Procter and gamble sources of competitive advantage

Analyze The Impact of Globalization and Technology Changes to determine the business-level strategy you think is most important to the long-term success of the firm and whether or not you judge this to be a good choice. Justify your opinion.

Analyze the corporate-level strategies for the corporation you chose to determine the corporate-level strategy you think is most important to the long-term success of the firm and whether or not you judge this to be a good choice. Justify your opinion.

Analyze the competitive environment to determine the corporation's most significant competitor. Compare their strategies at each level and evaluate which company you think is most likely to be successful in the long term. Justify your choice.

Determine whether your choice from Question 3 would differ in slow-cycle and fast-cycle markets.

Use at least three (3) quality references, one being Strategic Management

Our discussions of business-level strategies (Chapter 4) and the competitive rivalry and competitive dynamics associated with them (Chapter 5) have concentrated on firms competing in a single industry or product market.1 In this chapter, we introduce you to corporate-level strategies, which are strategies firms use to diversify their operations from a single business competing in a single market into several product markets—most commonly, into several businesses. Thus, a corporate-level strategy specifies actions a firm takes to gain a competitive advantage by selecting and managing a group of differ- ent businesses competing in different product markets. Corporate-level strategies help companies to select new strategic positions—positions that are expected to increase the firm’s value.2 As explained in the Opening Case, General Electric competes in 16 widely diverse industries.

As is the case with GE, firms use corporate-level strategies as a means to grow rev- enues and profits, but there can be different strategic intents in addition to growth. Firms can pursue defensive or offensive strategies that realize growth but have different strategic intents. Firms can also pursue market development by moving into different geographic markets (this approach will be discussed in Chapter 8). Firms can acquire competitors (horizontal integration) or buy a supplier or customer (vertical integration). These strategies will be discussed in Chapter 7. The basic corporate strategy, the topic of this chapter, focuses on diversification.

The decision to take actions to pursue growth is never a risk-free choice for firms. Indeed, as the Opening Case explored, GE experienced difficulty in its media businesses, especially NBC, and its environmental record suffered. In one case, it tried to control NBC too much, trying to protect the firm. In so doing, it created questions about the objectivity of NBC’s reporting. Its environmental record likely suffered because of the lack of adequate oversight and the strong interest in producing returns for the share- holders. Effective firms carefully evaluate their growth options (including the different corporate-level strategies) before committing firm resources to any of them.3

Because the diversified firm operates in several different and unique product markets and likely in several businesses, it forms two types of strategies: corporate-level (or com- pany-wide) and business-level (or competitive).4 Corporate-level strategy is concerned with two key issues: in what product markets and businesses the firm should compete and how corporate headquarters should manage those businesses.5 For the diversified corporation, a business-level strategy (see Chapter 4) must be selected for each of the businesses in which the firm has decided to compete. In this regard, each of GE’s product divisions uses different business-level strategies; while most focus on differentiation, its consumer electronics business has products that compete in market niches to include some that are intended to serve the average income consumer. Thus, cost must also be an issue along with some level of quality.

As is the case with a business-level strategy, a corporate-level strategy is expected to help the firm earn above-average returns by creating value.6 Some suggest that few corporate-level strategies actually create value.7 As the Opening Case indicates, realizing value through a corporate strategy can be achieved but it is challenging to do so. In fact, GE is one of the few widely diversified and large firms that has been successful over time.

Evidence suggests that a corporate-level strategy’s value is ultimately determined by the degree to which “the businesses in the portfolio are worth more under the management of the company than they would be under any other ownership.”8 Thus, an effective corporate-level strategy creates, across all of a firm’s businesses, aggre- gate returns that exceed what those returns would be without the strategy9 and con- tributes to the firm’s strategic competitiveness and its ability to earn above-average returns.10

Product diversification, a primary form of corporate-level strategies, concerns the scope of the markets and industries in which the firm competes as well as “how managers buy, create and sell different businesses to match skills and strengths with opportunities presented to the firm.”11 Successful diversification is expected to reduce variability in the firm’s profitability as earnings are generated from different businesses.12 Diversification can also provide firms with the flexibility to shift their investments to markets where the greatest returns are possible rather than being dependent on only one or a few markets.13 Because firms incur development and monitoring costs when diversifying, the ideal portfolio of businesses balances diversification’s costs and benefits. CEOs and their top-management teams are responsible for determining the best portfolio for their company.14

