Microsoft PowerPoint - 1c LANZOLLA Corporate Strategy

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Corporate Strategy-Creating Corporate Advantages –

Gianvito Lanzolla

Business strategy typically involves a single business model(and a single value chain)….

Business Strategy’s Goal =

Unique Value Creation (for Customer)

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“HOW”

“WHAT”

“WHO”

...while corporate strategy spans business models/ value chain activities

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Corporate strategy vs. Business Strategy

– Business Strategy is concerned with how a firm competes within a particular market

– Corporate strategy is concerned with where a firm competes

CorporateStrategy

CorporateHead Office

Where does corporate strategy take place?

BusinessStrategy

Division A Division B

FunctionalStrategies

R & D

H R

Finance

Production

Marketing/Sales

R & D

H R

Finance

Production

Marketing/Sales

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• Business-Level Strategy– Unique Value Creation (for Customers) in order to

maximize value (for Shareholders)

• Corporate-Level Strategy (companywide strategy)– The goal of corporate strategy is to build corporate

advantage so as to earn above normal returns (Collins and Montgomery 1997)

Corporate strategy vs. Business Strategy (continued)

A definition of Corporate Strategy

Corporate Strategy is the way a company creates value through the configuration and coordination of its multi-market activitiesThe definition has three important aspects:

– Value Creation (for shareholders) - the generation of superior financial performance (rents) from multi-market activities that create corporate advantages1

– Configuration - the multi-market scope of the corporation (product/market diversification, geographic focus, and vertical boundaries)

– Coordination - the management of activities and businesses that lie within the corporate hierarchy

Source: Collis and Montgomery, Corporate Strategy, 1997

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Premises of Corporate Strategy

Competition occurs at the business unit level• Corporations don’t compete; only their business units do• Value is created at the business unit level, it is only added up at the

corporate level• Successful corporate strategy must grow out of and reinforce business

strategyCorporate Strategy inevitably adds costs and constraints to business units

• Corporate overhead and costs of communication between HQ and SBUs• Bureaucratic costs, costs of coordination, costs of monitoring

Shareholders can readily diversify themselves• Shareholders can diversify their own portfolios of stocks, and they can

often do it more cheaply with less risk than corporations• Shareholders can buy shares at market prices and avoid paying large

acquisition premiums

P1 P2 P3 C1 C2 C3

Vertical Product GeographicalScope Scope Scope

V1

V2

V3P3P2P1 C3C2C1

V1

V2

V3

[A] Single IntegratedFirm

[B] SeveralSpecialized Firms linkedby Markets

In situation [A] the business units are integrated within a single firm.In situation [B] the business units are independent firms linked by markets.

Examples of different configurations

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Implications from these Premises

Corporate Strategy cannot succeed unless it truly adds value to business units:

– by providing tangible benefits that offset costs of lost independence → BETTER OFF TEST

• e.g. economies of scope in operations• e.g. economies of scale in administration and internal financing

– add value to shareholders in a way that shareholders could not replicate by themselves → OWNERSHIP TEST

Two fundamental Tests for the existence of corporate advantage

1. Better-off test (necessary condition)2. Ownership test (not always sufficient condition)

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1. Better-off Test

• Does the presence of the corporation in a given market improve the competitive advantage of other business units over and above what they could achieve on their own?

Better-off Test synergies between businesses’ value chains

Horizontal SynergiesBetween similar Value Chain Activities’

Vertical SynergiesBetween successive Value Chain Activities

Management SynergiesSupporting function

Synergies

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2. Ownership Test

• Does ownership of the business unit produce a greater competitive advantage than an alternative arrangement would produce?

Ownership Test: ownership vs. “other” agreements

M&A Non equity agreements –e.g. partnerships, alliances

Other Equity agreements (e.g. JVs)

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Jointly these two test help addressing the fundamental equations:

Rate of (Corporate) Profit > Cost of Capital

Savings from Synergies > Costs of a Corporation

Some alternatives to corporations

Financial investment ONLY (equity)

Financial investment (equity) +

Direct Management of the Businesses

Investment banks

Private equity Corporations

Venture capitalFamily office

Private banking

Hedge Funds

Sovereign Funds

Pension Funds

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The Dimensions of Corporate Strategy

Business Diversification - Horizontal expansionVertical Integration - Forward or backward expansion

Geographic Scope - Geographic and/or global expansion

Rate of (Corporate) Profit > Cost of Capital

We will now explore the potential sources of synergies in horizontal, vertical and

international expansion…

Savings from Synergies > Costs of a Corporation

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1. Where do synergies come from in Horizontal Diversification?

Does this horizontal diversification make sense?

PURCHASE MANUFAC. SALES & DIST.R&D

PURCHASE MANUFAC. SALES & DIST.R&D

Synergies?

