Pause proceed with caution strategy

Strategy Formulation: Corporate Strategy

Chapter 7

Learning Objectives

Understand the three aspects of corporate strategy

Apply the directional strategies of growth, stability and retrenchment

Understand the differences between vertical and horizontal growth as well as concentric and conglomerate diversification

Identify strategic options to enter a foreign country

Apply portfolio analysis to guide decisions in companies with multiple products and businesses

Develop a parenting strategy for a multiple-business corporation

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After reading this chapter, you should be able to:

Understand the three aspects of corporate strategy

Apply the directional strategies of growth, stability and retrenchment

Understand the differences between vertical and horizontal growth as well as concentric and conglomerate diversification

Identify strategic options to enter a foreign country

Apply portfolio analysis to guide decisions in companies with multiple products and businesses

Develop a parenting strategy for a multiple-business corporation

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Corporate Strategy

Corporate strategy

the choice of direction of the firm as a whole and the management of its business or product portfolio and concerns

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Corporate strategy is primarily about the choice of direction for a firm as a whole and the management of its business or product portfolio.

Corporate Strategy

Directional strategy

the firm’s overall orientation toward growth, stability or retrenchment

Portfolio analysis

industries or markets in which the firm competes through its products and business units

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Corporate strategy addresses 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 analysis).

Corporate Strategy

Parenting strategy

the manner in which management coordinates activities and transfers resources and cultivates capabilities among product lines and business units

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3. The manner in which management coordinates activities and transfers resources and cultivates capabilities among product lines and business units (parenting strategy).

Corporate Directional Strategies

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Figure 7-1

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Having chosen the general orientation (such as growth), a company’s managers can select from several more specific corporate strategies such as concentration within one product line/industry or diversification into other products/industries. (See Figure 7–1.)

Directional Strategy

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

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A corporation’s directional strategy is composed of three general orientations (sometimes called grand strategies):

■ 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.

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Growth Strategies

Merger

a transaction involving two or more corporations in which stock is exchanged but in which only one corporation survives

Acquisition

100% purchase of another company

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A merger is a transaction involving two or more corporations in which both companies exchange stock in order to create one new corporation. An acquisition is a 100% purchase of another company.

Concentration Strategies

Vertical growth

achieved by taking over a function previously provided by a supplier or distributor

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Vertical growth can be achieved by taking over a function previously provided by a supplier or distributor.

Concentration Strategies

Vertical integration

the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing

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Vertical growth results in vertical integration—the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing.

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Vertical Integration

Backward integration

assuming a function previously provided by a supplier

Forward integration

assuming a function previously provided by a distributor

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More specifically, assuming a function previously provided by a supplier is called backward integration (going backward on an industry’s value chain). Assuming a function previously provided by a distributor is labeled forward integration (going forward on an industry’s value chain).

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Vertical Integration

Transaction cost economies

vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying on the open market become too great

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Transaction cost economics proposes that 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.

Vertical Integration Continuum

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Harrigan proposes that a company’s degree of vertical integration can range from total ownership of the value chain needed to make and sell a product to no ownership at all. (See Figure 7–2.)

Vertical Integration

Full integration

a firm internally makes 100% of its key supplies and completely controls its distributors

Taper integration

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

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Under full integration, a firm internally makes 100% of its key supplies and completely controls its distributors.

With taper integration (also called concurrent sourcing), a firm internally produces less than half of its own requirements and buys the rest from outside suppliers (backward taper integration).

Vertical Integration

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

Long-term contracts

agreements between two firms to provide agreed-upon goods and services to each other for a specific period of time

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With 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 (backward quasi-integration).

Long-term contracts are agreements between two firms to provide agreed-upon goods and services to each other for a specified period of time.

Concentration Strategies

Horizontal growth

expansion of operations into other geographic locations and/or increasing the range of products and services offered to current markets

Horizontal integration

the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain

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A firm can achieve horizontal growth by expanding its operations into other geographic locations and/or by increasing the range of products and services

offered to current markets.

