SM Ch-6 Corporate Level Strategies

Strategic ManagementStrategic ManagementPart II: Strategic Actions: Strategy Part II: Strategic Actions: Strategy Formulation Formulation

Chapter 6: Corporate-Level Strategies & Diversification

““To acquire or not to acquire: To acquire or not to acquire:

that is the question.”that is the question.”

Robert J. Terry

““Make winners out of Make winners out of

every business in your every business in your

company. company.

Don’t carry losers.”Don’t carry losers.”

Jack WelchFormer CEO, General Electric

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The Strategic Management The Strategic Management ProcessProcess

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Chapter 6: Corporate-Level Chapter 6: Corporate-Level StrategyStrategy

Overview: Seven content areas

◦Define and discuss corporate-level strategy◦Different levels of diversification (N=3)◦Three primary reasons firms diversify◦Value creation: related diversification

strategy◦Value creation: unrelated diversification

strategy◦Incentives and resources encouraging

diversification◦Mgmt motives encouraging firm

overdiversification

Chapter RoadmapChapter Roadmap

When to Diversify Building Shareholder Value: The Ultimate

Justification for Diversifying Strategies for Entering New Businesses Choosing the Diversification Path: Related

versus Unrelated Businesses The Case for Diversifying into Related Businesses The Case for Diversifying into Unrelated

Businesses Combination Related-Unrelated Diversification

Strategies Evaluating the Strategy of a Diversified Company After a Company Diversifies: The Four Main

Strategy Alternatives

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Procter & Gamble’s Diversification Procter & Gamble’s Diversification Strategy Strategy

Purpose of diversification: Use expertise and knowledge gained in one business by diversifying into a business where it can be used in a related way

◦ Builds synergy: value added by corporate office adds up to more than the value if different businesses in the portfolio were separate and independent

◦ Product mix: beauty products targeting women and baby care products

◦ 2005: Acquired Gillette (consumer health care products) focused on masculine market

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Procter & Gamble’s Diversification Procter & Gamble’s Diversification Strategy Strategy

Procter & Gamble (P&G) ◦ Synergy created with combining toothbrush and

toothpaste businesses Had to sell off product lines with Gillette

acquisition, lost some prospective market power

Good for retailers (shelf space) Although strategy appeared to have potential,

it was more difficult to create actual operational relatedness between the products Comingle employees requiring actual physical re-location/talent exit

Different ways to make business decisions Conflicting organizational cultures

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IntroductionIntroduction

Corporate-level strategy: Specifies actions a firm takes to gain a competitive advantage by selecting and managing a group of different businesses competing in different product markets◦ Expected to help firm earn above-average returns◦ Value ultimately determined by degree to which

“the businesses in the portfolio are worth more under the management of the company then they would be under any other ownership Product diversification (PD): primary form of corporate-

level strategy

Diversification & Corporate Diversification & Corporate Strategy Strategy

A company is diversified when it is in two or more lines of business that operate in diverse market environments

Strategy-making in a diversified company is a bigger picture exercise than crafting a strategy for a single line-of-business

◦A diversified company needs a multi-industry,multi-business strategy

◦A strategic action plan must be developedfor several different businesses competingin diverse industry environments

Four Main Tasks in Crafting Four Main Tasks in Crafting Corporate StrategyCorporate Strategy

Pick new industries to enterand decide on means of entry

Initiate actions to boost combinedperformance of businesses

Pursue opportunities to leverage cross-business value chain relationships and strategic fits into competitive advantage

Establish investment priorities, steering resources into most attractive business units

Less ambiguity about◦ “Who we are”

◦ “What we do”

◦ “Where we are headed”

Resources can be focused on◦ Improving competitiveness

◦ Expanding into new geographic markets

◦ Responding to changing market conditions

◦ Responding to evolving customer preferences

Competitive Strengths of aCompetitive Strengths of aSingle-Business StrategySingle-Business Strategy

Putting all the “eggs” in one industry basket

If market becomes unattractive, a firm’s prospects can quickly dim

Unforeseen changes can undermine a single business firm’s prospects◦Technological innovation

