Formulating Corporate-Level Strategy

HCAD 5390

Strategies

Distinguishing Corporations from Strategic Business Units (SBUs)

Multi-SBU Corporations: Sole separate legal entity Authorized to execute contracts Able to borrow money and sell equity Produces no goods or services Quite small staff Primary function is to assemble and manage a

portfolio of SBUs

Distinguishing Corporations from Strategic Business Units (SBUs)

Strategic Business Units: No separate legal existence No separate ability to contract or raise capital Produce goods and services Compete in one or more markets Relative autonomy to manage operations and

strategy

Value-Adding Functions of the Corporate Center

Manage the Portfolio of SBUs Raise Financial Capital for Allocation to SBUs Allocate Resources and Services to SBUs Facilitate Synergies Among SBUs Choose Parenting Style for SBU Interactions Participate in SBU Strategic Planning Process Oversee and Monitor SBU Performance Manage Corporate Relations With Stakeholders

Corporate Management of an SBU Portfolio (I)

In pursuit of a corporate vision Acquires, merges with, or develops internally

new SBUs Divests existing, unwanted SBUs Set performance goals for SBU management Provide input to SBU strategic decisions Count upon SBUs to perform unique strategic

functions

Corporate Management of an SBU Portfolio (II)

Balance between central corporate direction and individual SBU autonomy

Control vs spontaneity Hire good SBU managers, give them general

guidelines, and let them loose … or … Give detailed directions, watch closely, and

intervene frequently

Model Portfolio Management Process

1. Choose strategic thrust of the corporation– Growth– Stability– Retrenchment

2. Choose geographic areas, markets, and products or services to offer in them

3. Decide how many SBUs in the portfolio and which businesses they will be

Texas Health Resources

Texas Health Resources (THR) is one of the largest faith-based, nonprofit health care delivery systems in the United States and the largest in North Texas in terms of patients served. The system's primary service area consists of 16 counties in north central Texas, home to more than 6.2 million people.  THR was formed in 1997 with the assets of Fort Worth-based Harris Methodist Health System and Dallas-based Presbyterian Healthcare Resources. Later that year, Arlington Memorial Hospital joined the THR system.  THR has 12 acute-care hospitals and one long-term care hospital that total 3,100 licensed hospital beds, employs more than 18,000 people, and counts more than 3,600 physicians with active staff privileges at its hospitals.  THR is also a corporate member or partner in six additional hospitals and surgery centers. 

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Adaptive Strategies

Corporate-Level Strategic Options:Growth – Expand the Portfolio

Most common corporate-level strategy direction Critical to maintaining share in a growing market In pursuit of economies of scale and scope Increase in experience and learning Top executive egos to be satisfied

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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?

Adaptive Strategies

Growth By Concentration

All businesses start here Dedicate all resources and competencies to

one or a few products or services Achieved in one of three ways:

– Sell more of current products in current markets– Sell current products in new markets– Sell new products in current markets

To sell new products in new markets is diversification

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Basic Growth Strategies:Concentration

– Current product line in one industry– Market Development– Product Development– Penetration

Diversification– Into other product lines in other industries

Adaptive Strategies

Concentration on a Single Business

SEARSCoca-ColaCoca-ColaMcDonaldsMcDonalds

Southwest Airlines

Concentration on a Single Business

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 No Longer Sufficient to Maintain Growth

Unlikely to capture a greater share of current market

Current market is stagnating, maturing, shrinking, or otherwise lacking growth potential

Excess cash on hand needs to be invested productively

Management has greater ambitions for further strategic achievement

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.

