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Strategic Management BUSM 3200

                     These Lecture Slides summarize the key points covered in the respective chapters in your
                     recommended text; these slides do NOT substitute, at all, the required reading of the assigned
                     chapter from the text. These slides also may contain additional supplementary material extracted
                     from other texts and sources outside your text book.
                                                                                                                        6-1
BUSM 3200- Strategic Management (Jan 2013) GDS
Strategic choices




                                                      Chapter Seven


     Figure II.i   Strategic choices

                                                                      6-2
BUSM 3200- Strategic Management (Jan 2013) GDS
Learning outcomes for Chapter 7

         Identify alternative strategy options, including
          market penetration, product development,
          market development and diversification.

         Distinguish between different diversification
          strategies (related and conglomerate
          diversification) and evaluate diversification
          drivers.



BUSM 3200- Strategic Management (Jan 2013) GDS               6-3
Learning outcomes for Chapter 7

         Assess the relative benefits of vertical
          integration and outsourcing.
         Analyse the ways in which a corporate parent
          can add or destroy value for its portfolio of
          business units.
         Analyse portfolios of business units and judge
          which to invest in and which to divest.




BUSM 3200- Strategic Management (Jan 2013) GDS             6-4
STRENGTHENING A COMPANY’S
             MARKET POSITION VIA ITS SCOPE
             OF OPERATIONS


                                                         Defining the Scope of
                                                         the Firm’s Operations




                                                                            Extent of its
                                                                                             Size of its
            Range of its                                                    geographic
                                                 Breadth of its                             competitive
              activities                                                      market
                                                  product and                               footprint on
             performed                                                     presence and
                                                service offerings                            its market
             internally                                                       mix of
                                                                                             or industry
                                                                            businesses


                                                                                                                 6-5
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                   6–5
Levels of strategy

                                   Wesfarmers Limited                     Corporate Strategy


Chemicals                                                  Industrial &
                             Energy                                                         Hardware
& Fertilisers                                                Safety



                                            Supermarkets                   Business Strategy


              Insurance                                                     Forest Products




Sales & Marketing          Operations                   Finance              Functional Strategy

         Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                                 6-6
                                                                             Beamish/Strategic Management/4th edition
What is corporate strategy?

 Corporate strategy deals with issues related to the
  portfolio mix of businesses held by a multi-business
  organisation/corporation.
 Issues such as:
      What the portfolio of businesses is or should be
       within the corporation
      the rationale behind the design of the portfolio
      allocation of resources to the various businesses
      performance and returns required of the businesses



         Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                                 6-7
                                                                             Beamish/Strategic Management/4th edition
Strategic directions and
                                             corporate-level strategy




     Figure 7.1     Strategic directions and corporate-level strategy

BUSM 3200- Strategic Management (Jan 2013) GDS                          6-8
Some additional notes on the concept of
                                      diversification

        Before we move into the Ansoff model discussion,
         it is important that you understand the concept of
         diversification
        Diversification is an important topic and almost
         always appears in the exam paper
        You need to know about the types of
         diversification, the motives for diversification and
         the advantages and disadvantages of
         diversification strategy



BUSM 3200- Strategic Management (Jan 2013) GDS                      6-9
What is diversification?

 Multi-business corporations have diversified
  beyond a single business.
 Diversification is defined as:
      ‘the entry of a firm or business unit into new lines of
       activity, either by processes of internal business
       development or acquisition, which entail changes in
       its administrative structure, systems and other
       management processes.’
 Two types of diversification:
      into ‘related’ businesses and industries
      Into ‘unrelated’ businesses and industries


         Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                                6-10
                                                                             Beamish/Strategic Management/4th edition
Reasons for diversification

 General environment becomes unattractive
 Industry’s competitive environment becomes
  unattractive
 Strategic intent of the organisation covers more
  than one business
 Surplus capabilities or capability gaps
 Diversification achieves managerial goals
      Aggressive managerial goals
      Defensive managerial goals


         Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                                6-11
                                                                             Beamish/Strategic Management/4th edition
WHEN TO DIVERSIFY

   ♦ A firm should consider diversifying when:
            ●    It can expand into businesses whose technologies
                 and products complement its present business.
            ●    Its resources and capabilities can be used as
                 valuable competitive assets in other businesses.
            ●    Costs can be reduced by cross-business sharing or
                 transfer of resources and capabilities.
            ●    Transferring a strong brand name to the products of
                 other businesses helps drive up sales and profits of
                 those businesses.

                                                                              6-12
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   8–12
BUILDING SHAREHOLDER VALUE:
           THE ULTIMATE JUSTIFICATION FOR
           DIVERSIFYING


                                 Testing Whether a Diversification
                                     Move Will Add Long-Term
                                       Value for Shareholders



                The industry
                                                               The cost-of-entry   The better-off
               attractiveness
                                                                     test              test
                     test


                                                                                                       6-13
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                            8–13
Advantages and disadvantages of
diversification

Advantages                                         Disadvantages
Efficient capital allocation                      Shareholders have no say
                                                   in capital allocation
Trains general managers                           process
Spreads risk                                      May not align with
More strategic options                            shareholder risk profile

Good control systems                              Easier to hide poorly
                                                   performing businesses
                                                   Performance measures
                                                   usually concentrate on
                                                   financial returns




          Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                                 6-14
                                                                              Beamish/Strategic Management/4th edition
Testing Whether Diversification Will Add
                 Value for Shareholders

   ♦ The Attractiveness Test:
            ●    Are the industry’s returns on investment as
                 good or better than present business(es)?
   ♦ The Cost of Entry Test:
            ●    Is the cost of overcoming entry barriers so
                 great that profitability is too long delayed?
   ♦ The Better-Off Test:
            ●    How much synergy will be gained by
                 diversifying into the industry?

                                                                              6-15
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   8–15
Development of corporate strategy

 Synergy and the resource-based view (RBV)
     Corporations have capabilities that can be
      transferred from one business to another
     These core capabilities were the basis of competitive
      advantage
     Similar businesses could develop synergies by
      sharing core capabilities
     This view leads to related diversification not
      unrelated conglomerates



        Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                               6-16
                                                                            Beamish/Strategic Management/4th edition
Better Performance through Synergy


                                                         Firm A purchases Firm B in
                                                         another industry. A and B’s        No
                                                         profits are no greater than      Synergy
                                                         what each firm could have        (1+1=2)
     Evaluating the                                      earned on its own.
      Potential for
        Synergy
        through
                                                          Firm A purchases Firm C in
     Diversification
                                                          another industry. A and C’s
                                                                                          Synergy
                                                          profits are greater than what
                                                          each firm could have earned     (1+1=3)
                                                          on its own.




