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Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Tomislav Rimac – Fall 2012
Escola Superior de Comerç Internacional - UPF
INTERNATIONAL MANAGEMENT Lecture 7: Organizational Strategy
Tomislav Rimac – Fall 2013
Universitat Autònoma de Barcelona – ADE in English – 3 rd^ year
STRATEGIC MANAGEMENT I Presentation 6 : Corporate Strategy Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 1
1 Define corporate strategy
Understand the roles of economies of scope and
revenue-enhancement synergy in corporate
strategy
3 Explain the different forms of diversification
Understand when it makes sense for a firm to
own a particular business
Explain the corporate strategy implications of
the stable and dynamic perspectives
6 Explain the corporate strategy implications of
the stable and dynamic perspectives
Objectives
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 2
1. DIVERSIFICATION AND
CORPORATE STRATEGY
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 3
RETURN ON CAPITAL
> COST OF CAPITAL
INDUSTRY
ATTRACTIVENESS
COMPETITIVE
ADVANTAGE
Superior profit derives from two sources:
Diversification decisions involve these same two issues:
• How attractive is the sector to be entered?
• Can the firm achieve a competitive advantage?
To Diversify Or Not To Diversify?
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 6 Diversification And Shareholder Value: Porter’s Three Essential Tests If diversification is to create shareholder value, it must meet three tests:
1. The Attractiveness Test: diversification must be directed
towards attractive industries (or have the potential to
become attractive)
2. The Cost of Entry Test: the cost of entry must not capitalize all
future profits
3. The Better-Off Test: either the new unit must gain
competitive advantage from its link with the company , or
vice-versa. (i.e. some form of “synergy” must be present)
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 7
Corporate Management Tasks Determinants of Strategic Similarity
Resource allocation
Similar sizes of capital investment projects
Similar time spans of investment projects
Similar sources of risk
Similar general management skills required fo
business unit managers
Strategy formulation
Similar key success factors
Similar stages of the industry life cycle
Similar competitive positions occupied by each
business within its industry
Performance management and
control
Targets defined in terms of similar performance
variables
The Determinants Of Strategic Relatedness Between Businesses
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 8
Diversification process Types of businesses
Heavy reliance on
acquisition
Many seemingly un-
related businesses
Primarily organic Many businesses
clustered in a few related
industries
Company
Product extensions/
new product lines
Few related product lines
Diversification Examples Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 9
In which business arenas should a
company compete?
Which vehicles should it use to enter/exit
a business?
What underlining economic logic makes it sensible
to compete in multiple businesses?
Also,
how do
we create
synergies
between
our
businesses?
Three Corporate Strategy Entry/Exit Decisions
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 12
The Answers can change
What businesses should
we be in?
PC’s and Mainframes
THEN…..
Computer Services
A Shift in IBM’s Corporate Strategy Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 13
General motors began operating
steel plants
DuPont moved from gunpowder
making onto dynamite,
nitroglycerine, guncotton, and
smokeless power
Examples
Integration
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 14 Conglomerates are firms that have a great deal of unrelated diversification These firms grew as a result of anti-trust policy as many large firms chose to use their free cash flow and excess financial resources to fund growth into new businesses that were unrelated to their core business and thus generally exempt from anti-trust considerations Conglomerates Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 15
Can a paper production plant
be shared?
P & G manufactures paper
towels and diapers
P & G
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 18 P 1 P 2 P 3 C 1 C 2 C 3
Vertical Scope
V 1 V 2 V 3 P 1 P 2 P 3 C 1 C 2 C 3 V 1 V 2 V 3
[A] Single
Integrated
Firm
[B] Several
Specialized
Firms Linked
by Markets
In situation [A] businesses 1, 2 & 3 are integrated within a single firm.
In situation [B] businesses 1, 2 & 3 are independent firms linked by markets.
Which situation is more efficient? Depends upon whether the administrative
costs of the integrated firm are less than the transaction costs of markets?
