in quality

- Reduction in flexibility

- Increase in the potential for legal repercussions

Vertical market failure

When the markets along the industry value chain are too risky, and alternatives too costly in time or money

Taper Integration

A way of orchestrating value activities in which a firm is backwardly integrated but also relies on outside market firms for some of its supplies, and/or is forwardly integrated but also relies on outside market firms for some of its distribution.

benefits of taper integration

-exposes in house suppliers and distributers to market competition so that performance comparisons are possible

-enhances firms flexibility

-combine internal and external knowledge

Strategic outsourcing

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

Outsourcing

Sending jobs out of the country

Offshore outsourcing

Outsourced activities take place outside the home country

Opportunism

self-interest seeking with guile

Specialized assets

Unique assets with high opportunity cost

They have significantly more value in their intended use than in their next best use.

They come in three types: site specificity, physical asset specificity, and human-asset specificity.

Physical asset specificity

Assets whose physical and engineering properties are designed to satisfy a particular customer

Human asset specificity

Investments made in human capital to acquire unique knowledge and skills

Site specificity

Assets required to be co-located, such as the equipment necessary for mining bauxite and aluminum smelting

Product diversification strategy

Corporate strategy in which a firm is active in several different product markets

Geographic diversification strategy

Corporate strategy in which a firm is active in several different countries

Product-market diversification strategy

Corporate strategy in which a firm is active in several different product markets and several different countries

Two key variables of diversification

The percentage of revenue from the dominant or primary business

The relationship of the core competencies across the business units

Four main types of business diversification

1. Single business

2. Dominant business

3. Related diversification

4. Unrelated diversification: the conglomerate

Single business

a firm earning more than 95% of the revenues from a one business

Ex) Birkenstock, Coca Cola, Facebook

Dominant business

a firm that earns between 70% and 95% of its revenues from a single business, but it pursues at least one other business activity that accounts for the remainder of revenue

Ex) UPS, Nestle, Harley Davidson

Related diversification strategy

Corporate strategy in which a firm derives less than 70 percent of its revenues from a single business activity and obtains revenues from other lines of business that are linked to the primary business activity.

Related-Constrained diversification strategy

A kind of related diversification strategy in which executives pursue only businesses where they can apply the resources and core competencies already available in the primary business

Ex) Nike, Johnson & Johnson, Exxon

Related-linked diversification strategy

A kind of related diversification strategy in which executives pursue various businesses opportunities that share only a limited number of linkages

Ex) Amazon, Disney, GE

Unrelated diversification strategy

Corporate strategy in which a firm derives less than 70 percent of its revenues from a single business and there are few, if any, linkages among its businesses.

Often unable to create additional value

Ex) Samsung, Yamaha

Diversification discount

Situation in which the stock price of highly diversified firms is valued at less than the sum of their individual business units

Diversification premium

Situation in which the stock price of related-diversification firms is valued at greater than the sum of their individual business units

For diversification to enhance firm performance, it must do at least one of the following:

Provide economies of scale, which reduces costs.

Exploit economies of scope, which increases value.

Reduce costs and increase value.

Restructuring

describes the process of reorganizing and divesting business units and activities to refocus a company in order to leverage its core competencies more fully

Boston Consulting Group (BCG) growth-share matrix

A corporate planning tool in which the corporation is viewed as a portfolio of business units, which are represented graphically along relative market share (horizontal axis) and speed of market growth (vertical axis). SBUs are plotted into four categories (dog, cash cow, star, and question mark), each of which warrants a different investment strategy.

The degree of vertical integration

in what stages of the industry value chain to participate

The type of diversification

what range of products and services to offer

The geographic scope

where to compete

Core competence market matrix

A framework to guide corporate diversification strategy by analyzing possible combinations of existing/new core competencies and existing/new markets

New CC/Existing Market: building new CC to protect and extend current market position

New CC/New Market: building new CC to create and compete in markets of the future

Existing CC/Existing M: leveraging CC to improve the firm's current market position

Existing Cc/New M: redeploying and recombining CCs to compete in future markets

Four Options to Formulate Corporate Strategy via Core Competencies

1. leverage existing core competencies to improve current market position

2. build new core competencies to protect and extend current market position

3. redeploy and recombine existing core competencies to compete in markets of the future

4. build new core competencies to create and compete in markets of the future

Conglomerate

A company that combines two or more strategic business units under one overarching corporation; follows an unrelated diversification strategy

Build-borrow-or-buy Framework

Conceptual model that aids firms in deciding whether to pursue internal development (build), enter a contractual arrangement or strategic alliance (borrow), or acquire new resources, capabilities, and competencies (buy).