                                                                                                       6-17
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                            8–17
STRATEGIES FOR ENTERING NEW
           BUSINESSES


                                                         Diversifying into
                                                         New Businesses




                                                                 Internal new
                  Acquisition                                                       Joint venture
                                                               venture (start-up)


                                           These topics will be covered in Chapter 10 :
                                              Mergers, Acquisitions and Alliances
                                                                                                       6-18
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                            8–18
Development of corporate strategy

 Internationalisation
     Continued internationalisation of business has
      encouraged businesses to ‘stick to their knitting’
      by accessing foreign markets instead of
      unrelated domestic growth strategies
     International expansion often financed by
      divestment of unrelated businesses

                                                    Covered in next lecture on
                                                    International Strategy



        Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                               6-19
                                                                            Beamish/Strategic Management/4th edition
Corporate strategy directions

      Ansoff
      Matrix




     Figure 7.2       Corporate strategy directions
     Source: Adapted from H.I. Ansoff, Corporate Strategy, Penguin, 1988, Chapter 6. Ansoff originally had a matrix with four separate boxes, but in practice strategic directions involve
     more continuous axes. The Ansoff matrix itself was later developed – see Reference 1


BUSM 3200- Strategic Management (Jan 2013) GDS                                                                                                                                               6-20
Market penetration
               Market penetration refers to a strategy of
               increasing share of current markets with the
               current product range.
               This strategy:
                     strategic capabilities; builds on established
                     scope is unchanged; means the organisation’s
                      increased power; leads to greater market share and with
                      buyers and suppliers;
                      economies of scale; and provides greater and experience
                      curve benefits.




BUSM 3200- Strategic Management (Jan 2013) GDS                                   6-21
Constraints of
                                       market penetration



                  Retaliation
                                                           Legal
                     from
                                                         constraints
                  competitors


                                           Economic
                                          Constraints
                                         (recession or
                                            funding
                                             crisis)

                                                                       6-22
BUSM 3200- Strategic Management (Jan
2013) GDS
Consolidation & retrenchment

         Consolidation refers to a strategy by which an
          organisation focuses defensively on their current
          markets with current products.

         Retrenchment refers to a strategy of withdrawal
          from marginal activities in order to concentrate on
          the most valuable segments and products within
          their existing business.




BUSM 3200- Strategic Management (Jan 2013) GDS                  6-23
Product development

           Product development refers to a strategy by which
         an organisation delivers modified or new products to
         existing markets.
         This strategy :
                    involves varying degrees of related diversification (in
                     terms of products);
                     can be an expensive and high risk
                    may require new strategic capabilities
                     typically involves project management risks.



BUSM 3200- Strategic Management (Jan 2013) GDS                                 6-24
Market development (1)

                Market development refers to a strategy by
                which an organisation offers existing products
                to new markets




BUSM 3200- Strategic Management (Jan 2013) GDS                   6-25
Market development (2)
        This strategy involves varying degrees of related
        diversification (in terms of markets) it;
             may also entail some product development (e.g. new styling or
              packaging);
             can take the form of attracting new users (e.g. extending the
              use of aluminium to the automobile industry);
             can take the form of new geographies (e.g. extending the
              market covered to new areas – international markets being the
              most important);
             must meet the critical success factors of the new market if it is
              to succeed;
             may require new strategic capabilities especially in marketing.



BUSM 3200- Strategic Management (Jan 2013) GDS                                    6-26
Diversification
        Diversification involves increasing the range of
         products or markets served by an
         organisation.
        Related diversification involves diversifying
         into products or services with relationships to
         the existing business.
        Conglomerate (unrelated) diversification
         involves diversifying into products or services
         with no relationships to the existing
         businesses.
                                                      See later discussion on this topic

BUSM 3200- Strategic Management (Jan 2013) GDS                                             6-27
Conglomerate diversification

                Conglomerate (or unrelated) diversification
                takes the organisation beyond both its
                existing markets and its existing products and
                radically increases the organisation’s scope.




BUSM 3200- Strategic Management (Jan 2013) GDS                   6-28
Drivers for diversification

         Exploiting economies of scope – efficiency gains
          through applying the organisation’s existing
          resources or competences to new markets or
          services.
         Stretching corporate management competences.
         Exploiting superior internal processes.
         Increasing market power.




BUSM 3200- Strategic Management (Jan 2013) GDS                      6-29
Synergy

                Synergy refers to the benefits gained where
                activities or assets complement each other so
                that their combined effect is greater than the
                sum of the parts.

                N.B. Synergy is often referred to as the
                                ‘2 + 2 = 5’ effect.



BUSM 3200- Strategic Management (Jan 2013) GDS                   6-30
Value-destroying diversification drivers
              Some drivers for diversification which may
              involve value destruction (negative
              synergies):
               Responding to market decline,
               Spreading risk and

              N.B. Despite these being common
                justifications for diversifying, finance theory
                suggests these are misguided.

                    Managerial ambition.


BUSM 3200- Strategic Management (Jan 2013) GDS                    6-31
So which is better?

        Related Diversification

        Unrelated Diversification

        The following set of slides explain the
         differences in detail



BUSM 3200- Strategic Management (Jan 2013) GDS                         6-32
CHOOSING THE DIVERSIFICATION
           PATH: RELATED VERSUS
           UNRELATED BUSINESSES

   ♦ Related Businesses
            ●    Have competitively valuable cross-business
                 value chain and resource matchups.
   ♦ Unrelated Businesses
            ●    Have dissimilar value chains and resource
                 requirements, with no competitively important
                 cross-business relationships at the value
                 chain level.
                                                                              6-33
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   8–33
Related diversification

 Businesses need to be ‘related’ in some
  way for synergy to occur. If no synergy, no
  value in having the combination within the
  corporation.
 Related diversification strategies:
      Capability-based diversification
      Product-market diversification
      Vertical integration


        Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                               6-34
                                                                            Beamish/Strategic Management/4th edition
CHOOSING THE DIVERSIFICATION
           PATH: RELATED VERSUS
           UNRELATED BUSINESSES


                                                  Which Diversification
                                                    Path to Pursue?




                                                                                   Both Related
                   Related                                             Unrelated
                                                                                   and Unrelated
                  Businesses                                          Businesses
                                                                                    Businesses


                                                                                                      6-35
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                           8–35
What is ‘relatedness’?

 ‘Relatedness’ concerns degree of
  similarity or fit between the businesses
  held within the corporation
 What appears to be related to one
  observer, may seem to be quite unrelated
  to another
 There is no hard and fast definition of
  relatedness


       Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard &
                                                                                                              6-36
                                                                           Beamish/Strategic Management/4th edition
STRATEGIC FIT AND DIVERSIFICATION
          INTO RELATED BUSINESSES

   ♦ Strategic Fit Benefits
            ●    Occur when the value chains of the different
                 businesses present opportunities for:
                      Transfer                   of resources among businesses.
                      Lowering     of costs in combining related value
                          chain activities or resource sharing.
                      Use            of a potent brand name across businesses.
                      Cross-business    collaboration to build stronger
                          competitive capabilities.

                                                                                      6-37
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.           8–37
Related Businesses Provide Opportunities to Benefit
                              from Competitively Valuable Strategic Fit




Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.            8–386-38
Identifying Cross-Business Strategic Fit
                     along the Value Chain

                                                                      Supply Chain
                                                                        Activities
               R&D and                                                                  Manufacturing-
              Technology                                                               Related Activities
               Activities



                                                                Potential
                                                           Cross-Business Fits


                Sales and
                Marketing                                                                Distribution-
                Activities                                                             Related Activities

                                                                     Customer
                                                                  Service Activities



                                                                                                               6-39
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                    8–39
Strategic Fit, Economies of Scope,
                      and Competitive Advantage

                                  Using Economies of Scope to Convert
                                 Strategic Fit into Competitive Advantage




      Transferring                               Combining                  Leveraging        Using cross-
     specialized and                           related value               brand names          business
       generalized                            chain activities               and other        collaboration
      skills andor                              to achieve                differentiation   and knowledge
       knowledge                                lower costs                  resources           sharing




                                                                                                                 6-40
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                      8–40
Economies of Scope Differ from
                             Economies of Scale

   ♦ Economies of Scope
            ●    Are cost reductions that flow from cross-
                 business resource sharing in the activities
                 of the multiple businesses of a firm.
   ♦ Economies of Scale
            ●    Accrue when unit costs are reduced due
                 to the increased output of larger-size
                 operations of a firm.