◦New products

◦Changing customer needs

◦New substitutes

Risks of a Single Business Risks of a Single Business StrategyStrategy

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Levels of Diversification Levels of Diversification (N=3)(N=3)

1. Low Levels

◦Single Business Strategy Corporate-level strategy in which the firm

generates 95% or more of its sales revenue from its core business area

◦Dominant Business Diversification Strategy Corporate-level strategy whereby firm

generates 70-95% of total sales revenue within a single business area

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Levels of Diversification (N=3) Levels of Diversification (N=3) (Cont’d)(Cont’d)

2. Moderate to High Levels ◦ Related Constrained Diversification Strategy

Less than 70% of revenue comes from the dominant business

Direct links (I.e., share products, technology and distribution linkages) between the firm's businesses

◦ Related Linked Diversification Strategy (Mixed related and unrelated)

Less than 70% of revenue comes from the dominant business

Mixed: Linked firms sharing fewer resources and assets among their businesses (compared with related constrained, above), concentrating on the transfer of knowledge and competencies among the businesses

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Levels of Diversification (N=3 ) Levels of Diversification (N=3 ) (Cont’d)(Cont’d)

3. Very High Levels: Unrelated Less than 70% of revenue comes from dominant business

No relationships between businesses

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Levels and Types of Levels and Types of DiversificationDiversification

It is faced with diminishing growth prospects in present business

It has opportunities to expand into industries whose technologies and products complement its present business

It can leverage existing competencies and capabilities by expanding into businesses where these resource strengths are key success factors

It can reduce costs by diversifying into closely related businesses

It has a powerful brand name it can transfer to products of other businesses to increase sales and profits of these businesses

When Should a Firm When Should a Firm Diversify?Diversify?

Why Diversify?Why Diversify?

To build shareholder value!

Diversification is capable of building shareholder value if it passes three tests1.Industry Attractiveness Test — the industry

presents good long-term profit opportunities2.Cost of Entry Test — the cost of entering is not

so high as to spoil the profit opportunities3.Better-Off Test — the company’s different

businesses should perform better together than as stand-alone enterprises, such that company A’s diversification into business B produces a 1 + 1 = 3 effect for shareholders

1 + 1 = 31 + 1 = 3

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Reasons for DiversificationReasons for Diversification

A number of reasons exist for diversification including

◦Value-creating Operational relatedness: sharing activities

between businesses Corporate relatedness: transferring core

competencies into business

◦Value-neutral ◦Value-reducing

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Value-Creating Diversification Value-Creating Diversification Strategies: Operational and Corporate Strategies: Operational and Corporate

RelatednessRelatedness

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Value-Creating Diversification (VCD): Value-Creating Diversification (VCD): Related StrategiesRelated Strategies

Purpose: Gain market power relative to competitors

Related diversification wants to develop and exploit economies of scope between its businesses◦ Economies of scope: Cost savings firm creates

by successfully sharing some of its resources and capabilities or transferring one or more corporate-level core competencies that were developed in one of its businesses to another of its businesses

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Value-Creating Diversification (VCD): Value-Creating Diversification (VCD): Related Strategies Related Strategies (Cont’d)(Cont’d)

VCD: Composed of ‘related’ diversification strategies including Operational and Corporate relatedness

1. Operational Relatedness: Sharing activities◦ Can gain economies of scope◦ Share primary or support activities (in value chain)

Risky as ties create links between outcomes◦ Related constrained share activities in order to create

value◦ Not easy, often synergies not realized as planned

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Value-Creating Diversification (VCD): Value-Creating Diversification (VCD): Related Strategies Related Strategies (Cont’d)(Cont’d)

2. Corporate Relatedness: Core competency transfer◦ Complex sets of resources and capabilities linking

different businesses through managerial and technological knowledge, experience and expertise

◦ Two sources of value creation Expense incurred in first business and knowledge transfer

reduces resource allocation for second business Intangible resources difficult for competitors to understand

and imitate, so immediate competitive advantage over competition

◦ Use related-linked diversification strategy

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Value-Creating Diversification (VCD): Value-Creating Diversification (VCD): Related Strategies Related Strategies (Cont’d)(Cont’d)

Market Power◦ Exists when a firm is able to sell its products

above the existing competitive level, to reduce costs of primary and support activities below the competitive level, or both.