We begin this chapter by examining different levels of diversification (from low to high). After describing the different reasons firms diversify their operations, we focus on two types of related diversification (related diversification signifies a moderate to high level of diversification for the firm). When properly used, these strategies help create value in the diversified firm, either through the sharing of resources (the related con- strained strategy) or the transferring of core competencies across the firm’s different businesses (the related linked strategy). We then discuss unrelated diversification, which is another corporate-level strategy that can create value. The chapter then shifts to the topic of incentives and resources that may stimulate diversification which is value neu- tral. However, managerial motives to diversify, the final topic in the chapter, can actually destroy some of the firm’s value.

Levels of Diversification

Diversified firms vary according to their level of diversification and the connections between and among their businesses. Figure 6.1 lists and defines five categories of businesses according to increasing levels of diversification. The single- and dominant- business categories denote relatively low levels of diversification; more fully diversi- fied firms are classified into related and unrelated categories. A firm is related through its diversification when its businesses share several links; for example, businesses may share products (goods or services), technologies, or distribution channels. The more links among businesses, the more “constrained” is the relatedness of diversification. “Unrelated” refers to the absence of direct links between businesses.

Low Levels of Diversification

A firm pursuing a low level of diversification uses either a single- or a dominant-business, corporate-level diversification strategy. A single-business diversification strategy is a corporate-level strategy wherein the firm generates 95 percent or more of its sales revenue from its core business area.15 For example, Wm. Wrigley Jr. Company, the world’s largest producer of chewing and bubble gums, historically used a single-business strategy while operating in relatively few product markets. Wrigley’s trademark chewing gum brands include Spearmint, Doublemint, and Juicy Fruit, although the firm produces other prod- ucts as well. Sugar-free Extra, which currently holds the largest share of the U.S. chewing gum market, was introduced in 1984.

In 2005, Wrigley shifted from its traditional focused strategy when it acquired the confectionary assets of Kraft Foods Inc., including the well-known brands Life Savers and Altoids. As Wrigley expanded, it may have intended to use the dominant-business strategy with the diversification of its product lines beyond gum; however, Wrigley was acquired in 2008 by Mars, a privately held global confection company (the maker of Snickers and M&Ms).16

With the dominant-business diversification strategy, the firm generates between 70 and 95 percent of its total revenue within a single business area. United Parcel Service (UPS) uses this strategy. Recently UPS generated 60 percent of its revenue from its U.S. package delivery business and 22 percent from its international package business, with the remaining 18 percent coming from the firm’s non-package business.17 Though the U.S. package delivery business currently generates the largest percentage of UPS’s sales revenue, the firm anticipates that in the future its other two businesses will account for the majority of revenue growth. This expectation suggests that UPS may become more diversified, both in terms of its goods and services and in the number of countries in which those goods and services are offered.

Firms that focus on one or very few businesses and markets can earn positive returns, because they develop capabilities useful for these markets and can provide superior ser- vice to their customers. Additionally, there are fewer challenges in managing one or a very small set of businesses, allowing them to gain economies of scale and efficiently use their resources.18 Family-owned and controlled businesses are commonly less diversified. They prefer the focus because the family’s reputation is related closely to that of the busi- ness. Thus, family members prefer to provide quality goods and services which a focused strategy better allows.1

Moderate and High Levels of Diversification

A firm generating more than 30 percent of its revenue outside a dominant business and whose businesses are related to each other in some manner uses a related diversification corporate-level strategy. When the links between the diversified firm’s businesses are rather direct, a related constrained diversification strategy is being used. Campbell Soup, Procter & Gamble, and Merck & Company all use a related constrained strategy, as do some large cable companies. With a related constrained strategy, a firm shares resources and activities between its businesses.

Clearly, the Publicis Groupe uses a related constrained strategy, deriving value from the potential synergy across its various groups, especially the digital capabilities in its advertising business. Given its recent performance, the related constrained strategy has created value for Publicis customers and its shareholders.