                                                                              6-41
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   8–41
From Competitive Advantage to Added
   Profitability and Gains in Shareholder Value


                                  Capturing the Cross-Business Benefits
                                         of Related Diversification




       Builds more                                                         Yields value in   Requires that
                                              Is only possible
       shareholder                                                         the application   management
                                               via a strategy
        value than                                                          of specialized   take internal
                                                 of related
      owning a stock                                                       resources and      actions to
                                               diversification
         portfolio                                                           capabilities    realize them




                                                                                                                6-42
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                     8–42
DIVERSIFICATION INTO UNRELATED
           BUSINESSES

                                                                           Can it meet corporate targets
                                                                           for profitability and return on
                                                                           investment?
                  Evaluating the
                  acquisition of a
                                                                           Is it is in an industry with
                 new business or
                                                                           attractive profit and growth
                 the divestiture of
                                                                           potentials?
                    an existing
                     business
                                                                           Is it is big enough to contribute
                                                                           significantly to the parent firm’s
                                                                           bottom line?




                                                                                                                   6-43
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                        8–43
Building Shareholder Value via
                             Unrelated Diversification


                               Using an Unrelated Diversification
                                   Strategy to Pursue Value




                                                                 Cross-Business   Acquiring and
               Astute Corporate
                                                                  Allocation of   Restructuring
                 Parenting by
                                                                    Financial      Undervalued
                 Management
                                                                   Resources       Companies



                                                                                                     6-44
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                          8–44
Building Shareholder Value via
                             Unrelated Diversification

    Astute Corporate                            • Provide leadership, oversight, expertise, and guidance.
      Parenting by                              • Provide generalized or parenting resources that lower
      Management                                  operating costs and increase SBU efficiencies.


      Cross-Business
                                                 • Serve as an internal capital market.
       Allocation of
                                                 • Allocate surplus cash flows from businesses to fund
         Financial
                                                   the capital requirements of other businesses.
        Resources

        Acquiring and
                                                 • Acquire weakly performing firms at bargain prices.
        Restructuring
                                                 • Use turnaround capabilities to restructure them to
         Undervalued
                                                   increase their performance and profitability.
         Companies



                                                                                                               6-45
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                    8–45
The Path to Greater Shareholder Value
             through Unrelated Diversification


                                                                       Do a superior job of diversifying into
                                                                       businesses that produce good
                                                                       earnings and returns on investment.
        Actions taken by
       upper management
                                                                       Do an excellent job of negotiating
       to create value and
                                                                       favorable acquisition prices.
         gain a parenting
            advantage
                                                                       Provide managerial oversight and
                                                                       resource sharing, financial resource
                                                                       allocation and portfolio management,
                                                                       and restructure underperforming
                                                                       businesses.


                                                                                                                   6-46
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                        8–46
The Drawbacks of Unrelated Diversification



                                                                  Pursuing an        Limited
             Demanding
                                                                   Unrelated       Competitive
             Managerial
                                                                 Diversification   Advantage
            Requirements
                                                                    Strategy        Potential



              Monitoring and                                                       Potential lack of
                maintaining                                                        cross-business
               the parenting                                                         strategic-fit
                 advantage                                                             benefits




                                                                                                          6-47
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                               8–47
Inadequate Reasons for Pursuing
                         Unrelated Diversification


                                                      Poor Rationales for
                                                    Unrelated Diversification




                                                                               Seeking
         Seeking                               Pursuing rapid                                  Pursuing
                                                                           stabilization to
       reduction of                            or continuous                                   personal
                                                                           avoid cyclical
         business                              growth for its                                 managerial
                                                                              swings in
     investment risk                             own sake                                      motives
                                                                             businesses




                                                                                                              6-48
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                                   8–48
A Company’s Four Main
Strategic Alternatives
After It Diversifies




 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   8–496-49
Diversification and performance




     Figure 7.3     Diversity and performance

BUSM 3200- Strategic Management (Jan 2013) GDS             6-50
Vertical integration
        Vertical integration describes entering
         activities where the organisation is its own
         supplier or customer.
        Backward integration refers to development
         into activities concerned with the inputs into
         the company’s current business.
        Forward integration refers to development
         into activities concerned with the outputs of a
         company’s current business.


BUSM 3200- Strategic Management (Jan 2013) GDS                          6-51
VERTICAL INTEGRATION STRATEGIES


   ♦ Vertically Integrated Firm
           ●    Is one that participates in multiple segments
                or stages of an industry’s overall value chain.
   ♦ Vertical Integration Strategy
           ●    Can expand the firm’s range of activities
                backward into its sources of supply and/or
                forward toward end users of its products.



Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–52
Types of Vertical Integration Strategies



                                                     Vertical Integration
                                                           Choices




                       Full                                              Partial      Tapered
                   Integration                                        Integration   Integration




Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.                          6–53
Types of Vertical Integration Strategies

   ♦ Full Integration
            ●    A firm participates in all stages
                 of the vertical activity chain.
   ♦ Partial Integration
            ●    A firm builds positions only in selected
                 stages of the vertical chain.
   ♦ Tapered Integration
            ●    Involves a mix of in-house and outsourced
                 activity in any stage of the vertical chain.

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–54
Backwards Integration Towards Suppliers

   ♦ Integrating Backwards By:
            ●    Achieving the same scale economies as outside
                 suppliers—low-cost based competitive advantage.
            ●    Matching or beating suppliers’ production efficiency
                 with no drop-off in quality—differentiation-based
                 competitive advantage.
   ♦ Reasons for Integrating Backwards:
            ●    Reduction of supplier power
            ●    Reduction in costs of major inputs
            ●    Assurance of the supply and flow of critical inputs
            ●    Protection of proprietary know-how

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–55
Diversification and integration options




     Figure 7.4     Diversification and integration options: car manufacturer example

BUSM 3200- Strategic Management (Jan 2013) GDS                                          6-56
Integrating Forward to Enhance
                               Competitiveness

   ♦ Reasons for Integrating Forward:
            ●    To lower overall costs by increasing channel
                 activity efficiencies relative to competitors.
            ●    To increase bargaining power through control
                 of channel activities.
            ●    To gain better access to end users.
            ●    To strengthen and reinforce brand awareness.
            ●    To increase product differentiation.




Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–57
Disadvantages of a Vertical Integration Strategy

   ♦ Increased business risk due to large capital investment.
   ♦ Acceptance of technological advances or more efficient
     production methods.
   ♦ Loss of operating flexibility through dependence on
     internally self-produced parts and components.
   ♦ Less flexibility in meeting buyer preferences if they
     require non-internally produced parts and components.
   ♦ Internal production levels and capacity matching
     problems may not allow for economies of scale.
   ♦ Requirements for new skills and business capabilities.



Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–58
Weighing the Pros and Cons of Vertical Integration


   ♦ Can vertical integration enhance the performance of
     strategy-critical activities in ways that lower cost, build
     expertise, protect proprietary know-how, or increase
     differentiation?
   ♦ What is the impact of vertical integration on investment
     costs, flexibility and response times, and the
     administrative costs of coordinating operations across
     more vertical chain activities?
   ♦ How difficult it will be for the company to acquire the set
     of skills and capabilities needed to operate in another
     stage of the vertical chain.


Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–59
Benefits of Increasing Horizontal Scope

   ♦ Increasing a firm’s horizontal scope strengthens
     its business and increases its profitability by:
            ●    Improving the efficiency of its operations
            ●    Heightening its product differentiation
            ●    Reducing market rivalry
            ●    Increasing the firm’s bargaining power over
                 suppliers and buyers
            ●    Enhancing its flexibility and dynamic capabilities




Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–60
Outsourcing

                Outsourcing is the process by which activities
                previously carried out internally are
                subcontracted to external suppliers.




BUSM 3200- Strategic Management (Jan 2013) GDS                   6-61
OUTSOURCING STRATEGIES: NARROWING
           THE SCOPE OF OPERATIONS

   ♦ Outsourcing
            ●     Involves farming out value chain activities to outside vendors.
   ♦ Outsource an Activity When It:
            ●     Can be performed better or more cheaply by outside specialists.
            ●     Is not crucial to achieving sustainable competitive advantage and
                  does not hollow out the firm’s core competencies.
            ●     Improves organizational flexibility and speed time to market.
            ●     Reduces risks due to new technology and/or buyer preferences.
            ●     Assembles diverse kinds of expertise speedily and efficiently.
            ●     Allows a firm to concentrate on its core business, leverage key
                  resources, and do even better what it does best.

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.            6–62
To outsource or not?

         The decision to integrate or subcontract rests on the
         balance between two distinct factors:
               Relative strategic capabilities:
         Does the subcontractor have the potential to do the
         work significantly better?
               Risk of opportunism:
         Is the subcontractor likely to take advantage of the
         relationship over time?



BUSM 3200- Strategic Management (Jan 2013) GDS                          6-63
The Risks of Outsourcing Value Chain Activities

          ♦ Hollowing out the resources and capabilities that
            the firm needs to be a master of its own destiny.
          ♦ Loss of control when monitoring, controlling, and
            coordinating activities of outside parties by means
            of contracts and arm’s-length transactions.
          ♦ Lack of incentives for outside parties to make
            investments specific to the needs of the
            outsourcing firm’s value chain.




Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.   6–64
Value-adding activities



                                                 Coaching and
                             Envisioning
                                                  facilitating


                      Providing central
                       services and               Intervening
                         resources




BUSM 3200- Strategic Management (Jan
2013) GDS
                                                                 6-65
Value-destroying activities



                                         Adding management costs


                                       Adding bureaucratic complexity


                                   Obscuring financial performance




BUSM 3200- Strategic Management (Jan
2013) GDS                                                               6-66
Corporate rationales (1)




     Figure 7.5      Portfolio managers, synergy managers and parental developers
     Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994



BUSM 3200- Strategic Management (Jan 2013) GDS                                                            6-67
Corporate rationales (2)
        The portfolio manager operates as an active
         investor in a way that shareholders in the
         stock market are either too dispersed or too
         inexpert to be able to do.
        The synergy manager is a corporate parent
         seeking to enhance value for business units by
         managing synergies across business units.
        The parental developer seeks to employ its
         own central capabilities to add value to its
         businesses.

BUSM 3200- Strategic Management (Jan 2013) GDS                      6-68
Portfolio matrices



                       Growth/Share (BCG) Matrix


              Directional Policy (GE-McKinsey) Matrix


                            Parenting Matrix




BUSM 3200- Strategic                     69             6-69
The growth share (or BCG) matrix (1)




     Figure 7.6     The growth share (or BCG) matrix

BUSM 3200- Strategic Management (Jan 2013) GDS         6-70
The growth share (or BCG) matrix (2)
        A star is a business unit which has a high
         market share in a growing market.
        A question mark (or problem child) is a business
         unit in a growing market, but it does not have
         a high market share.
        A cash cow is a business unit that has a high
         market share in a mature market.
        A dog is a business unit that has a low market
         share in a static or declining market.


BUSM 3200- Strategic Management (Jan 2013) GDS              6-71
The growth share (or BCG) matrix (3)

           Problems with the BCG matrix:
           definitional vagueness,
           capital market assumptions,
           motivation problems,
           self-fulfilling prophecies and
           possible links to other business units.


BUSM 3200- Strategic Management (Jan 2013) GDS         6-72
The directional policy
                                           (GE–McKinsey) matrix (1)




     Figure 7.7     Directional policy (GE–McKinsey) matrix

BUSM 3200- Strategic Management (Jan 2013) GDS                        6-73
The directional policy
                                           (GE–McKinsey) matrix (2)




     Figure 7.8     Strategy guidelines based on the directional policy matrix

BUSM 3200- Strategic Management (Jan 2013) GDS                                   6-74
The parenting matrix (1)




     Figure 7.9      The parenting matrix: the Ashridge Portfolio Display
     Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994



BUSM 3200- Strategic Management (Jan 2013) GDS                                                            6-75
The parenting matrix (2)
      1. Heartland business units - the parent understands these well and
         can add value. The core of future strategy.
      2. Ballast business units - the parent understands these well but can
         do little for them. They could be just as successful as independent
         companies.
         If not divested, they should be spared corporate bureaucracy.
      3. Value-trap business units are dangerous. There are attractive
         opportunities to add value but the parent’s lack of feel will result in
         more harm than good The parent needs new capabilities to move
         value-trap businesses into the heartland. It is easier to divest to
         another corporate parent which could add value.
      4. Alien business units are misfits. They offer little opportunity to add
         value and the parent does not understand them. Exit is the best
         strategy.

BUSM 3200- Strategic Management (Jan 2013) GDS                                 6-76
Summary (1)
        Many corporations comprise several, sometimes
         many business units. Decisions and activities
         above the level of business units are the concern
         of what in this chapter is called the corporate
         parent.
        Organisational scope is considered in terms of
         related and unrelated diversification.
        Corporate parents may seek to add value by
         adopting different parenting roles: the portfolio
         manager, the synergy manager or the parental
         developer.

BUSM 3200- Strategic Management (Jan 2013) GDS                 6-77
Summary (2)

         There are several portfolio models to help
          corporate parents manage their businesses, of
          which the most common are: the BCG matrix,
          the directional policy matrix and the parenting
          matrix.
         Divestment and outsourcing should be
          considered as well as diversification, particularly
          in the light of relative strategic capabilities and
          the transaction costs of opportunism.


BUSM 3200- Strategic Management (Jan 2013) GDS                 6-78
PRACTICE ESSAY QUESTIONS
                IMPORTANT NOTE: →
              These questions are provided for your reference only – they are only
               INDICATIVE of the standard of questions you might expect in the final exam.
              DO NOT use these questions to “spot”
              The RMIT examiner will post advice on the exam on the Learning Hub closer
               to the exam; you are required to pay attention to that advise
              The questions here show the range of topics that could be tested from this
               lecture; they are NOT exhaustive
              To score a high grade it is important to LINK the theory to applications and
               examples. Where from?
                  You have been assigned specific cases to read from the text. Each case

                   study will show you the kinds of strategic decisions the case company
                   needs to make. You can draw from these examples.
                  You have selected a case company for your project; you may use

                   examples from there.
                  You are supposed to read widely from the business press about local,

                   regional and international companies strategies. You can use examples
                   from there as well.