Relevancy

How relevant are the firm's existing internal resources to solving the resource gap?

If the firm's internal resources are highly relevant to closing the identified gap, the firm should itself build the new resources needed through internal development.

Firms evaluate the relevance of internal resources in two ways by testing whether resources are

(1) similar to those the firm needs to develop

(2) superior to those of competitors in the targeted area.

If both conditions are met, then the firm's internal resources are relevant and the firm should pursue internal development.

Tradable

implies that the firm is able to source the resource externally through a contract that allows for the transfer of ownership or use of the resource

Tradability

How tradable are the targeted resources that may be available externally?

If a resource is highly tradable, then the resource should be borrowed via a licensing agreement or other contractual agreement.

If the resource in question is not easily tradable, then the firm needs to consider either a deeper strategic alliance through an equity alliance or a joint venture, or an outright acquisition.

Closeness

How close do you need to be to your external resource partner?

Implies that only if extreme closeness to the resource partner is necessary to understand and obtain its underlying knowledge should M&A be considered the buy option.

Regardless, the firm should always first consider borrowing the necessary resources through integrated strategic alliances before looking at M&A

Integration

How well can you integrate the targeted firm, should you determine you need to acquire the resource partner?

Low relevancy, low tradability, and high need for closeness leads strategic leaders to consider M&A

If the firm's internal resources are insufficient to build, and the resource needed to fill the strategic gap cannot be borrowed through a strategic alliance, and closeness to the resource partner is needed, then the final question to consider is whether the integration of the two firms using a merger or acquisition will be successful.

strategic

The resource gap is ___________ because closing this gap is likely to lead to a competitive advantage

valuable, rare, and difficult to imitate

Resources that are _____________, _________, and ___________________ are often embedded deep within a firm, frequently making up a resource bundle that is hard to unplug whole or in part.

Relational view of competitive advantage

Strategic management framework that proposes that critical resources and capabilities frequently are embedded in strategic alliances that span firm boundaries

Why do firms enter strategic alliances?

-Strengthen competitive position.

-Enter new markets.

-Hedge against uncertainty.

-Access critical complementary assets.

-Learn new capabilities

Real-options perspective

Approach to strategic decision making that breaks down a larger investment decision into a set of smaller decisions that are staged sequentially over time

Co-opetition

Cooperation by competitors to achieve a strategic objective

Learning races

Situations in which both partners in a strategic alliance are motivated to form an alliance for learning, but the rate at which the firms learn may vary

-Non-equity alliances

-Equity alliances

-Joint ventures

Alliances can be governed by the following mechanisms:

(1)

(2)

(3)

Non-Equity alliance

Partnership based on contracts between firms

Ex) supply, licensing, and distribution agreements

Key characteristics of non-equity alliance

Governance mechanism: contract

Frequency: most common

Type of knowledge exchanged: explicit

Pros: flexible, fast, easy to initiate and terminate

Cons: weak tie, lack of trust and commitment

Examples: Microsoft-IBM (nonexclusive) licensing agreement

Explicit knowledge

Knowledge that can be codified

Concerns knowing about a process or product

Key characteristics of equity alliances

Governance mechanism: equity investment

Frequency: less common than non-equity; more common than joint ventures

Type of knowledge exchanged: explicit; tacit kinda

Pros: stronger tie, trust and commitment, window into new technology

Cons: less flexible, slower, can entail significant investments

Examples: Roche's equity investment in Genentech (prior to full integration)

Key characteristics of joint ventures

Governance mechanism: creation of two entities by two or more parent firms

Frequency: least common

Type of knowledge exchanged: tacit and explicit

Pros: strongest tie, trust and commitment more likely, may be required by institutional setting

Cons: long-term solutions, managers double report (2 bosses), can entail long negotiations and significant investments

Examples: Hulu, owned by NBC (30%), Fox (30%), Disney-ABC (30%), and Turner Broadcasting System (10%)