CHAPTER 6STRATEGY FORMULATION :

CORPORATE STRATEGY

Read : Hewlett-Packard Company P. 132 – 133

6.1 CORPORATE STRATEGYCorporate strategy : deals

with three key issues facing the corporation as a whole

1. The firm’s overall orientation toward growth, stability, or retrenchment (directional strategy)

2. The industries or markets in which the firm competes through its products and business units (portfolio strategy)

3. The manner in which management coordinates activities and transfers

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resources and cultivates capabilities among product line and business units (parenting strategy)

Corporate strategy is primarily about the choice of direction for the firm as a whole; therefore, includes decisions regarding the flow of financial and other resources to and from a company’s product lines and business units

This chapter is organized into three parts that examine corporate strategy in terms of directional strategy (orientational toward growth), portfolio analysis (coordination of cash flow among units), and corporate parenting (building corporate synergies through resource sharing and development)

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6.2 DIRECTIONAL STRATEGYJust as every product or

business unit must follow a business strategy to improve its competitive position, every corporation must decide its orientation toward growth by asking the following three questions :

Should we expand, cut back, or continue our operations unchanged?

Should we concentrate our activities within our current industry or should we diversify into other industries ?

If we want to grow and expand nationally and/or globally, should we do so through internal development or through external acquisitions,

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mergers, or strategic alliances?

Corporation’s directional strategy is composed of :

Growth strategies : expand the company’s activities

Stability strategies : make no change to the company’s current activities

Retrenchment strategies : reduce the company’s level of activities

* Fig. 6.1 P. 135 – each strategy – has several more specific corporate strategies (such as concentration in growth strategy)

Growth StrategiesBy far the most widely

pursued corporate directional strategies are those designed

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to achieve growth in sales, assets, profits or some combination- companies that do

business in expanding industries must grow to survive

Continuing growths sales and chance to take

advantage of the experience curve to reduce the per-unit cost of products sold extremely importantEx. Motorola Inc. P. 134grow internally : expanding its operations both globally and domesticallygrow externally :

Merger : transaction involving two or more corporations in which stock is exchanged, but from which only one corporation survives

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– usually similar size & friendlyAB + CD = BC

Acquisition : the purchase of a company that is completely absorbed as an operating subsidiary or division of the acquiring corporation- usually firms of different

sizes- can be friendly or hostile

(hostile acquisitions – takeovers)

Strategic alliance : a partnership of two or more corporation or business units to achieve strategically significant objectives that are mutually beneficial

Two basic growth strategies : concentration and diversificationConcentration :

vertical growth

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horizontal growth

Vertical growth : taking over a function previously provided by a supplier or by distributor – can be either internally (expanding current operations : Ford or externally (through acquisitions : DuPont)

Vertical growth results in vertical integration – the degree to which a firm operates vertically in multiple locations on and industry’s value chain

backward integrationsupplierforward integrationdistributorVertical growth : a logical

strategy for a corporation or business unit with a strong competitive position in a highly attractive industry –

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especially when technology is predictable and markets are growing

Although backward integration is usually more profitable than forward, but it can reduce a corporation’s strategic flexibility – can create an exit barrier (preventing the corporation from leaving that particular industry) Ex. Ford

Transaction cost economies : vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great.Read : Key Theory P. 137

Full integration : a firm internally make 100 % of its

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key supplies and complete controls its distributors

Taper integration : a firm internally produces less than half of its own requirements and buys the rest from outside suppliers

Quasi–integration : a company does not make any of its key supplies, but purchases most of its requirements from outside suppliers that are under its partial control

It a company does not want to invest in suppliers or distributors (but it still wants to guarantee access to needed supplies or distribution) – long-term contracts – supplier or distributor is really a “captive company”

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Outsourcing : resources are purchased from outsiders through long-term contracts instead of being made in-houseHorizontal Growth : expanding the firm’s products into other geographic locations and/or services offered to current markets

Horizontal growth results in horizontal integrationEx. KLMRead : Company Spotlight P. 139

Diversification Strategies :Concentric

Conglomerate

When an industry consolidates an becomes mature, most serving firms

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have reached the limits of growth using vertical and horizontal growth strategies – if they want to continue growing – they may have no choice but to diversify

Concentric (Related) Diversification

appropriate corporate strategy when a firm has a strong competitive position but industry attractiveness is low search for synergy Ex. American Airlines (unprofitable airline business)

to AMR Corporation (related businesses)Conglomerate (unrelated) Diversification

Appropriate corporate strategy when current industry is unattractive and that the firm lacks outstanding abilities or skills

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in related products or services

International Entry OptionsToday’s world, growth

usually has international implications a corporation can select from several strategic options Read : 21st

Century Global Society P. 141

Exporting : Licensing : Budweiser in

Japan, UK etc. Joint Ventures : Acquisition : quick way to

move into international area

Green–Field Development : building it own manufacturing plant

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and distribution system in foreign countries

Production Sharing : process of combining the higher labor skills and technology (in developed countries) with the lower-cost labor (in developing countries)

Turnkey Operations : contracts for the construction of operating facilities in exchange for a fee Ex. Fiat built auto plant in Russia under Russian brand Name

BOT Concept : (build, operate, transfer)

Management Contracts :

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Controversies in Directional Growth Strategies

Is vertical growth better than historical growth ? Is concentric diversification better that conglomerate diversification ? Although the research is not in complete agreement – related are more successful

The results : 80 % vertical growth

50 % horizontal growth

35 % concentric diversification

28 % conglomerate diversification synergy ?