Horizontal growth results in horizontal integration—the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain

International Entry Options for Horizontal Growth

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Some of the most popular options for international entry are as follows:

Exporting

Licensing

Franchising

Joint Venture

Acquisitions

Green-Field Development

Production Sharing

Turn-Key Operations

BOT Concept

Management Contracts

Exporting

Licensing

Franchising

Joint Venture

Acquisitions

Green-Field Development

Production Sharing

Turn-Key Operations

BOT Concept

Management Contracts

Diversification Strategies

Concentric (Related) diversification

growth into a related industry when a firm has a strong competitive position but attractiveness is low

Synergy

the concept that two businesses will generate more profits together than they could separately

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Growth through concentric diversification into a related industry may be a very appropriate corporate strategy when a firm has a strong competitive position but industry attractiveness is low.

The search is for synergy, the concept that two businesses will generate more profits together than they could separately.

Diversification Strategies

Conglomerate (Unrelated) diversification

diversifying into an industry unrelated to its current one

Management realizes that the current industry is unattractive.

Firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries.

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When management realizes that the current industry is unattractive and that the firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries, the most likely strategy is conglomerate diversification—diversifying into an industry unrelated to its current one.

Controversies in Directional Strategies

Is vertical growth better than horizontal growth?

Is concentration better than diversification?

Is concentric diversification better than conglomerate diversification?

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Is vertical growth better than horizontal growth? Is concentration better than diversification? Is concentric diversification better than conglomerate diversification?

Stability Strategies

Pause/Proceed with caution strategy

an opportunity to rest before continuing a growth or retrenchment strategy

No-change strategy

decision to do nothing new—a choice to continue current operations and policies for the foreseeable future

Profit strategies

decision to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary

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A pause/proceed-with-caution strategy is, in effect, a timeout—an opportunity to rest before continuing a growth or retrenchment strategy.

A no-change strategy is a decision to do nothing new—a choice to continue current operations and policies for the foreseeable future.

A profit strategy is a decision to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary.

Retrenchment Strategies

Retrenchment strategies

used when the firm has a weak competitive position in some or all of its product lines from poor performance

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A company may pursue retrenchment strategies when it has a weak competitive position in some or all of its product lines resulting in poor performance—sales are down and profits are becoming losses.

Retrenchment Strategies

Turnaround strategy

emphasizes the improvement of operational efficiency when the corporation’s problems are pervasive but not critical

Contraction

effort to quickly “stop the bleeding” across the board but in size and costs

Consolidation

stabilization of the new leaner corporation

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Turnaround strategy emphasizes the improvement of operational efficiency and is probably most appropriate when a corporation’s problems are pervasive but not yet critical.

Contraction is the initial effort to quickly “stop the bleeding” with a general, across-the-board cutback in size and costs.

The second phase, consolidation, implements a program to stabilize the now-leaner corporation.

Retrenchment Strategies

Captive company strategy

company gives up independence in exchange for security

Sell-out strategy

management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the company to another firm

Divestment

sale of a division with low growth potential

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A captive company strategy involves giving up independence in exchange for security. The sell-out strategy makes sense if management can still obtain

a good price for its shareholders and the employees can keep their jobs by selling the entire company to another firm. If the corporation has multiple business lines and it chooses to sell off a division with low growth potential, this is called divestment.

Retrenchment Strategies

Bankruptcy

company gives up management of the firm to the courts in return for some settlement of the corporation’s obligations

Liquidation

management terminates the firm

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Bankruptcy involves giving up management of the firm to the courts in return for some settlement of the corporation’s obligations. In contrast to bankruptcy, which seeks to perpetuate a corporation, liquidation is the termination of the firm.

Portfolio Analysis

Portfolio analysis

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

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In portfolio analysis, top management views its product lines and business units as a series of investments from which it expects a profitable return

BCG Growth—Share Matrix

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Figure 7-3

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Using the BCG (Boston Consulting Group) Growth-Share Matrix depicted in Figure 7–3 is the simplest way to portray a corporation’s portfolio of investments. 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.

BCG Matrix

Question marks

new products with the potential for success but need a lot of cash for development

Stars

market leaders that are typically at or nearing the peak of their product life cycle and are able to generate enough cash to maintain their high share of the market and usually contribute to the company’s profits

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Question marks (sometimes called “problem children” or “wildcats”) are new products with the potential for success, but they need a lot of cash for development.

Stars are market leaders that are typically at or nearing the peak of their product life cycle and are able to generate enough cash to maintain their high share of the market and usually contribute to the company’s profits.

BCG Matrix

Cash cows

products that bring in far more money than is needed to maintain their market share

Dogs

products with low market share and do not have the potential to bring in much cash

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Cash cows typically bring in far more money than is needed to maintain their market share.