BUSM 3200- Strategic Management (Jan 2013) GDS                                                6-79
Sample essay question

        Discuss the benefits and risks associated
         with related and unrelated diversification
         strategy.
        Use specific examples from one of the cases
         studied in this course to illustrate how
         potential risks might be managed
         effectively for a firm to achieve sustainable
         competitive advantage.


BUSM 3200- Strategic Management (Jan 2013) GDS                    6-80
Sample essay question
        Discuss the advantages and disadvantages
         associated with related and unrelated
         diversification strategy for international
         expansion. Illustrate your answer with examples
         from one case studied in this course.

        Hint: Question is tricky: need to LINK two chapter
         content, one on diversification (Chapter 7) and
         one on international strategy (Chapter 8)




BUSM 3200- Strategic Management (Jan 2013) GDS                    6-81
Sample essay questions
        Explain using examples, how a company can
         implement a diversification strategy for long
         term advantage.
         Consider an alternative approach that might
         have been more successful and discuss why
         such a company might not have adopted this
         approach.




BUSM 3200- Strategic Management (Jan 2013) GDS                   6-82
Sample essay questions

        Explain the three corporate rationales
         of diversification and discuss their
         logic, strategic requirements and
         organizational requirements. Can
         more than one rationale co-exist in a
         particular organization?




BUSM 3200- Strategic Management (Jan 2013) GDS                   6-83
Sample essay question
        Synergy is often said to be important in the
         selection of a corporate level strategy. Is
         synergy necessary to ensure corporate
         success? Your answer must address the
         three corporate parenting roles associated
         with corporate strategy and give examples
         whenever necessary to illustrate the points.




BUSM 3200- Strategic Management (Jan 2013) GDS                    6-84
Sample essay question
        There are broad three ways or rationales
         for corporate headquarters to add value.
         Explain these three corporate rationales
         and discuss their logic, strategic
         requirements and organisational
         requirements. Can more than one rationale
         co-exist in a particular corporation? Use
         Wesfarmers case as an example to support
         your argument.


BUSM 3200- Strategic Management (Jan 2013) GDS                    6-85

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SM Lecture Six : Corporate Strategy and Diversification

