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Corporate-Level Strategy

MANA 5336
Directional Strategies

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Directional Strategies

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?

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Directional Strategies

Basic Growth Strategies:


Concentration
– Current product line in one industry
– Vertical Integration
– Market Development
– Product Development
– Penetration

Diversification
– Into other product lines in other industries
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Directional Strategies

Expansion of Scope
Basic Concentration Strategies:
Vertical growth
Horizontal growth

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Directional Strategies

Vertical growth

– Vertical integration
 Full integration
 Taper integration
 Quasi-integration

– Backward integration

– Forward integration

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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

Intermediate
Raw materials Assembly Distribution End user
manufacturer

Examples: Examples: Examples: Examples:


Dow Chemical Intel Apple Best Buy
Union Carbide Seagate Hp Office Max
Kyocera Micron Dell
Vertical Integration
Integration backward into supplier functions
– Assures constant supply of inputs.
– Protects against price increases.
Integration forward into distributor functions
– Assures proper disposal of outputs.
– Captures additional profits beyond activity costs.
Integration choice is that of which value-adding
activities to compete in and which are better suited for
others to carry out.
Creating Value Through Vertical Integration

Advantages of a vertical integration strategy:


– Builds entry barriers to new competitors by denying
them inputs and customers.
– Facilitates investment in efficiency-enhancing
assets that solve internal mutual dependence
problems.
– Protects product quality through control of input
quality and distribution and service of outputs.
– Improves internal scheduling (e.g., JIT inventory
systems) responses to changes in demand.
Creating Value Through Vertical
Integration

Disadvantages of vertical integration


– Cost disadvantages of internal supply purchasing.
– Remaining tied to obsolescent technology.
– Aligning input and output capacities with
uncertainty in market demand is difficult for
integrated companies.
Directional Strategies

Horizontal Growth

– Horizontal integration

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Directional Strategies

Basic Diversification Strategies:

– Concentric Diversification

– Conglomerate Diversification

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Directional Strategies

Concentric Diversification

– Growth into related industry


– Search for synergies

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Concentration on a Single Business

Southwest Airlines
S
SE AC
R
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la
o n a l d s
McD
Concentration on a Single Business

Advantages Disadvantages
– Operational focus on a – No diversification of market
single familiar industry or risks.
market. – Vertical integration may be
– Current resources and required to create value
capabilities add value. and establish competitive
– Growing with the market advantage.
brings competitive – Opportunities to create
advantage. value and make a profit
may be missed.
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.
Related Diversification

Marriott
3M
P ack ar d
Hew l et t
Unrelated Diversification

co
Ty
Amer
G r ou p
I TT
Diversification and Corporate Performance: A
Disappointing History

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.
Directional Strategies
Directional Strategies

Unrelated (Conglomerate) Diversification


– Growth into unrelated industry
– Concern with financial considerations

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Directional Strategies
Reasons for Diversification

Incentives
Reasons to Enhance Strategic
Competitiveness
Resources
• Economies of scope/scale
• Market power
Managerial • Financial economics
Motives
Reasons for Diversification

Incentives with Neutral


Incentives
Effects on Strategic
Competitiveness
• Anti-trust regulation
Resources • Tax laws
• Low performance
• Uncertain future cash flows
Managerial
• Firm risk reduction
Motives
Incentives to Diversify

External Incentives:
 Relaxation of anti-trust regulation allows more related
acquisitions than in the past
 Before 1986, higher taxes on dividends favored spending
retained earnings on acquisitions
 After 1986, firms made fewer acquisitions with retained
earnings, shifting to the use of debt to take advantage of tax
deductible interest payments
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
Reasons for Diversification

Incentives
Managerial Motives (Value
Reduction)

Resources • Diversifying managerial


employment risk
• Increasing managerial
Managerial compensation
Motives
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
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.
Relationship Between
Diversification and Performance
Performance

Dominant Related Unrelated


Business Constrained Business

Level of Diversification
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
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.
Adaptive Strategies

Maintenance of Scope
Enhancement
Status Quo
Market Entry Strategies

 Acquisition: a strategy through which one organization buys a


controlling interest in another organization with the intent of
making the acquired firm a subsidiary business within its own
portfolio
 Licensing: a strategy where the organization purchases the
right to use technology, process, etc.
 Joint Venture: a strategy where an organization joins with
another organization(s) to form a new organization
Reasons for Making Acquisitions
Learn and develop
new capabilities
Increase Reshape firm’s
market power competitive scope

Overcome Acquisitions Increase


entry barriers diversification

Cost of new Lower risk compared


product development to developing new
Increase speed products
to market
Reasons for Making Acquisitions:

Increased Market Power


 Factors increasing market power
– when a firm is able to sell its goods or services above
competitive levels or
– when the costs of its primary or support activities are below
those of its competitors
– usually is derived from the size of the firm and its resources
and capabilities to compete
 Market power is increased by
– horizontal acquisitions
– vertical acquisitions
– related acquisitions
Reasons for Making Acquisitions:

Overcome Barriers to Entry


 Barriers to entry include
– economies of scale in established competitors
– differentiated products by competitors
– enduring relationships with customers that create product
loyalties with competitors
 acquisition of an established company
– may be more effective than entering the market as a
competitor offering an unfamiliar good or service that is
unfamiliar to current buyers
 Cross-border acquisition
Reasons for Making Acquisitions:

 Significant investments of a firm’s resources are


required to
– develop new products internally
– introduce new products into the marketplace
 Acquisition of a competitor may result in
– lower risk compared to developing new products
– increased diversification
– reshaping the firm’s competitive scope
– learning and developing new capabilities
– faster market entry
– rapid access to new capabilities
Reasons for Making Acquisitions:

Lower Risk Compared to Developing


New Products
 An acquisition’s outcomes can be estimated more
easily and accurately compared to the outcomes of an
internal product development process
 Therefore managers may view acquisitions as lowering
risk
Reasons for Making Acquisitions:

Increased Diversification
 It may be easier to develop and introduce new products
in markets currently served by the firm
 It may be difficult to develop new products for markets
in which a firm lacks experience
– it is uncommon for a firm to develop new products internally to
diversify its product lines
– acquisitions are the quickest and easiest way to diversify a firm
and change its portfolio of businesses
Reasons for Making Acquisitions:
Reshaping the Firms’ Competitive Scope

 Firms may use acquisitions to reduce their


dependence on one or more products or markets
 Reducing a company’s dependence on specific
markets alters the firm’s competitive scope
Reasons for Making Acquisitions:
Learning and Developing New Capabilities

 Acquisitions may gain capabilities that the firm does


not possess
 Acquisitions may be used to
– acquire a special technological capability
– broaden a firm’s knowledge base
– reduce inertia
Problems With Acquisitions
Integration Resulting firm
difficulties is too large

Inadequate Acquisitions Managers overly


evaluation of target focused on acquisitions

Large or Too much


extraordinary debt diversification

Inability to
achieve synergy
Problems With Acquisitions

Integration Difficulties
 Integration challenges include
– melding two disparate corporate cultures
– linking different financial and control systems
– building effective working relationships (particularly when
management styles differ)
– resolving problems regarding the status of the newly
acquired firm’s executives
– loss of key personnel weakens the acquired firm’s
capabilities and reduces its value
Problems With Acquisitions

Inadequate Evaluation of Target


 Evaluation requires that hundreds of issues be
closely examined, including
– financing for the intended transaction
– differences in cultures between the acquiring and target firm
– tax consequences of the transaction
– actions that would be necessary to successfully meld the
two workforces
 Ineffective due-diligence process may
– result in paying excessive premium for the target company
Problems With Acquisitions

Large or Extraordinary Debt


 Firm may take on significant debt to acquire a
company
 High debt can
– increase the likelihood of bankruptcy
– lead to a downgrade in the firm’s credit rating
– preclude needed investment in activities that contribute to
the firm’s long-term success
Problems With Acquisitions

Inability to Achieve Synergy


 Synergy exists when assets are worth more when
used in conjunction with each other than when they
are used separately
 Firms experience transaction costs (e.g., legal fees)
when they use acquisition strategies to create
synergy
 Firms tend to underestimate indirect costs of
integration when evaluating a potential acquisition
Problems With Acquisitions

Too Much Diversification


 Diversified firms must process more information of
greater diversity
 Scope created by diversification may cause
managers to rely too much on financial rather than
strategic controls to evaluate business units’
performances
 Acquisitions may become substitutes for innovation
Problems With Acquisitions

Managers Overly Focused on Acquisitions


 Managers in target firms may operate in a state of
virtual suspended animation during an acquisition
 Executives may become hesitant to make decisions
with long-term consequences until negotiations have
been completed
 Acquisition process can create a short-term
perspective and a greater aversion to risk among
top-level executives in a target firm
Problems With Acquisitions

Too Large
 Additional costs may exceed the benefits of the
economies of scale and additional market power
 Larger size may lead to more bureaucratic controls
 Formalized controls often lead to relatively rigid and
standardized managerial behavior
 Firm may produce less innovation
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
Strategic Alliance
Firm A Firm B
Resources Resources
Capabilities Capabilities
Core Competencies Core Competencies
Combined
Resources
Capabilities
Core Competencies

Mutual interests in designing, manufacturing,


or 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
M
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M

Technological Development
Human Resource Mgmt.
Support Activities

• vertical complementary strategic


Service
Firm Infrastructure

Marketing & Sales

alliance is formed between firms


Procurement

Outbound Logistics

that agree to use their skills and


Operations
Vertical Alliance

Inbound Logistics

Primary Activities
capabilities in different stages of
Supplier the value chain to create value
for both firms
M
M
ar
gin ar
gin • outsourcing is one example of
Technological Development

this type of alliance


Human Resource Mgmt.
Support Activities

Service
Firm Infrastructure

Marketing & Sales


Procurement

Outbound Logistics

Operations
Inbound Logistics

Primary Activities
Strategic Alliances
Buyer Buyer
M Potential Competitors M
gin ar gin ar
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M M

Technological Development
Technological Development
Human Resource Mgmt.

Human Resource Mgmt.


Support Activities

Support Activities
Service Service
Firm Infrastructure

Firm Infrastructure
Marketing & Sales Marketing & Sales
Procurement

Procurement
Outbound Logistics Outbound Logistics

Operations Operations
Inbound Logistics Inbound Logistics

Primary Activities Primary Activities

• 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