Dogs have low market share and do not have the potential (because they are in an unattractive industry) to bring in much cash.

BCG Matrix—Limitations

Use of highs and lows to form categories is too simplistic.

Link between market share and profitability is questionable.

Growth rate is only one aspect of industry attractiveness.

Product lines or business units are considered only in relation to one competitor.

Market share is only one aspect of overall competitive position.

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Unfortunately, the BCG Growth-Share Matrix also has some serious limitations:

■ The use of highs and lows to form four categories is too simplistic.

■ The link between market share and profitability is questionable

■ Growth rate is only one aspect of industry attractiveness.

■ Product lines or business units are considered only in relation to one competitor: the market leader. Small competitors with fast-growing market shares are ignored.

■ Market share is only one aspect of overall competitive position.

Advantages and Limitations of Portfolio Analysis

Advantages

Encourages top management to evaluate each of the corporation’s businesses individually and to set objectives and allocate resources for each

Stimulates the use of externally oriented data to supplement management’s judgment

Raises the issue of cash flow availability to use in expansion and growth

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Portfolio analysis is commonly used in strategy formulation because it offers certain advantages:

■ It encourages top management to evaluate each of the corporation’s businesses individually and to set objectives and allocate resources for each.

■ It stimulates the use of externally oriented data to supplement management’s judgment.

■ It raises the issue of cash-flow availability for use in expansion and growth.

■ Its graphic depiction facilitates communication.

Advantages and Limitations of Portfolio Analysis

Limitations

Defining product/market segments is difficult

Suggest the use of standard strategies that can miss opportunities or be impractical

Value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies

Lack of clarity on what makes an industry attractive or where a product is in its life cycle

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Portfolio analysis does, however, have some very real limitations that have caused some companies to reduce their use of this approach:

Defining product/market segments is difficult.

It suggests the use of standard strategies that can miss opportunities or be impractical.

It provides an illusion of scientific rigor, when in reality positions are based on subjective judgments.

Its value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies.

It is not always clear what makes an industry attractive or where a product is in its life cycle.

Naively following the prescriptions of a portfolio model may actually reduce corporate profits if they are used inappropriately.

Tasks Necessary for Managing a Strategic Alliance Portfolio

Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing all the alliances of the entire company

Monitoring the alliance portfolio in terms of implementing business units’ strategies and corporate strategy and policies

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A study of 25 leading European corporations found four tasks of multi-alliance management that are necessary for successful alliance portfolio management:

Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing all the alliances of the entire company

Monitoring the alliance portfolio in terms of implementing business units’ strategies and corporate strategy and policies

Tasks Necessary for Managing a Strategic Alliance Portfolio

Coordinating the portfolio to obtain synergies and avoid conflicts among alliances

Establishing an alliance management system to support other tasks of multi-alliance management

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Also necessary are:

Coordinating the portfolio to obtain synergies and avoid conflicts among alliances

Establishing an alliance management system to support other tasks of multi-alliance management

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Corporate Parenting

Corporate parenting

views a corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units

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Corporate parenting, or parenting strategy, in contrast, views a corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units.

Corporate Parenting

Generates corporate strategy by focusing on the core competencies of the parent corporation and the value created from the relationship between the parent and its businesses

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Corporate parenting generates corporate strategy by focusing on the core competencies of the parent corporation and on the value created from the relationship between the parent and its businesses

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Developing a Corporate Parenting Strategy

Examine each business unit in terms of its strategic factors

Examine each business unit in terms of areas in which performance can be improved

Analyze how well the parent corporation fits with the business unit

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The search for appropriate corporate strategy involves three analytical steps:

Examine each business unit in terms of its strategic factors

Examine each business unit in terms of areas in which performance can be improved

Analyze how well the parent corporation fits with the business unit

Horizontal Strategy and Multipoint Competition

Horizontal strategy

cuts across business unit boundaries to build synergy across business units and to improve competitive position in one of more business units

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A horizontal strategy is a corporate strategy that cuts across business unit boundaries to build synergy between business units and to improve the competitive position of one or more business units

Horizontal Strategy and Multipoint Competition

Multipoint competition

large multi-business corporations compete against other large multi-business firms in a number of markets

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In multipoint competition, large multi-business corporations compete against other large multi-business firms in a number of markets. These multipoint

competitors are firms that compete with each other not only in one business unit, but also in a number of business units.