The diversified company with a portfolio of businesses that have only a few links between them is called a mixed related and unrelated firm and is using the related linked diversification strategy (see Figure 6.1). As displayed in the Opening Case, GE uses this corporate-level diversification strategy. Compared with related constrained firms, related linked firms share fewer resources and assets between their businesses, concentrating instead on transferring knowledge and core competencies between the businesses. GE has four strategic business units (see Chapter 11 for a definition of SBUs) it calls “divisions,” each composed of related businesses. There are no relation- ships among the strategic business units, only within them. As with firms using each type of diversification strategy, companies implementing the related linked strategy constantly adjust the mix in their portfolio of businesses as well as make decisions about how to manage these businesses.20 Managing a diversified firm such as GE is highly challenging, but GE appears to have been well managed over the years given its success.

A highly diversified firm that has no relationships between its businesses follows an unrelated diversification strategy. United Technologies, Textron, Samsung, and Hutchison Whampoa Limited (HWL) are examples of firms using this type of corporate-level strategy. Commonly, firms using this strategy are called conglomerates. HWL is a leading international corporation with five core businesses: ports and related services; property and hotels; retail; energy, infrastructure, investments and others; and telecommunications. These businesses are not related to each other, and the firm makes no efforts to share activities or to transfer core competencies between or among them. Each of these five businesses is quite large; for example, the retailing arm of the retail and manufacturing business has more than 9,300 stores in 33 countries. Groceries, cosmet- ics, electronics, wine, and airline tickets are some of the product categories featured in these stores. This firm’s size and diversity suggest the challenge of successfully managing the unrelated diversification strategy. However, Hutchison’s CEO Li Ka-shing has been successful at not only making smart acquisitions, but also at divesting businesses with good timing.21

Reasons for Diversification

A firm uses a corporate-level diversification strategy for a variety of reasons (see Table 6.1). Typically, a diversification strategy is used to increase the firm’s value by improving its overall performance. Value is created either through related diversification or through unrelated diversification when the strategy allows a company’s businesses to increase revenues or reduce costs while implementing their business-level strategies.

Other reasons for using a diversification strategy may have nothing to do with increasing the firm’s value; in fact, diversification can have neutral effects or even reduce

a firm’s value. Value-neutral reasons for diversification include a desire to match and thereby neutralize a competitor’s market power (such as to neutralize another firm’s advantage by acquiring a similar distribution outlet). Decisions to expand a firm’s port- folio of businesses to reduce managerial risk can have a negative effect on the firm’s value. Greater amounts of diversification reduce managerial risk in that if one of the businesses in a diversified firm fails, the top executive of that business does not risk total failure by the corporation. As such, this reduces the top executives’ employment risk. In addition, because diversification can increase a firm’s size and thus managerial com- pensation, managers have motives to diversify a firm to a level that reduces its value.22 Diversification rationales that may have a neutral or negative effect on the firm’s value are discussed later in the chapter.

Operational relatedness and corporate relatedness are two ways diversification strate- gies can create value (see Figure 6.2). Studies of these independent relatedness dimen- sions show the importance of resources and key competencies.23 The figure’s vertical dimension depicts opportunities to share operational activities between businesses (oper- ational relatedness) while the horizontal dimension suggests opportunities for transfer- ring corporate-level core competencies (corporate relatedness). The firm with a strong capability in managing operational synergy, especially in sharing assets between its busi- nesses, falls in the upper left quadrant, which also represents vertical sharing of assets through vertical integration. The lower right quadrant represents a highly developed corporate capability for transferring one or more core competencies across businesses.

This capability is located primarily in the corporate headquarters office. Unrelated diversification is also illustrated in Figure 6.2 in the lower left quadrant. Financial econo- mies (discussed later), rather than either operational or corporate relatedness, are the source of value creation for firms using the unrelated diversification strategy.

Value-Creating Diversification: Related Constrained and Related Linked Diversification

With the related diversification corporate-level strategy, the firm builds upon or extends its resources and capabilities to build a competitive advantage by creating value for cus- tomers.24 The company using the related diversification strategy wants to develop and exploit economies of scope between its businesses.25 Available to companies operating in multiple product markets or industries,26 economies of scope are cost savings that the firm creates by successfully sharing some of its resources and capabilities or transferring one or more corporate-level core competencies that were developed in one of its busi- nesses to another of its businesses.