  • 1. Strategic Management BUSM 3200 These Lecture Slides summarize the key points covered in the respective chapters in your recommended text; these slides do NOT substitute, at all, the required reading of the assigned chapter from the text. These slides also may contain additional supplementary material extracted from other texts and sources outside your text book. 6-1 BUSM 3200- Strategic Management (Jan 2013) GDS
  • 2. Strategic choices Chapter Seven Figure II.i Strategic choices 6-2 BUSM 3200- Strategic Management (Jan 2013) GDS
  • 3. Learning outcomes for Chapter 7 Identify alternative strategy options, including market penetration, product development, market development and diversification. Distinguish between different diversification strategies (related and conglomerate diversification) and evaluate diversification drivers. BUSM 3200- Strategic Management (Jan 2013) GDS 6-3
  • 4. Learning outcomes for Chapter 7 Assess the relative benefits of vertical integration and outsourcing. Analyse the ways in which a corporate parent can add or destroy value for its portfolio of business units. Analyse portfolios of business units and judge which to invest in and which to divest. BUSM 3200- Strategic Management (Jan 2013) GDS 6-4
  • 5. STRENGTHENING A COMPANY’S MARKET POSITION VIA ITS SCOPE OF OPERATIONS Defining the Scope of the Firm’s Operations Extent of its Size of its Range of its geographic Breadth of its competitive activities market product and footprint on performed presence and service offerings its market internally mix of or industry businesses 6-5 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–5
  • 6. Levels of strategy Wesfarmers Limited Corporate Strategy Chemicals Industrial & Energy Hardware & Fertilisers Safety Supermarkets Business Strategy Insurance Forest Products Sales & Marketing Operations Finance Functional Strategy Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-6 Beamish/Strategic Management/4th edition
  • 7. What is corporate strategy?  Corporate strategy deals with issues related to the portfolio mix of businesses held by a multi-business organisation/corporation.  Issues such as:  What the portfolio of businesses is or should be within the corporation  the rationale behind the design of the portfolio  allocation of resources to the various businesses  performance and returns required of the businesses Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-7 Beamish/Strategic Management/4th edition
  • 8. Strategic directions and corporate-level strategy Figure 7.1 Strategic directions and corporate-level strategy BUSM 3200- Strategic Management (Jan 2013) GDS 6-8
  • 9. Some additional notes on the concept of diversification Before we move into the Ansoff model discussion, it is important that you understand the concept of diversification Diversification is an important topic and almost always appears in the exam paper You need to know about the types of diversification, the motives for diversification and the advantages and disadvantages of diversification strategy BUSM 3200- Strategic Management (Jan 2013) GDS 6-9
  • 10. What is diversification?  Multi-business corporations have diversified beyond a single business.  Diversification is defined as:  ‘the entry of a firm or business unit into new lines of activity, either by processes of internal business development or acquisition, which entail changes in its administrative structure, systems and other management processes.’  Two types of diversification:  into ‘related’ businesses and industries  Into ‘unrelated’ businesses and industries Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-10 Beamish/Strategic Management/4th edition
  • 11. Reasons for diversification  General environment becomes unattractive  Industry’s competitive environment becomes unattractive  Strategic intent of the organisation covers more than one business  Surplus capabilities or capability gaps  Diversification achieves managerial goals  Aggressive managerial goals  Defensive managerial goals Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-11 Beamish/Strategic Management/4th edition
  • 12. WHEN TO DIVERSIFY ♦ A firm should consider diversifying when: ● It can expand into businesses whose technologies and products complement its present business. ● Its resources and capabilities can be used as valuable competitive assets in other businesses. ● Costs can be reduced by cross-business sharing or transfer of resources and capabilities. ● Transferring a strong brand name to the products of other businesses helps drive up sales and profits of those businesses. 6-12 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–12
  • 13. BUILDING SHAREHOLDER VALUE: THE ULTIMATE JUSTIFICATION FOR DIVERSIFYING Testing Whether a Diversification Move Will Add Long-Term Value for Shareholders The industry The cost-of-entry The better-off attractiveness test test test 6-13 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–13
  • 14. Advantages and disadvantages of diversification Advantages Disadvantages Efficient capital allocation Shareholders have no say in capital allocation Trains general managers process Spreads risk May not align with More strategic options shareholder risk profile Good control systems Easier to hide poorly performing businesses Performance measures usually concentrate on financial returns Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-14 Beamish/Strategic Management/4th edition
  • 15. Testing Whether Diversification Will Add Value for Shareholders ♦ The Attractiveness Test: ● Are the industry’s returns on investment as good or better than present business(es)? ♦ The Cost of Entry Test: ● Is the cost of overcoming entry barriers so great that profitability is too long delayed? ♦ The Better-Off Test: ● How much synergy will be gained by diversifying into the industry? 6-15 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–15
  • 16. Development of corporate strategy  Synergy and the resource-based view (RBV)  Corporations have capabilities that can be transferred from one business to another  These core capabilities were the basis of competitive advantage  Similar businesses could develop synergies by sharing core capabilities  This view leads to related diversification not unrelated conglomerates Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-16 Beamish/Strategic Management/4th edition
  • 17. Better Performance through Synergy Firm A purchases Firm B in another industry. A and B’s No profits are no greater than Synergy what each firm could have (1+1=2) Evaluating the earned on its own. Potential for Synergy through Firm A purchases Firm C in Diversification another industry. A and C’s Synergy profits are greater than what each firm could have earned (1+1=3) on its own. 6-17 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–17
  • 18. STRATEGIES FOR ENTERING NEW BUSINESSES Diversifying into New Businesses Internal new Acquisition Joint venture venture (start-up) These topics will be covered in Chapter 10 : Mergers, Acquisitions and Alliances 6-18 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–18
  • 19. Development of corporate strategy  Internationalisation  Continued internationalisation of business has encouraged businesses to ‘stick to their knitting’ by accessing foreign markets instead of unrelated domestic growth strategies  International expansion often financed by divestment of unrelated businesses Covered in next lecture on International Strategy Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-19 Beamish/Strategic Management/4th edition
  • 20. Corporate strategy directions Ansoff Matrix Figure 7.2 Corporate strategy directions Source: Adapted from H.I. Ansoff, Corporate Strategy, Penguin, 1988, Chapter 6. Ansoff originally had a matrix with four separate boxes, but in practice strategic directions involve more continuous axes. The Ansoff matrix itself was later developed – see Reference 1 BUSM 3200- Strategic Management (Jan 2013) GDS 6-20
  • 21. Market penetration Market penetration refers to a strategy of increasing share of current markets with the current product range. This strategy:  strategic capabilities; builds on established  scope is unchanged; means the organisation’s  increased power; leads to greater market share and with buyers and suppliers;  economies of scale; and provides greater and experience curve benefits. BUSM 3200- Strategic Management (Jan 2013) GDS 6-21
  • 22. Constraints of market penetration Retaliation Legal from constraints competitors Economic Constraints (recession or funding crisis) 6-22 BUSM 3200- Strategic Management (Jan 2013) GDS
  • 23. Consolidation & retrenchment Consolidation refers to a strategy by which an organisation focuses defensively on their current markets with current products. Retrenchment refers to a strategy of withdrawal from marginal activities in order to concentrate on the most valuable segments and products within their existing business. BUSM 3200- Strategic Management (Jan 2013) GDS 6-23
  • 24. Product development Product development refers to a strategy by which an organisation delivers modified or new products to existing markets. This strategy :  involves varying degrees of related diversification (in terms of products);  can be an expensive and high risk  may require new strategic capabilities  typically involves project management risks. BUSM 3200- Strategic Management (Jan 2013) GDS 6-24
  • 25. Market development (1) Market development refers to a strategy by which an organisation offers existing products to new markets BUSM 3200- Strategic Management (Jan 2013) GDS 6-25
  • 26. Market development (2) This strategy involves varying degrees of related diversification (in terms of markets) it;  may also entail some product development (e.g. new styling or packaging);  can take the form of attracting new users (e.g. extending the use of aluminium to the automobile industry);  can take the form of new geographies (e.g. extending the market covered to new areas – international markets being the most important);  must meet the critical success factors of the new market if it is to succeed;  may require new strategic capabilities especially in marketing. BUSM 3200- Strategic Management (Jan 2013) GDS 6-26
  • 27. Diversification Diversification involves increasing the range of products or markets served by an organisation. Related diversification involves diversifying into products or services with relationships to the existing business. Conglomerate (unrelated) diversification involves diversifying into products or services with no relationships to the existing businesses. See later discussion on this topic BUSM 3200- Strategic Management (Jan 2013) GDS 6-27
  • 28. Conglomerate diversification Conglomerate (or unrelated) diversification takes the organisation beyond both its existing markets and its existing products and radically increases the organisation’s scope. BUSM 3200- Strategic Management (Jan 2013) GDS 6-28