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Horizontal Diversification: main drivers of Synergies

1. Economies of scope:C(Y1, Y2) < C(Y1, 0) + C(0, Y2)

2. Cross Selling:R(Y1, Y2) > R(Y1, 0) + R(0, Y2)

Where:C = Cost functionR = Revenue functionYi = Products

Economies of Scope

• Economies of scope are most frequently encountered when a corporation possesses a resource or capability that is not fully utilized in production of a single product– Such assets can be tangible, such as manufacturing plants or

distribution channels, or intangible, such as skills or R&D

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Stamping facilities can be shared to produce:

Trucks

Cars

Example: automobile industry

Knowledge about efficient cardboard production can be shared to produce tissues

Example: paper industry

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Cross-selling

• Cross-selling is more important:– in one-stop-shop situations – when brand is important

Examples: IBM & Honda

IBM’s corporate strategy to provide a complete solution for a company’s IT needs (HW and SW)

Honda producing cars, motorbikes and power equipments

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Exercise: Business Development at Nespresso

http://www.nespresso.com/precom/home_ch_en.html?

Branson & the Virgin Companies: Making strategic sense of apparent entrepreneurial chaos

KEY RESOURCES•Virgin brand•Branson-charisma/image--PR skills-networking skills-entrepreneurial flair

DOMINANT LOGIC•Seek competitive advantage by start-up cos.pursuing innovative differentiation inunderserved market with sleepy incumbents

CHARACTERISTICS OFMARKETSTHAT CONFORM TO THIS LOGIC•Consumer businesses•dominant incumbent •scope for new approachesto customer service•high entry barriers to otherstart-ups•Branson/Virgin imageappeals to customers

DESIGNING A CORPORATE STRATEGY& STRUCTURE• What’s the business model?(Does Virgin create value bybeing an entrepreneurial incubator,a venture capital fund, adiversified corporation, or what?)

• Which businesses to divest?• Criteria for future diversification• What type of structure?—Is therea need for greater formalization?

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Diversification among the US Fortune 500, 1949-74

Percentage of Specialized Companies (single-business,vertically-integrated and dominant-business)Percentage of Diversified Companies (related-business and unrelated business)

Note: During the 1980s and 1990s the trend reversed as largecompanies refocused upon their core businesses

1949 1954 1959 1964 1969 1974

70.2 63.5 53.7 53.9 39.9 37.029.8 36.5 46.3 46.1 60.1 63.0

DEVELOPMENTSIN CORPORATE

STRATEGY

MANAGEMENT PRIORITIES

STRATEGY TOOLS& CONCEPTS

Quest for GrowthAddressing under-performance of widely-diversified firms

Creating shareholder value

1960 1970 1980 1990 2000 2006

•Emergence of conglomerates

•Diversification by established companies into related sectors

Emphasis on “related’ & “concentric” diversification

•Refocusing on core businesses •Divesting diversified businesses

•Financial analysis•Diffusion of M form structures •Creation of corporate planning depts.

•Economies of scope & synergy”• Portfolio planning models• Capital asset pricing model

•Maximization of shareholder wealth•Core competences•Dominant logic

Diversification: The Evolution of Strategy and Management Thinking

•Competitive advantage through speed & flexibility•Creating opportunities for future growth

•Joint ventures and alliances•Creating growth optionsthrough focused

diversification

•Dynamic capabilities•Transaction cost analysis•Real options

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Other rationales for Horizontal Diversification

– Call Option on an emerging market opportunity• Often there are cheaper alternatives

– Risk spreading• Often there are cheaper alternatives

– Growth or to escape stagnating markets• Tend to destroy shareholders’ value while maximising

management’s ego

Are they likely to create corporate advantage?

Does this horizontal diversification make sense?

PURCHASE MANUFAC. SALES & DIST.R&D

PURCHASE MANUFAC. SALES & DIST.R&D

Economies of scope and cross selling (brand & one stop-shop)

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Group work - McDonalds: What’s next?

• Which business do you think would make most sense for McDonalds to diversify into? Please quantify the extent of the potential synergies.

– Frozen foods

– Theme parks

– Photo processing

• Each group to pick ONE option– Explain why they support it– Also explain why they oppose the other options

• Corporate advantage, over and above stand alone

• No variable costs

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Apple case

– Should Apple expand horizontally?– Which product(s)?– Why?

2. Where do synergies come from in Vertical Integration?

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Vertical synergies across value chains

Upstream

Downstream

Where can we find synergies in vertical integration?

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When should a paper producer integrate vertically?

Vertical Integration: Drivers of synergies

1. Relationship-specific investments– Such synergies arise when business units in a

vertical relationship tailor their assets to exchanges with each order in order to reduce production costs or enhance output

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Relationship-specific investments

Vertical Integration: Drivers of synergies

2. Downstream free-riding– When firms free ride on the efforts of their

competitors?

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Free-riding: should Giorgio Armani integrate into retailing?

Vertical Integration: Drivers of Synergies

3. Double marginalization– When two firms in a vertical relationships each

posses market power, integration creates more value for both the corporation and consumers

4. Vertical foreclosure– If a company buys an upstream supplier, it might

enjoys lower input costs. Furthermore, by taking out a supplier, upstream competition decrease so they remaining upstream might increase their price. By doing so, other downstream companies will pay more their input factors (limited evidence of this effect)

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Example: GM and Fisher Body

• Fisher body had custom machines and dies to produce car bodies for GM

• GM’s chassis were likewise customized for Fisher’s bodies.