As illustrated in Figure 6.2, firms seek to create value from economies of scope through two basic kinds of operational economies: sharing activities (operational relatedness) and transferring corporate-level core competencies (corporate related- ness). The difference between sharing activities and transferring competencies is based on how separate resources are jointly used to create economies of scope. To create economies of scope tangible resources, such as plant and equipment or other business- unit physical assets, often must be shared. Less tangible resources, such as manu- facturing know-how and technological capabilities, can also be shared.27 However, know-how transferred between separate activities with no physical or tangible resource involved is a transfer of a corporate-level core competence, not an operational sharing of activities.28

Operational Relatedness: Sharing Activities

Firms can create operational relatedness by sharing either a primary activity (such as inventory delivery systems) or a support activity (such as purchasing practices)—see Chapter 3’s discussion of the value chain. Firms using the related constrained diversi- fication strategy share activities in order to create value. Procter & Gamble (P&G) uses this corporate-level strategy. P&G’s paper towel business and baby diaper business both use paper products as a primary input to the manufacturing process. The firm’s paper production plant produces inputs for both businesses and is an example of a shared activ- ity. In addition, because they both produce consumer products, these two businesses are likely to share distribution channels and sales networks.

Activity sharing is also risky because ties among a firm’s businesses create links between outcomes. For instance, if demand for one business’s product is reduced, it may not generate sufficient revenues to cover the fixed costs required to operate the shared facilities. These types of organizational difficulties can reduce activity-sharing success. Additionally, activity sharing requires careful coordination between the busi- nesses involved. The coordination challenges must be managed effectively for the appro- priate sharing of activities.2

Although activity sharing across businesses is not risk-free, research shows that it can create value. For example, studies of acquisitions of firms in the same indus- try (horizontal acquisitions), such as the banking industry and software, found that sharing resources and activities and thereby creating economies of scope contributed to post-acquisition increases in performance and higher returns to shareholders.30 Additionally, firms that sold off related units in which resource sharing was a possible source of economies of scope have been found to produce lower returns than those that sold off businesses unrelated to the firm’s core business.31 Still other research discov- ered that firms with closely related businesses have lower risk.32 These results suggest that gaining economies of scope by sharing activities across a firm’s businesses may be important in reducing risk and in creating value. Further, more attractive results are obtained through activity sharing when a strong corporate headquarters office facilitates it.33

Corporate Relatedness: Transferring of Core Competencies

Over time, the firm’s intangible resources, such as its know-how, become the founda- tion of core competencies. Corporate-level core competencies are complex sets of resources and capabilities that link different businesses, primarily through managerial and technological knowledge, experience, and expertise.34 Firms seeking to create value through corporate relatedness use the related linked diversification strategy as exempli- fied by GE.

In at least two ways, the related linked diversification strategy helps firms to cre- ate value.35 First, because the expense of developing a core competence has already been incurred in one of the firm’s businesses, transferring this competence to a second business eliminates the need for that business to allocate resources to develop it. Such is the case at Hewlett-Packard (HP), where the firm trans- ferred its competence in ink printers to high-end copiers. Rather than the standard laser print- ing technology in most high-end copiers, HP is using ink-based technology. One manager liked the product because, as he noted, “We are able to do a lot better quality at less price.”36 This capa- bility gives HP the opportunity to sell more ink products and create higher profit margins.