Product Scope Geographical Scope
Transaction Costs And The Scope Of The Firm Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 19 Sometimes vertical expansion is pursued due to economic necessity, such as preserving the supply of critical inputs or because the investments necessary in the supply industry to meet the firm’s specific needs are so specific to your firm that the suppliers are hesitant to make these investments Vertical scope can be a logical growth option because managers and employees will be very familiar with the context of expansion Vertical Diversification
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 20 The Costs And Benefits Of Vertical Integration - Benefits Technical economies from integrating processes (e.g., iron and steel production)
But doesn’t necessarily require common ownership
Superior coordination Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 21 The Costs And Benefits Of Vertical Integration - Benefits Avoids transactions costs of market contracts in situations where there are:
Small numbers of firms
Transaction-specific investments
Opportunism and strategic misrepresentation
Taxes and regulations on market transactions
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 24
How many firms are available The fewer the companies
to transact with? the more attractive is VI
Is transaction-specific investment If yes, VI more attractive
needed?
Does limited information permit VI can limit opportunism
cheating?
Are taxes or regulation imposed VI can avoid them
on transactions?
Are future market conditions uncertain? Uncertainty favors VI
Do the different stages have similar Greater the similarity, the
optimal scales of operation? more attractive is VI
Are the two stages strategically Strategic similarity favors VI
Is continued investment required Investment needs favor VI
in each activity
Is entrepreneurial initiative required If so, VI may blunt high-
powered profit incentives,
How uncertain is market demand? Greater the unpredictability
—the more costly is VI
Are risks compounded by VI increases risk.
linkages between vertical stages When Is Vertical Integration More Attractive Than Outsourcing? Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 25 From competitive contracting to supplier partnerships (e.g., in autos) From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services) Diffusion of franchising Recent Trends In Vertical Relationships
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 26 Technology partnerships (e.g., IBM- Apple; Canon- HP) Inter-firm networks General conclusion :- boundaries between firms and markets becoming increasingly blurred Recent Trends In Vertical Relationships Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 27
Spot sales/
purchases
Long-term
contracts
Agency
agreements
Franchises
Vertical
integration
Joint
ventures
Informal
supplier/
customer
relationships
Supplier/
customer
partnerships
Degree of Commitment
Formalization
Low High
Low
High
Different Types Of Vertical Relationship
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 30
Geographic
Horizontal
From one market
segment to another
From one industry
to another
Vertical
Wal-Mart
expanded
into
Europe
Coke and
Pepsi expanded
into water
Pulte Homes
Inc. created Pulte
Mortgage LLC)
Forms And Scope Of Diversification Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 31
Risk reduction
Empire building
Compensation
More efficient for investors to diversify
themselves
Rarely results in higher share- holder value or
margins
Acquisition motivated by executive
pay - a bigger company usually implies
a bigger pay check - rarely creates value
Other Reasons To Diversify
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 32
Example
Fed Ex acquired Kinko’s
Drop off and pick up points for packages
Integration Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 33
Economies of scope
Lower price of a common
resource by combining purchases
Share manufacturing capacity to
reduce average costs
Share distribution to reduce
average distribution costs
Revenue-enhancement synergies
Bundle products to appeal to
new customers
Cross sell to existing customers
Achieve higher valuation from larger,
more predictable cash flows
Sources of Value From Diversification/Expansion
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 36 Economies of scope not a sufficient basis for diversification - must be supported by transaction costs Diversified firm can avoid external transactions by operating internal capital and labor markets (think Mondragon or any business groups such as Toyota, Samsung, and Tata) Diversified firm has better information on resource characteristics than external markets Economies From Internalizing Transactions Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 37
Profit
Revenue
Value
Costs
Valuatio
n of
profit
Non-value
generating
No cross-sell
opportunities
Dis-
economies of
scope
No perceived
value logic
Value generating
Revenue
enhancement
Economic of
scope
Investor-
perceived
“quality”
Diversification Does Not Necessarily Create Value
Universidad Autònoma de Barcelona – ADE – Tomislav Rimac
Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 38
Diversification and Performance in S&P 500 and S&P
MidCap Firms (1992-2000)
Low (25 %tile) Moderate (50th %tile) High (75th %tile) Level of Diversification
ROA
Total Shareholder Returns
ROA
TSR
Diversification is Difficult To Manage Universidad Autònoma de Barcelona – ADE – Strategic Management I Tomislav Rimac – Fall 2013 39 Since diversified firms are more difficult to manage, it stands to reason that there must be limits to the benefits of diversification Indeed, research demonstrates that the positive benefits of diversification are only valued by the market to a point, after which firm performance actually starts to decline Diversification And Performance