• There was upstream and downstream market power (double marginalization problem)

• GM acquires Fisher body

Iron oremining

Steelproduction

Steel stripproduction

Canmaking

The value chain for steel cans

MARKETCONTRACTS

VERTICAL INTEGRATION

MARKETCONTRACTS

Canning of food, drink,

oil, etc.

VERTICAL INTEGRATION,AND MARKETCONTRACTS

What factors explain why some stages are vertically integrated,while others are linked by market transactions?

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Recent Trends in Vertical Relationships

• From competitive contracting to supplier partnerships, e.g. in autos

• From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services).

• Diffusion of franchising• Technology partnerships (e.g. IBM- Apple; Canon- HP)• Inter-firm networks

General conclusion:- boundaries between firms and markets becoming increasingly blurred.

An Emerging Model: the Distributed Organization

The Distributed Organization reduces the scope of what it owns…

…yet increases the scope of what it does!

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3. Geographical Scope

International expansion

Horizontal SynergiesBetween similar Value Chain Activities’

Vertical SynergiesBetween successive Value Chain Activities

Management SynergiesSupporting function

Synergies

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Synergies across value chains

http://www.telenor.com/en/global-presence/#/expanded

Telenor - global presence

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Two fundamental Tests for the existence of corporate advantage

1. Better-off test (necessary condition)2. Ownership test (not necessarily a sufficient

condition)

The ownership test

• Ownership vs. Contractual arrangements

Acquisition Greenfield

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Portfolio of “relationships”

Spot sales/ purchases

Long-term contracts

Agency agreements

Franchises

Ownership

Joint ventures

Informal supplier/ customer

relationships

Supplier/ customer

partnerships

Low Degree of Commitment High

Low

Low

Form

aliz

atio

nH

igh

Failure rates

• Acquisitions: 50%-70%

• Alliances: 60% -70%– Simple rules for making alliances work By Jonathan Hughes and

Jeff Weiss, Harvard Business Review 2007

• Organic growth: 40%-70%– Is it real? Can we win? Is it worth doing? By George Day,

Harvard Business Review 2007

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Why do M&A fail so often?

• Because of organizational complexity!

1. Complexity in understanding the sources of value creation- i.e. synergies

2. Complexity in understanding how to collaborate to leverage synergies

Effective Collaboration

• It’s all about creating the right incentives (non-monetary or monetary). Right?

• No!

• Collaboration between competent individuals who are highly motivated to work together may still fail.

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Collaboration failures

Coordination failures

Failures to predict &interpret each othersactions…….

Resulting in misunderstanding,lack of synchronization, delays

Cooperation failures

Failures to align interests…..

Resulting in hold-up, shirking, poaching, free-riding

The fundamental paradox of information

• The value of information is often embedded in the information itself

• When I disclose it, its value goes to 0!

How do we deal with this paradox?

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The ownership test around the world

• The institutional environment may shift the trade offs between ownership and contractual agreements– That’s way in

emerging countries it is more likely to see corporations with a broad scope…

Corporate strategy at Alghanim

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A brief history of corporate Strategy

Industry Attractiveness Criteria• Market size• Market growth• Industry profitability• Inflation recovery

Indu

stry

Attr

activ

enes

s

Portfolio Planning Models: The GE/ McKinsey Matrix

Business unit position

HARVEST

BUILD

Low

Medium

High

Low Medium High

HOLD

Business Unit Position • Market share (domestic, global, and relative)• Competitive position• Relative profitability

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HIGH

Portfolio Planning Models: The BCG Growth-Share Matrix

LOW

HIGH

LOW

Ann

ual r

eal r

ate

of m

arke

t gro

wth

(%)

Relative market share

Earnings : high stable, growing

Cash flow : neutral

Strategy : invest for growth

Earnings : high stable

Cash flow : high stable

Strategy : milk

Earnings : low, unstable

Cash flow : neutral or negative

Strategy : divest

Earnings : low, unstable, growing

Cash flow : negative

Strategy : analyze to determine whether business can be grown into a star, or will degenerate into a dog

Ann

ual r

eal r

ate

of m

arke

t gro

wth

(%)

Relative market share2 1.5 1 0.5 0.1

-2

0

2

4

6

8

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Frozen fooddivision

Fruit juicesdivision

Bakery division

Health foodsdivision

Portfolio Planning Models: Applying the BCG Matrix to a Foods company

Current position Previous position. Area of circle proportional to $ sales.

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Do Portfolio Planning Models Help or Hinder Corporate Strategy Formulation?

ADVANTAGES

• Simplicity & Big picture

• Analytically versatile

DISADVANTAGES

• Sensitive to market definition

• Ignores synergy

• Ignores financing from capital markets

Current marketvalue

Maximum raideropportunity

Current perceptions gap

Companyvalue as is

Optimalrestructuredvalue

Strategic andoperating

opportunities

Potential valuewith internal

improvements

Disposal/acquisitionopportunities

Total companyopportunities

1

2 5RESTRUCTURINGFRAMEWORK

3 4Potential valuewith externalimprovements

Corporate Restructuring to Create Value: The McKinsey Pentagon