Resource intangibility is a second source of value creation through corporate relatedness. Intangible resources are difficult for competitors to understand and imitate. Because of this difficulty, the unit receiving a transferred corporate-level competence often gains an immediate competi- tive advantage over its rivals.37

A number of firms have successfully trans- ferred one or more corporate-level core competencies across their businesses. Virgin Group Ltd. transfers its marketing core competence across airlines, cosmetics, music, drinks, mobile phones, health clubs, and a number of other businesses.38 Honda has developed and transferred its competence in engine design and manufacturing among its businesses making products such as motorcycles, lawnmowers, and cars and trucks. Company officials state that Honda is a major manufacturer of engines and is focused on

providing products for all forms of human mobility.39 One way managers facilitate the transfer of corporate-level core competencies is by

moving key people into new management positions.40 However, the manager of an older business may be reluctant to transfer key people who have accumulated knowledge and experience critical to the business’s success. Thus, managers with the ability to facilitate the transfer of a core competence may come at a premium, or the key people involved may not want to transfer. Additionally, the top-level managers from the transferring business may not want the competencies transferred to a new business to fulfill the firm’s diversification objectives.41 Research also suggests too much dependence on outsourcing can lower the usefulness of core competencies and thereby reduce their useful transfer- ability to other business units in the diversified firm.42

Market Power

Firms using a related diversification strategy may gain market power when successfully using a related constrained or related linked strategy. Market power exists when a firm is able to sell its products above the existing competitive level or to reduce the costs of its primary and support activities below the competitive level, or both.43 Mars’ acquisi- tion of the Wrigley assets was part of its related constrained diversification strategy and added market share to the Mars/Wrigley integrated firm, as it realized 14.4 percent of the market share. This catapulted Mars/Wrigley above Cadbury and Nestle, which had 10.1 and 7.7 percent of the market share, respectively, at the time and left Hershey with only 5.5 percent of the market.44

In addition to efforts to gain scale as a means of increasing market power, as Mars did when it acquired Wrigley, firms can create market power through multipoint competition and vertical integration. Multipoint competition exists when two or more diversified firms simultaneously compete in the same product areas or geo- graphic markets.45 The actions taken by UPS and FedEx in two markets, overnight delivery and ground shipping, illustrate multipoint competition. UPS has moved into overnight delivery, FedEx’s stronghold; FedEx has been buying trucking and ground shipping assets to move into ground shipping, UPS’s stronghold. Moreover, geographic competition for markets increases. The strongest shipping company in Europe is DHL. All three competitors (UPS, FedEx, and DHL) are moving into large foreign markets to either gain a stake or to expand their existing share. If one of these firms successfully gains strong positions in several markets while competing against its rivals, its market power may increase. Interestingly, DHL had to exit the U.S. market because it was too difficult to compete against UPS and FedEx, which are dominant in the United States.

Some firms using a related diversification strategy engage in vertical integration to gain market power. Vertical integration exists when a company produces its own inputs (backward integration) or owns its own source of output distribution (forward integration). In some instances, firms partially integrate their operations, producing and selling their products by using company businesses as well as outside sources.46

Vertical integration is commonly used in the firm’s core business to gain market power over rivals. Market power is gained as the firm develops the ability to save on its operations, avoid market costs, improve product quality, possibly protect its technol- ogy from imitation by rivals, and potentially exploit underlying capabilities to handle special resources (e.g., sophisticated chemicals or technologies).47 Market power also is created when firms have strong ties between their assets for which no market prices exist. Establishing a market price would result in high search and transaction costs, so firms seek to vertically integrate rather than remain separate businesses.48

Vertical integration has its limitations. For example, an outside supplier may produce the product at a lower cost. As a result, internal transactions from vertical integration may be expensive and reduce profitability relative to competitors.49 Also, bureaucratic costs can be present with vertical integration.50 Because vertical integration can require substantial investments in specific technologies, it may reduce the firm’s flexibility, espe- cially when technology changes quickly. Finally, changes in demand create capacity bal- ance and coordination problems. If one business is building a part for another internal business but achieving economies of scale requires the first division to manufacture quantities that are beyond the capacity of the internal buyer to absorb, it would be neces- sary to sell the parts outside the firm as well as to the internal business. Thus, although vertical integration can create value, especially through market power over competitors, it is not without risks and costs.51

As noted in the Strategic Focus, Google is diversifying into new markets that allow it to engage in multipoint competition. For example, Google is competing with Microsoft and Apple now in several markets. All of its competitors know that Google is a formi- dable rival with significant resources to invest in the competition. As such, the com- petitors have reacted, some with substantive actions and others in less positive ways. For example, Apple acquired Siri, a small voice search firm, to help it compete with Google’s search business.52 As noted in the Strategic Focus, Microsoft filed a complaint with the EU about potential antitrust violations by Google. Yahoo! has undertaken advertising that criticizes Google, and Facebook hired a public relations firm to plant negative stories in the press about Google.53 Some of Google’s diversification moves represent a form of vertical integration because the new business areas build on the company’s substantial search business (forward integration).