Is internal growth better than external growth ? Not yet conclusive, however,

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- firms go through acquisitions (external) do not perform financially as well as firms that grow through internal means, however,- acquisitions have a higher

survival rate that do new internally generated business ventures

Stability StrategiesContinuing its current

activities without any significant change in direction- very popular with small

business owners who have found a niche and are happy with their success and the manageable size- can be very useful in the

short run, but they can be dangerous if followed for

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too long (i.e. when Wal-Mart came to town)

pause/proceed with caution strategy

Stability no change strategy

Profit strategy

Pause/Proceed with Caution Strategy :- a timeout an

opportunity to rest before continuing a growth or retrenchment strategy- it is typically conceived as

a temporary strategyEx. Dell Computer CorporationNo Change Strategy- a decision to do nothing

new a choice to continue current operations and policies for the foreseeable future

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- most small-town businesses probably follow this strategy before Wal-Mart moves into their areas

Profit Strategy- a decision to do nothing

new in a worsening situation, but instead to act as though the company’s problems are only temporary attempting to artificially support profits when company’s sales are declining by reducing investment and short-term discretionary expenditures

- profit strategy is useful only to help a company get through a temporary this strategy is seductive and if continued long enough will lead to a serious deterioration

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in a corporation’s competitive position- usually top management’s

passive, short-term, and often self-serving response to the situation

Retrenchment StrategyMay pursue retrenchment

strategies when it has a weak competitive position in some or all of its product lines resulting in poor performance

TurnaroundRetrenchment Captive company

Sell-Out/Divestment

Bankruptcy/Liquidation

Turnaround Strategycontraction

consolidation

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emphasizes the improvement of operational efficiency and probably most appropriate when a corporation’s problems are pervasive, but not yet criticalContraction : the initial effort to quickly “stop the bleeding” with a general across-the-board cutback in size and costsConsolidation : implements a program to stabilize the now-leaner corporation to streamline the company, plans are developed to reduce unnecessary overhead and to make functional activities cost-justifiedRead : Strategy in a Changing World P. 145

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Captive Company StrategyThe giving up of

independence in exchange for securityEx. Simpson Industries of Birmingham – let a special team from GM inspect in return, nearly 80% of company’s production was sold to GM

Sell – Out / Divestment Strategy

If weak and unable either to pull itself up or to find customer to which it can become a captive company – sell out and leave the industry completely

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Divestment : sell off a division with low growth potential

Bankruptcy / Liquidation Strategy

Bankruptcy : giving up management of the firm to the courts in return for some settlement of the corporation’s obligations

Liquidation : the termination of the firm – convert as many saleable assets as possible to cash

benefit of liquidation over bankruptcy – top management make the decision instead of court

6.3 PORTFOLIO ANALYSISCH.5 – dealt with how

individual product lines and business units can gain

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competitive advantage in the marketplace by using competitive and cooperative strategies

How about multiple product lines or business units ?

How much of our time and money should we spend on our best products and business units to ensure that they continue to be successful ?

How much of our time and money should we spend developing new costly products, most of which will never be successful ?

Portfolio analysis : one of the most popular aids to developing corporate strategy in a multibusiness corporation

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- top management views its product lines and business unit as a series of investments from which it expects a profitable return

two approaches BCG Growth-Share Matrix

GE Business Screen

BCG Growth-Share MatrixBCG (Boston Consulting

Group) Fig. 6.2 P. 148- each of the corporation’s

product lines or business units is plotted on the matrix according to both the growth rate of the industry in which it competes and its relative market share

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A unit’s relative competitive position = its market share in the industry divided by that of the largest other competitor – relative market share above 1.0 belongs to the market leader

Fig. 6.2BCG has a lot in common with the product life cycle

Question marks (problem children or wildcats) : new products with the potential for success, but they need a lot of cash for development – if a product is to gain enough market share a star

Stars : market leaderstypically at the peak of

their product life cycle are usually able to generate enough cash to maintain high share of the market

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when their market growth rate slows stars become cash cows

Cash cows : typically bring in far more money than is needed to maintain their market share in this decline stage of their life cycle, these products are “milked” for cash that will be invested in new question marks if question marks is unable to obtain a dominant market share (to become stars) – by the time the industry growth rate inevitably slows become dogs

Dogs : low market share and do not have the potential (because they are in an unattractive