Growth By Related Diversification

Move beyond existing markets and products Employ existing resources and competencies New businesses are closely connected

(“related”) to existing businesses Directions of related diversification

– Vertical forward integration (toward customers)– Vertical backward integration (toward suppliers)– Horizontal expansion

Forms of Relatedness

Products or services Markets Processes, systems, or other operating features Manufacturing facilities, distribution channels,

marketing media, or support services Brand image, corporate reputation, creativity or

innovation skills, or general managerial expertise

Vertical Integration

Forward or backward in the industry value chain Moving “upstream” toward suppliers

– Hospital acquiring a physician group practice Moving “downstream” toward customers

– Hospital acquiring a long-term care facility Examples: physician-hospital organizations

(failed), integrated delivery systems (succeeded)

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

Upstream Downstream

Stages in the Raw-Material-to-Consumer Value Chain in the Personal Computer Industry

End userDistributionAssemblyIntermediatemanufacturerRaw materials

Examples:Dow ChemicalUnion CarbideKyocera

Examples:IntelSeagateMicron

Examples:AppleHpDell

Examples:Best BuyOffice Max

Vertical Integration

Decision Steps in Vertical Integration

Adequate resources and competencies to bring the new business operations in-house

Choose form of integration – full ownership, partial ownership, joint venture, or long-term contract

Consider impact on other stakeholders Pay attention to share of industry value chain

being brought in-house

Good Reasons for Vertical Integration

Reduce costs by eliminating redundancy throughout the value chain

Better coordination at interface between value chain components

Profit-taking at several levels in the chain is eliminated Greater overall control of inputs (resources) and

outputs (distribution channels) Wider network of sources of competitive intelligence Opportunity to reengineer the value chain

Vertical Integration Problems (I)

Does the value chain function as well after integration as it did before?

Excessive costs may be incurred in managing the new businesses and their interactions

Inability to use full capacity of acquired businesses so must … sell to competitors?

Must the business deal exclusively with its new integration partners?

Vertical Integration Problems (II)

Commitment to entire chain reduces strategic flexibility

Commitment may tie business to inefficient processes, poorly managed units, and obsolete technologies

Inability to coordinate added units may increase costs and limit opportunities to create value for customers

Horizontal Expansion

Moving sideways in the value chain, acquiring similar businesses in different geographic areas

Acquisition target may be a competitor May create antitrust enforcement concerns Examples: multistate hospital networks,

nursing home chains, national health plan systems

Best Circumstances for Horizontal Expansion

Current market is growing, requiring additional capacity to meet demand

Target acquisition doing poorly – lacks resources or competencies possessed by the acquirer

Expanded size enables economies of scale leading to competitive advantage

Opportunity to create dominant market position by acquiring a competitor

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Basic Diversification Strategies:

– Concentric (Related) Diversification

– Conglomerate (Unrelated) Diversification

Diversification

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

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

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Concentric Diversification

– Growth into related industry– Search for synergies

Related Diversification

Related Diversification

3M3M

Hewlett PackardHewlett Packard

Marriott

Related Diversification

Advantages of Related Diversification (I)

Synergies among existing and acquired businesses

Lower overall corporate risk – balancing high and low-risk SBUs

Greater bargaining power vis-à-vis competitors, suppliers and customers

Advantages of Related Diversification (II)

Cross-subsidization among businesses at different life cycle stages

General increase in revenues and profits from acquired businesses

Opportunity to acquire new knowledge, competencies, and technologies

Enhance status, power, and compensation of top executives

Forms of Inter-SBU Synergy (I)

Share solutions to problems and ideas for improving operational efficiency

Use slack capacity to achieve economies of scale

Earn volume discounts and greater bargaining power with suppliers

Integration of computer systems and capabilities

Forms of Inter-SBU Synergy (II)

By sharing R&D facilities, reduce innovation costs and spread research risks

Share distribution channels Leverage the use of influential brand names

and images Wide opportunities for knowledge transfer

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Unrelated (Conglomerate) Diversification– Growth into unrelated industry– Concern with financial considerations

Adaptive Strategies

Growth By Unrelated Diversification

Few similarities or commonalities among businesses in the portfolio

Operate in different industries/markets, serve different customers, face different competitors

Corporation composed of unrelated businesses may be called a “conglomerate”

What value is added by bringing unrelated businesses together into one corporation?

Unrelated Diversification

TycoAmer Group Amer Group

ITTITT

Adaptive Strategies

Relationship Between Diversification and Performance

Perf

orm

ance

Perf

orm

ance

Level of DiversificationLevel of Diversification

DominantBusiness

UnrelatedBusiness

RelatedConstrained

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.