  • 29. Drivers for diversification Exploiting economies of scope – efficiency gains through applying the organisation’s existing resources or competences to new markets or services. Stretching corporate management competences. Exploiting superior internal processes. Increasing market power. BUSM 3200- Strategic Management (Jan 2013) GDS 6-29
  • 30. Synergy Synergy refers to the benefits gained where activities or assets complement each other so that their combined effect is greater than the sum of the parts. N.B. Synergy is often referred to as the ‘2 + 2 = 5’ effect. BUSM 3200- Strategic Management (Jan 2013) GDS 6-30
  • 31. Value-destroying diversification drivers Some drivers for diversification which may involve value destruction (negative synergies):  Responding to market decline,  Spreading risk and N.B. Despite these being common justifications for diversifying, finance theory suggests these are misguided.  Managerial ambition. BUSM 3200- Strategic Management (Jan 2013) GDS 6-31
  • 32. So which is better? Related Diversification Unrelated Diversification The following set of slides explain the differences in detail BUSM 3200- Strategic Management (Jan 2013) GDS 6-32
  • 33. CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES ♦ Related Businesses ● Have competitively valuable cross-business value chain and resource matchups. ♦ Unrelated Businesses ● Have dissimilar value chains and resource requirements, with no competitively important cross-business relationships at the value chain level. 6-33 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–33
  • 34. Related diversification  Businesses need to be ‘related’ in some way for synergy to occur. If no synergy, no value in having the combination within the corporation.  Related diversification strategies:  Capability-based diversification  Product-market diversification  Vertical integration Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-34 Beamish/Strategic Management/4th edition
  • 35. CHOOSING THE DIVERSIFICATION PATH: RELATED VERSUS UNRELATED BUSINESSES Which Diversification Path to Pursue? Both Related Related Unrelated and Unrelated Businesses Businesses Businesses 6-35 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–35
  • 36. What is ‘relatedness’?  ‘Relatedness’ concerns degree of similarity or fit between the businesses held within the corporation  What appears to be related to one observer, may seem to be quite unrelated to another  There is no hard and fast definition of relatedness Copyright ©2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442528680/Hubbard & 6-36 Beamish/Strategic Management/4th edition
  • 37. STRATEGIC FIT AND DIVERSIFICATION INTO RELATED BUSINESSES ♦ Strategic Fit Benefits ● Occur when the value chains of the different businesses present opportunities for:  Transfer of resources among businesses.  Lowering of costs in combining related value chain activities or resource sharing.  Use of a potent brand name across businesses.  Cross-business collaboration to build stronger competitive capabilities. 6-37 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–37
  • 38. Related Businesses Provide Opportunities to Benefit from Competitively Valuable Strategic Fit Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–386-38
  • 39. Identifying Cross-Business Strategic Fit along the Value Chain Supply Chain Activities R&D and Manufacturing- Technology Related Activities Activities Potential Cross-Business Fits Sales and Marketing Distribution- Activities Related Activities Customer Service Activities 6-39 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–39
  • 40. Strategic Fit, Economies of Scope, and Competitive Advantage Using Economies of Scope to Convert Strategic Fit into Competitive Advantage Transferring Combining Leveraging Using cross- specialized and related value brand names business generalized chain activities and other collaboration skills andor to achieve differentiation and knowledge knowledge lower costs resources sharing 6-40 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–40
  • 41. Economies of Scope Differ from Economies of Scale ♦ Economies of Scope ● Are cost reductions that flow from cross- business resource sharing in the activities of the multiple businesses of a firm. ♦ Economies of Scale ● Accrue when unit costs are reduced due to the increased output of larger-size operations of a firm. 6-41 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–41
  • 42. From Competitive Advantage to Added Profitability and Gains in Shareholder Value Capturing the Cross-Business Benefits of Related Diversification Builds more Yields value in Requires that Is only possible shareholder the application management via a strategy value than of specialized take internal of related owning a stock resources and actions to diversification portfolio capabilities realize them 6-42 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–42
  • 43. DIVERSIFICATION INTO UNRELATED BUSINESSES Can it meet corporate targets for profitability and return on investment? Evaluating the acquisition of a Is it is in an industry with new business or attractive profit and growth the divestiture of potentials? an existing business Is it is big enough to contribute significantly to the parent firm’s bottom line? 6-43 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–43
  • 44. Building Shareholder Value via Unrelated Diversification Using an Unrelated Diversification Strategy to Pursue Value Cross-Business Acquiring and Astute Corporate Allocation of Restructuring Parenting by Financial Undervalued Management Resources Companies 6-44 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–44
  • 45. Building Shareholder Value via Unrelated Diversification Astute Corporate • Provide leadership, oversight, expertise, and guidance. Parenting by • Provide generalized or parenting resources that lower Management operating costs and increase SBU efficiencies. Cross-Business • Serve as an internal capital market. Allocation of • Allocate surplus cash flows from businesses to fund Financial the capital requirements of other businesses. Resources Acquiring and • Acquire weakly performing firms at bargain prices. Restructuring • Use turnaround capabilities to restructure them to Undervalued increase their performance and profitability. Companies 6-45 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–45
  • 46. The Path to Greater Shareholder Value through Unrelated Diversification Do a superior job of diversifying into businesses that produce good earnings and returns on investment. Actions taken by upper management Do an excellent job of negotiating to create value and favorable acquisition prices. gain a parenting advantage Provide managerial oversight and resource sharing, financial resource allocation and portfolio management, and restructure underperforming businesses. 6-46 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–46
  • 47. The Drawbacks of Unrelated Diversification Pursuing an Limited Demanding Unrelated Competitive Managerial Diversification Advantage Requirements Strategy Potential Monitoring and Potential lack of maintaining cross-business the parenting strategic-fit advantage benefits 6-47 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–47
  • 48. Inadequate Reasons for Pursuing Unrelated Diversification Poor Rationales for Unrelated Diversification Seeking Seeking Pursuing rapid Pursuing stabilization to reduction of or continuous personal avoid cyclical business growth for its managerial swings in investment risk own sake motives businesses 6-48 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–48
  • 49. A Company’s Four Main Strategic Alternatives After It Diversifies Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 8–496-49
  • 50. Diversification and performance Figure 7.3 Diversity and performance BUSM 3200- Strategic Management (Jan 2013) GDS 6-50
  • 51. Vertical integration Vertical integration describes entering activities where the organisation is its own supplier or customer. Backward integration refers to development into activities concerned with the inputs into the company’s current business. Forward integration refers to development into activities concerned with the outputs of a company’s current business. BUSM 3200- Strategic Management (Jan 2013) GDS 6-51
  • 52. VERTICAL INTEGRATION STRATEGIES ♦ Vertically Integrated Firm ● Is one that participates in multiple segments or stages of an industry’s overall value chain. ♦ Vertical Integration Strategy ● Can expand the firm’s range of activities backward into its sources of supply and/or forward toward end users of its products. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–52
  • 53. Types of Vertical Integration Strategies Vertical Integration Choices Full Partial Tapered Integration Integration Integration Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–53
  • 54. Types of Vertical Integration Strategies ♦ Full Integration ● A firm participates in all stages of the vertical activity chain. ♦ Partial Integration ● A firm builds positions only in selected stages of the vertical chain. ♦ Tapered Integration ● Involves a mix of in-house and outsourced activity in any stage of the vertical chain. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–54
  • 55. Backwards Integration Towards Suppliers ♦ Integrating Backwards By: ● Achieving the same scale economies as outside suppliers—low-cost based competitive advantage. ● Matching or beating suppliers’ production efficiency with no drop-off in quality—differentiation-based competitive advantage. ♦ Reasons for Integrating Backwards: ● Reduction of supplier power ● Reduction in costs of major inputs ● Assurance of the supply and flow of critical inputs ● Protection of proprietary know-how Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–55
  • 56. Diversification and integration options Figure 7.4 Diversification and integration options: car manufacturer example BUSM 3200- Strategic Management (Jan 2013) GDS 6-56
  • 57. Integrating Forward to Enhance Competitiveness ♦ Reasons for Integrating Forward: ● To lower overall costs by increasing channel activity efficiencies relative to competitors. ● To increase bargaining power through control of channel activities. ● To gain better access to end users. ● To strengthen and reinforce brand awareness. ● To increase product differentiation. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–57