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industry) to bring in much cash dogs should be either sold off or managed carefully for the small amount of cash they can generate- Underlying BCG – is the

concept of the experience curve (CH. 4) the key success is assumed to be market share firms with the highest market share tend to has a cost leadership (economies of scale)- If a company is able to

use the experience curve to its advantage (sell new products at a price low enough to garner early market share leadership)- Having plotted the

current positions of its product lines or business

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units an a matrix, a company can project their future positions

assuming no change in strategy

advantages : easy to use

disadvantages : P. 149

GE Business ScreenGE & McKinley and

Company developed a more complicated matrix Fig. 6.3

P. 150GE Business Screen : includes nine cells based on long-term industry attractiveness and business strength/competitive positionGE Business Screen includes much more data – i.e. market growth rate, industry profitability, size and pricing

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practices, among other possible opportunities and threatsSteps in Fig. 6.3 P. 149 – 150 Industry attractiveness-1 (very unattractive) to 5 (very attractive)Key factors needed for success in each product (strength / competitive position) -1 (very weak) to 5 (very strong)- many more variables and

does not lead to such simplistic conclusion – i.e. attractiveness of an industry can be assessed in many different ways (other than simple using growth rate)

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International Portfolio Analysis Fig. 6.4 P. 151

Two factors country’s attractiveness

product’s competitive strength

Country’s attractiveness : its market size, the government regulation, and economic and political factors Product’s competitive strength : its market share, product fit, contribution margin, and market support

Advantages and Limitations of Portfolio AnalysisRead : P. 151 – 152

6.4 CORPORATE PARENTINGCampbell, Goold, and

Alexander : contend that

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corporate strategists must address two crucial questions :

What businesses should this company own and why ?

What organizational structure, management processes, and philosophy will foster superior performance from the company’s business units ?

Portfolio analysis : tends to primarily view matters financially, regarding business units and product lines as separate and independent investments

Corporate parenting : views the corporation in terms of resources and capabilities that can be used to build business units value as well

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as generate synergies across business units

Corporate parenting generates corporate strategy by focusing on the core competencies of the parent corporation and on the value create from the relationship b/w the parent and its businesses- if there is a good fit b/w

the parent’s skills and resources and the needs and opportunities of the business units corporation is likely to create value - if there is not a good fit

corporation is likely to destroy value

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Developing a Corporate Parenting Strategy

Campbell, Goold, and Alexander three analytical steps

First, examine each business unit (or target firm in the case of acquisition) in terms of it critical success factors (CSF – Those elements of a company that determine its strategic success or failure)

Second, examine each business unit (or target firm) in terms of areas in which performance can be improved - these are considered to be parenting opportunities – i.e. can gain economies of scope by combining their sales forces or share manufacturing and logistics skills

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Third, analyze how well the parent corporation fits with the business unit (or target firm) must be aware of its own strengths and weaknesses in terms of resources, skills, and capabilities

Parenting – Fit MatrixSummarizes the various

judgements regarding corporate/business unit fit for the corporation as a whole – this matrix emphasizes their fit with the corporate parent Fig. P. 154

Matrix composed of 2 dimensions :

Positive contributionsNegative effects

2 dimensions create 5 different positions

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Heartland BusinessesShould be at the heart of

the corporation’s future – have opportunities for improvement by the parent, and the parent understands their critical success factors wellEdge-of-Heartland Businesses

Some parenting characteristics fit the business, but other do not – Ex. P. 154 (perfumes)Ballast Businesses

Fit very comfortably with the parent corporation but contain very few opportunities to be improved by the parent – like cash cows – but if environmental changes, ballast could move to alien territory – decision makers should consider divesting as soon as they can

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get price that exceeds the expected value of future cash flowsEx. IBM’s mainframe businessAlien Territory Businesses

Little opportunities to be improved by the corporate parent, and a misfit exists b/w the parenting characteristics and the units CSF – divest this unit while it still has valueValue Trap Businesses

Fit well with parenting opportunities, but they are a misfit with the parent’s understanding of the units’ CSF – this is where corporate headquarters can make its biggest error (ex. To make the unit a world-class manufacturer because the parent has world-class manufacturing skills- it may not notice that the unit is

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primarily successful because of its unique product development and niche marketing expertise)

Horizontal Strategy : Corporate Competitive Strategy

Horizontal strategy : a corporate strategy that cuts across business unit boundaries to build synergy across business units and to improve the competitive position of one or more business unit Read : Ex. P. 155

6.5 GLOBAL ISSUES FOR THE 21ST CENTURY

The international implications of corporate growth strategies are increasing

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A disadvantage of a vertical growth strategy for a corporation operating in a global industry is that its functional value chain will be spread over the world, making logistics and communication especially important

As more corporations become involved in international operations through acquisitions, strategic alliances, and other options expect conglomerate (unrelated) diversification to become less popular

Expect corporate parenting to become the dominant model in corporate strategy for evaluating business units

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and working to achieve synergies across unit boundaries

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