Tools for Implementing Growth Strategies

Internal development Internal new venture creation Investments in new ventures Acquisition Merger Joint venture, strategic alliance or partnership

AcquisitionsAcquisitions

Reasons for Making Acquisitions

IncreaseIncreasemarket powermarket power

OvercomeOvercomeentry barriersentry barriers

Cost of newCost of newproduct developmentproduct development Increase speedIncrease speed

to marketto market

IncreaseIncreasediversificationdiversification

Reshape firm’sReshape firm’scompetitive scopecompetitive scope

Lower risk comparedLower risk comparedto developing newto developing new

productsproducts

Learn and developLearn and developnew capabilitiesnew capabilities

Diversification and Corporate Performance: A Disappointing History

Sources: Lipin, S. & Deogun, N. 2000. Big merges of the 90’s prove disappointing to shareholders. Wall Street Journal, October 30: C1; A study by Dr. G. William Schwert, University of Rochester, cited in Pare, T. P. 1994. The new merger boom. Fortune, November 28:96; and Porter, M.E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3):43.

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.

AcquisitionsAcquisitions

Problems With AcquisitionsIntegrationIntegrationdifficultiesdifficulties

InadequateInadequateevaluation of targetevaluation of target

Large orLarge orextraordinary debtextraordinary debt

Inability toInability toachieve synergyachieve synergy

Too muchToo muchdiversificationdiversification

Managers overlyManagers overlyfocused on acquisitionsfocused on acquisitions

Resulting firmResulting firmis too largeis too large

Corporate-Level Strategic Options:Stability – Maintain the Portfolio

Rapid growth outstripped financial and managerial resources

Difficulties in assimilating recent portfolio additions

Some current SBUs may have serious financial or operational problems

No attractive acquisition opportunities available Waiting for environmental changes to develop

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

Corporate-Level Strategic Options:Retrenchment – Cut Back the Portfolio

Need to do more than pause and rethink– Regain control of inefficient operations– Rebuild resources and competencies– Reconsider strategic direction

Result may be a radical restructure and redirection of the organization

Retrenchment Options

Getting back down to fighting weight Returning to core businesses and competencies Seeking a “white knight” to take over Selling the entire organization Divesting pieces of the corporate portfolio Voluntary filing for bankruptcy/reorganization Voluntary/involuntary filing for

bankruptcy/liquidation

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.

Tools for Portfolio Analysis and Management

Graphical matrix diagrams showing variablefactors key to strategic portfolios decisions

1. Boston Consulting Group Growth-Share Matrix2. General Electric Business Screen

Reviewing the Corporate Portfolio

Portfolio Planning under the Boston Consulting Group (BCG) matrix:– Identifying the Strategic Business Units (SBUs) by

business area or product market– Assessing each SBU’s prospects (using relative

market share and industry growth rate) relative to other SBUs in the portfolio.

– Developing strategic objectives for each SBU.

The BCG Matrix

Source: Perspectives, No. 66, “The Product Portfolio.” Adapted by permission from The Boston Consulting Group, Inc., 1970.

The BCG Matrix

Stars– High relative market shares in fast growing industries.

Question marks– Low relative market shares in fast growing industries.

Cash cows– High relative market shares in low-growth industries.

Dogs– Low relative market shares in low-growth industries.

The Strategic Implications of the BCG Matrix

Stars– Aggressive investments to support continued growth and

consolidate competitive position of firms. Question marks

– Selective investments; divestiture for weak firms or those with uncertain prospects and lack of strategic fit.

Cash cows– Investments sufficient to maintain competitive position. Cash

surpluses used in developing and nurturing stars and selected question mark firms.

Dogs– Divestiture, harvesting, or liquidation and industry exit.

Limitations on Portfolio Planning

Flaws in portfolio planning:– The BCG model is simplistic; considers only two

competitive environment factors– relative market share and industry growth rate.

– High relative market share is no guarantee of a cost savings or competitive advantage.

– Low relative market share is not always an indicator of competitive failure or lack of profitability.

– Multifactor models (e.g., the McKinsey matrix) are better though imperfect.