Although Google appears to be increasing its vertical integration, many manufactur- ing firms have been reducing vertical integration as a means of gaining market power.54 In fact, deintegration is the focus of most manufacturing firms, such as Intel and Dell, and even some large auto companies, such as Ford and General Motors, as they develop independent supplier networks.55 Flextronics, an electronics contract manufacturer, rep- resents a new breed of large contract manufacturers that is helping to foster this revolu- tion in supply-chain management.56 Such firms often manage their customers’ entire product lines and offer services ranging from inventory management to delivery and after-sales service.

Simultaneous Operational Relatedness and Corporate Relatedness

As Figure 6.2 suggests, some firms simultaneously seek operational and corporate relat- edness to create economies of scope.57 The ability to simultaneously create economies of scope by sharing activities (operational relatedness) and transferring core competen- cies (corporate relatedness) is difficult for competitors to understand and learn how to imitate. However, if the cost of realizing both types of relatedness is not offset by the benefits created, the result is diseconomies because the cost of organization and incentive structure is very expensive.58

Walt Disney Co. uses a related diversification strategy to simultaneously create econ- omies of scope through operational and corporate relatedness. Within the firm’s Studio Entertainment business, for example, Disney can gain economies of scope by sharing activities among its different movie distribution companies such as Touchstone Pictures, Hollywood Pictures, and Dimension Films. Broad and deep knowledge about its custom- ers is a capability on which Disney relies to develop corporate-level core competencies in terms of advertising and marketing. With these competencies, Disney is able to cre- ate economies of scope through corporate relatedness as it cross-sells products that are highlighted in its movies through the distribution channels that are part of its Parks and Resorts and Consumer Products businesses. Thus, characters created in movies become figures that are marketed through Disney’s retail stores (which are part of the Consumer Products business). In addition, themes established in movies become the source of new rides in the firm’s theme parks, which are part of the Parks and Resorts business and provide themes for clothing and other retail business products.59

Thus, Walt Disney Co. has been able to successfully use related diversification as a corporate-level strategy through which it creates economies of scope by sharing some activities and by transferring core competencies. However, it can be difficult for inves- tors to actually observe the value created by a firm (such as Walt Disney Co.) as it shares activities and transfers core competencies. For this reason, the value of the assets of a firm using a diversification strategy to create economies of scope often is discounted by investors.

Unrelated Diversification

Firms do not seek either operational relatedness or corporate relatedness when using the unrelated diversification corporate-level strategy. An unrelated diversification strategy (see Figure 6.2) can create value through two types of financial economies. Financial economies are cost savings realized through improved allocations of financial resources based on investments inside or outside the firm.60

Efficient internal capital allocations can lead to financial economies. Efficient internal capital allocations reduce risk among the firm’s businesses—for example, by leading to the development of a portfolio of businesses with different risk profiles. The second type of financial economy concerns the restructuring of acquired assets. Here, the diversified firm buys another company, restructures that company’s assets in ways that allow it to operate more profitably, and then sells the company for a profit in the external market.61 Next, we discuss the two types of financial economies in greater detail.

Efficient Internal Capital Market Allocation

In a market economy, capital markets are thought to efficiently allocate capital. Efficiency results as investors take equity positions (ownership) with high expected future cash- flow values. Capital is also allocated through debt as shareholders and debt holders try to improve the value of their investments by taking stakes in businesses with high growth and profitability prospects.

In large diversified firms, the corporate headquarters office distributes capital to its businesses to create value for the overall corporation. The nature of these distributions may generate gains from internal capital market allocations that exceed the gains that would accrue to shareholders as a result of capital being allocated by the external capi- tal market.62 Because those in a firm’s corporate headquarters generally have access to detailed and accurate information regarding the actual and prospective performance of the company’s portfolio of businesses, they have the best information to make capital distribution decisions.