  • 58. Disadvantages of a Vertical Integration Strategy ♦ Increased business risk due to large capital investment. ♦ Acceptance of technological advances or more efficient production methods. ♦ Loss of operating flexibility through dependence on internally self-produced parts and components. ♦ Less flexibility in meeting buyer preferences if they require non-internally produced parts and components. ♦ Internal production levels and capacity matching problems may not allow for economies of scale. ♦ Requirements for new skills and business capabilities. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–58
  • 59. Weighing the Pros and Cons of Vertical Integration ♦ Can vertical integration enhance the performance of strategy-critical activities in ways that lower cost, build expertise, protect proprietary know-how, or increase differentiation? ♦ What is the impact of vertical integration on investment costs, flexibility and response times, and the administrative costs of coordinating operations across more vertical chain activities? ♦ How difficult it will be for the company to acquire the set of skills and capabilities needed to operate in another stage of the vertical chain. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–59
  • 60. Benefits of Increasing Horizontal Scope ♦ Increasing a firm’s horizontal scope strengthens its business and increases its profitability by: ● Improving the efficiency of its operations ● Heightening its product differentiation ● Reducing market rivalry ● Increasing the firm’s bargaining power over suppliers and buyers ● Enhancing its flexibility and dynamic capabilities Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–60
  • 61. Outsourcing Outsourcing is the process by which activities previously carried out internally are subcontracted to external suppliers. BUSM 3200- Strategic Management (Jan 2013) GDS 6-61
  • 62. OUTSOURCING STRATEGIES: NARROWING THE SCOPE OF OPERATIONS ♦ Outsourcing ● Involves farming out value chain activities to outside vendors. ♦ Outsource an Activity When It: ● Can be performed better or more cheaply by outside specialists. ● Is not crucial to achieving sustainable competitive advantage and does not hollow out the firm’s core competencies. ● Improves organizational flexibility and speed time to market. ● Reduces risks due to new technology and/or buyer preferences. ● Assembles diverse kinds of expertise speedily and efficiently. ● Allows a firm to concentrate on its core business, leverage key resources, and do even better what it does best. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–62
  • 63. To outsource or not? The decision to integrate or subcontract rests on the balance between two distinct factors:  Relative strategic capabilities: Does the subcontractor have the potential to do the work significantly better?  Risk of opportunism: Is the subcontractor likely to take advantage of the relationship over time? BUSM 3200- Strategic Management (Jan 2013) GDS 6-63
  • 64. The Risks of Outsourcing Value Chain Activities ♦ Hollowing out the resources and capabilities that the firm needs to be a master of its own destiny. ♦ Loss of control when monitoring, controlling, and coordinating activities of outside parties by means of contracts and arm’s-length transactions. ♦ Lack of incentives for outside parties to make investments specific to the needs of the outsourcing firm’s value chain. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 6–64
  • 65. Value-adding activities Coaching and Envisioning facilitating Providing central services and Intervening resources BUSM 3200- Strategic Management (Jan 2013) GDS 6-65
  • 66. Value-destroying activities Adding management costs Adding bureaucratic complexity Obscuring financial performance BUSM 3200- Strategic Management (Jan 2013) GDS 6-66
  • 67. Corporate rationales (1) Figure 7.5 Portfolio managers, synergy managers and parental developers Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994 BUSM 3200- Strategic Management (Jan 2013) GDS 6-67
  • 68. Corporate rationales (2) The portfolio manager operates as an active investor in a way that shareholders in the stock market are either too dispersed or too inexpert to be able to do. The synergy manager is a corporate parent seeking to enhance value for business units by managing synergies across business units. The parental developer seeks to employ its own central capabilities to add value to its businesses. BUSM 3200- Strategic Management (Jan 2013) GDS 6-68
  • 69. Portfolio matrices Growth/Share (BCG) Matrix Directional Policy (GE-McKinsey) Matrix Parenting Matrix BUSM 3200- Strategic 69 6-69
  • 70. The growth share (or BCG) matrix (1) Figure 7.6 The growth share (or BCG) matrix BUSM 3200- Strategic Management (Jan 2013) GDS 6-70
  • 71. The growth share (or BCG) matrix (2) A star is a business unit which has a high market share in a growing market. A question mark (or problem child) is a business unit in a growing market, but it does not have a high market share. A cash cow is a business unit that has a high market share in a mature market. A dog is a business unit that has a low market share in a static or declining market. BUSM 3200- Strategic Management (Jan 2013) GDS 6-71
  • 72. The growth share (or BCG) matrix (3) Problems with the BCG matrix: definitional vagueness, capital market assumptions, motivation problems, self-fulfilling prophecies and possible links to other business units. BUSM 3200- Strategic Management (Jan 2013) GDS 6-72
  • 73. The directional policy (GE–McKinsey) matrix (1) Figure 7.7 Directional policy (GE–McKinsey) matrix BUSM 3200- Strategic Management (Jan 2013) GDS 6-73
  • 74. The directional policy (GE–McKinsey) matrix (2) Figure 7.8 Strategy guidelines based on the directional policy matrix BUSM 3200- Strategic Management (Jan 2013) GDS 6-74
  • 75. The parenting matrix (1) Figure 7.9 The parenting matrix: the Ashridge Portfolio Display Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994 BUSM 3200- Strategic Management (Jan 2013) GDS 6-75
  • 76. The parenting matrix (2) 1. Heartland business units - the parent understands these well and can add value. The core of future strategy. 2. Ballast business units - the parent understands these well but can do little for them. They could be just as successful as independent companies. If not divested, they should be spared corporate bureaucracy. 3. Value-trap business units are dangerous. There are attractive opportunities to add value but the parent’s lack of feel will result in more harm than good The parent needs new capabilities to move value-trap businesses into the heartland. It is easier to divest to another corporate parent which could add value. 4. Alien business units are misfits. They offer little opportunity to add value and the parent does not understand them. Exit is the best strategy. BUSM 3200- Strategic Management (Jan 2013) GDS 6-76
  • 77. Summary (1) Many corporations comprise several, sometimes many business units. Decisions and activities above the level of business units are the concern of what in this chapter is called the corporate parent. Organisational scope is considered in terms of related and unrelated diversification. Corporate parents may seek to add value by adopting different parenting roles: the portfolio manager, the synergy manager or the parental developer. BUSM 3200- Strategic Management (Jan 2013) GDS 6-77
  • 78. Summary (2) There are several portfolio models to help corporate parents manage their businesses, of which the most common are: the BCG matrix, the directional policy matrix and the parenting matrix. Divestment and outsourcing should be considered as well as diversification, particularly in the light of relative strategic capabilities and the transaction costs of opportunism. BUSM 3200- Strategic Management (Jan 2013) GDS 6-78
  • 79. PRACTICE ESSAY QUESTIONS IMPORTANT NOTE: →  These questions are provided for your reference only – they are only INDICATIVE of the standard of questions you might expect in the final exam.  DO NOT use these questions to “spot”  The RMIT examiner will post advice on the exam on the Learning Hub closer to the exam; you are required to pay attention to that advise  The questions here show the range of topics that could be tested from this lecture; they are NOT exhaustive  To score a high grade it is important to LINK the theory to applications and examples. Where from?  You have been assigned specific cases to read from the text. Each case study will show you the kinds of strategic decisions the case company needs to make. You can draw from these examples.  You have selected a case company for your project; you may use examples from there.  You are supposed to read widely from the business press about local, regional and international companies strategies. You can use examples from there as well. BUSM 3200- Strategic Management (Jan 2013) GDS 6-79
  • 80. Sample essay question Discuss the benefits and risks associated with related and unrelated diversification strategy. Use specific examples from one of the cases studied in this course to illustrate how potential risks might be managed effectively for a firm to achieve sustainable competitive advantage. BUSM 3200- Strategic Management (Jan 2013) GDS 6-80
  • 81. Sample essay question Discuss the advantages and disadvantages associated with related and unrelated diversification strategy for international expansion. Illustrate your answer with examples from one case studied in this course. Hint: Question is tricky: need to LINK two chapter content, one on diversification (Chapter 7) and one on international strategy (Chapter 8) BUSM 3200- Strategic Management (Jan 2013) GDS 6-81
  • 82. Sample essay questions Explain using examples, how a company can implement a diversification strategy for long term advantage.  Consider an alternative approach that might have been more successful and discuss why such a company might not have adopted this approach. BUSM 3200- Strategic Management (Jan 2013) GDS 6-82
  • 83. Sample essay questions Explain the three corporate rationales of diversification and discuss their logic, strategic requirements and organizational requirements. Can more than one rationale co-exist in a particular organization? BUSM 3200- Strategic Management (Jan 2013) GDS 6-83
  • 84. Sample essay question Synergy is often said to be important in the selection of a corporate level strategy. Is synergy necessary to ensure corporate success? Your answer must address the three corporate parenting roles associated with corporate strategy and give examples whenever necessary to illustrate the points. BUSM 3200- Strategic Management (Jan 2013) GDS 6-84
  • 85. Sample essay question There are broad three ways or rationales for corporate headquarters to add value. Explain these three corporate rationales and discuss their logic, strategic requirements and organisational requirements. Can more than one rationale co-exist in a particular corporation? Use Wesfarmers case as an example to support your argument. BUSM 3200- Strategic Management (Jan 2013) GDS 6-85