The McKinsey Matrix

Raise Financial Capital

SBUs may lack the separate legal existence to do this on their own

Corporate center performs this function by issuing stock and borrowing

Then, allocates the capital to SBUs in some rational, objective manner that maximizes total return to the corporation

This is the practice of corporate strategic financial management

Allocate Resources and Services

In addition to financial capital, corporate center may possess other resources useful to SBUs– Human resource management services– Research and development capability– Technology assessment competence– Information technology support– Corporate legal department

These too must be allocated to the SBUs

Facilitate Synergies Among SBUs

Inter-SBU synergies are one of the main reasons for assembling corporate portfolios

Synergies do not often occur naturally; the corporate center must foster them

– Watch each SBU’s operations and strategies– Notice lacks of resources and competencies– Inventory resources or competencies owned by the SBUs– Match lacking and owning SBUs– Facilitate actual sharing among them

Forms of Synergy Facilitation (I)

Disseminate knowledge and best practices Facilitate transfer of knowledge assets and

services Encourage collaboration and coordination Arrange transfer of skills and capabilities Build central database of resources and

competencies available to all SBUs

Forms of Synergy Facilitation (II)

Temporarily assign a specialist from one SBU to another

Sponsor all-SBU meetings to share information and problem solutions

Coordinate activities of common SBU functions to gain economies of scale

Provide synergy-supporting education, training, and coaching to SBU personnel

Choose a Corporate Parenting Style

Conscious choice on how the corporate center will interact with SBUs in its portfolio

Range along a continuum from complete detachment to intrusive micromanagement

Choice will affect behavior and performance of SBU top management

Too loose parenting can lead to rogue SBUs Too tight parenting can stifle creative

spontaneity

Participate in SBU Strategy-Making

Corporate degree of involvement in SBU strategic management is a parenting choice

Difference between a true SBU and a division or department of a business:– SBU – great autonomy and freedom of action– Division – close central direction and control

Essence of SBU success is in entrepreneurial impulses of their top executives

Oversee and Monitor SBU Performance

Every corporate center must monitor the performance of SBUs in its portfolio:– Are they meeting the strategic objectives of the SBU

and the overall corporation?– Are they financially healthy?– Are there any looming problems?– Are top executives meeting personal performance

standards?

Managing Relationships With External Stakeholders

Every organization has numerous stakeholders who must be tended to

Meaning of term “stakeholder” Examples of health care stakeholders:

– Suppliers (employees, unions, contractors)– Customers (patients, payers)– Competitors– Regulators– Capital sources (donors, grantors, shareholders, lenders)– Media

Corporate Value Negation

Systems and approvals that add costs, delay decisions, and slow market responsiveness

Insulate SBU executives from realities and pressures of financial markets

Portfolio so large and diverse that no common theme is apparent

Overly large corporate HQ that incur expense without providing added value to SBUs

Strategic Alliance

A strategic alliance is a cooperative strategy in which– firms combine some of their resources and capabilities– to create a competitive advantage

A strategic alliance involves– exchange and sharing of resources and capabilities– co-development or distribution of goods or services

CombinedCombinedResourcesResources

CapabilitiesCapabilitiesCore CompetenciesCore Competencies

ResourcesResourcesCapabilitiesCapabilities

Core CompetenciesCore Competencies

ResourcesResourcesCapabilitiesCapabilities

Core CompetenciesCore Competencies

Strategic AllianceFirm AFirm A Firm BFirm B

Mutual interests in designing, manufacturing,Mutual interests in designing, manufacturing,or distributing goods or servicesor distributing goods or services

Types of Cooperative Strategies

Joint venture: two or more firms create an independent company by combining parts of their assets

Equity strategic alliance: partners who own different percentages of equity in a new venture

Nonequity strategic alliances: contractual agreements given to a company to supply, produce, or distribute a firm’s goods or services without equity sharing

Strategic Alliances

Margin Margin

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SupplierSupplier

• vertical complementary strategic alliance is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms

• outsourcing is one example of this type of alliance

Strategic Alliances

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BuyerBuyerPotential CompetitorsPotential Competitors

• horizontal complementary strategic alliance is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chain

• focus on long-term product development and distribution opportunities

• the partners may become competitors• requires a great deal of trust between the partners

BuyerBuyer