◦ Multimarket (or Multipoint) Competition Exists when 2 or more diversified firms simultaneously

compete in the same product or geographic markets.

◦ Related diversification strategy may include Vertical Integration

Virtual integration

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Value-Creating Diversification (VCD): Value-Creating Diversification (VCD): UnUnrelated Strategiesrelated Strategies

Creates value through two types of financial economies

◦ Cost savings realized through improved allocations of financial resources based on investments inside or outside firm Efficient internal capital market allocation

◦ Restructuring of acquired assets Firm A buys firm B and restructures assets so it can

operate more profitably, then A sells B for a profit in the external market

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Value-Neutral Diversification: Value-Neutral Diversification: Incentives and ResourcesIncentives and Resources

Incentives to Diversify◦Antitrust Regulation and Tax Laws◦Low Performance◦Uncertain Future Cash Flows◦Synergy and Firm Risk Reduction◦Resources and Diversification

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The Curvilinear Relationship The Curvilinear Relationship between Diversification and between Diversification and

PerformancePerformance

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Value-Reducing Diversification: Value-Reducing Diversification: Managerial Motives to DiversifyManagerial Motives to Diversify

Top-level executives may diversify in order to diversity their own employment risk, as long as profitability does not suffer excessively

◦ Diversification adds benefits to top-level managers but not shareholders

◦ This strategy may be held in check by governance mechanisms or concerns for one’s reputation

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Summary Model of the Relationship Summary Model of the Relationship Between Diversification and Firm Between Diversification and Firm

PerformancePerformance

Strategies for EnteringStrategies for EnteringNew BusinessesNew Businesses

Acquire Existing Company

Internal Start-up

Joint Ventures/Strategic Partnerships

1. Acquisition of an Existing 1. Acquisition of an Existing CompanyCompanyMost popular approach to diversification

Advantages ◦ Quicker entry into target market◦ Easier to hurdle certain entry barriers

Acquiring technological know-how Establishing supplier relationships Becoming big enough to match rivals’ efficiency

and costs Having to spend large sums on introductory

advertising and promotion Securing adequate distribution access

2. Internal Startup2. Internal StartupMore attractive when

◦Parent firm already has most of needed resources to build a new business

◦Ample time exists to launch a new business◦ Internal entry has lower costs than entry

via acquisition◦New start-up does not have to go head-to-

head against powerful rivals◦Additional capacity will not adversely

impact supply-demand balance in industry ◦ Incumbents are slow in responding to new

entry

Good way to diversify when◦Uneconomical or risky to go it alone◦Pooling competencies of two partners

provides more competitive strength◦Only way to gain entry into a desirable

foreign market

Foreign partners are needed to◦Surmount tariff barriers and import quotas◦Offer local knowledge about

Market conditions Customs and cultural factors Customer buying habits Access to distribution outlets

3. Joint Ventures & Strategic 3. Joint Ventures & Strategic PartnershipsPartnerships

Raises questions

◦ Which partner will do what

◦ Who has effective control

Potential conflicts

◦ Conflicting objectives

◦ Disagreements over how to best operate the venture

◦ Culture clashes

Drawbacks of Joint Drawbacks of Joint VenturesVentures

Related Diversification

Involves diversifying into businesses whose value chains possess competitively valuable “strategic fits” with value chain(s) of firm’s present business(es)

Unrelated Diversification

Involves diversifying into businesses with no competitively valuable value chain match-ups or strategic fits with firm’s present business(es)

Related vs. Unrelated Related vs. Unrelated DiversificationDiversification

Fig. 9.1: Strategy Alternatives for a Fig. 9.1: Strategy Alternatives for a Company Looking to DiversifyCompany Looking to Diversify

RELATED DIVERSIFICATION

Involves diversifying into businesses whose value chains possess competitively valuable “strategic fits” with the value chain(s) of the present business(es)

Capturing the “strategic fits” makes related diversification a 1 + 1 = 3 phenomenon

What Is Related What Is Related Diversification?Diversification?

Exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for

◦Transferring competitively valuableexpertise or technological know-howfrom one business to another

◦Combining performance of commonvalue chain activities to achieve lower costs

◦Exploiting use of a well-known brand name

◦Cross-business collaboration to create competitively valuable resource strengths and capabilities

Core Concept: Strategic Core Concept: Strategic FitFit

Fig. 9.2: Related Businesses Possess Related Fig. 9.2: Related Businesses Possess Related Value Chain Activities and Competitively Value Chain Activities and Competitively Valuable Strategic FitsValuable Strategic Fits

Strategic Appeal of Related Strategic Appeal of Related DiversificationDiversification

Reap competitive advantage benefits of◦Skills transfer◦Lower costs◦Common brand name usage◦Stronger competitive capabilities

Spread investor risks over a broader basePreserve strategic unity across businesses Achieve consolidated performance

greater than the sum of what individual businesses can earn operating independently (1 + 1 = 3 outcomes)

Cross-business strategic fits can exist anywhere along the value chain

1. R&D And Technology Activities

2. Supply Chain Activities

3. Manufacturing Activities

4. Sales And Marketing Activities

5. Distribution Activities

6. Managerial And Administrative Support Activities

Types of Strategic FitsTypes of Strategic Fits

1. R&D and Technology 1. R&D and Technology FitsFitsOffer potential for sharing common

technologyor transferring technological know-how

Potential benefits

◦ Cost-savings in technologydevelopment and new product R&D

◦ Shorter times in gettingnew products to market

◦ Interdependence between resultingproducts leads to increased sales

2. Supply Chain Fits2. Supply Chain FitsOffer potential opportunities for skills

transferand/or lower costs

◦ Procuring materials

◦ Greater bargaining power innegotiating with common suppliers

◦ Benefits of added collaboration withcommon supply chain partners

◦ Added leverage with shippers in securingvolume discounts on incoming parts

3. Manufacturing Fits3. Manufacturing Fits

Potential source of competitive advantage when a diversifier’s expertise can be beneficially transferred to another business◦Quality manufacture◦Cost-efficient production methods

Cost-saving opportunities arise from ability to perform manufacturing/assembly activities jointly in same facility, making it feasible to◦Consolidate production into fewer plants◦Significantly reduce overall manufacturing costs

Offer potential cost-saving opportunities

◦ Share same distribution facilities

◦ Use many of same wholesaledistributors and retail dealersto access customers

4. Distribution Fits4. Distribution Fits

Reduction in sales costs◦ Single sales force for related products◦ Advertising related products together◦ Combined after-sale service and repair work◦ Joint delivery, shipping, order processing and

billing◦ Joint promotion tie-ins

Similar sales and marketing approaches provide opportunities to transfer selling, merchandising,and advertising/promotional skills

Transfer of a strong company’sbrand name and reputation

5. Sales and Marketing Fits:5. Sales and Marketing Fits:Types of Potential BenefitsTypes of Potential Benefits

6. Managerial and 6. Managerial and Administrative Support FitsAdministrative Support FitsEmerge when different business units

require comparable types of◦Entrepreneurial know-how◦Administrative know-how◦Operating know-how

Different businesses often entail same typesof administrative support facilities◦Customer data network◦Billing and customer accounting systems◦Customer service infrastructure

Core Concept: Economies of Core Concept: Economies of ScopeScopeStem from cross-business

opportunities to reduce costs

◦Arise when costs can be cut by operating two or more businesses under same corporate umbrella

◦Cost saving opportunities can stem from interrelationships anywhere along the value chains of different businesses

Related DiversificationRelated Diversificationand Competitive Advantageand Competitive Advantage

Competitive advantage can result from related diversification when a company captures cross-business opportunities to

◦ Transfer expertise/capabilities/technology from one business to another

◦ Reduce costs by combining related activities of different businesses into a single operation

◦ Transfer use of firm’s brand name reputation from one business to another

◦ Create valuable competitive capabilities via cross-business collaboration in performing related value chain activities

From Competitive Advantage From Competitive Advantage totoAdded Gains in Shareholder Added Gains in Shareholder ValueValueCapturing cross-business strategic fits

◦ Is possible only via a strategy of related diversification

◦Builds shareholder value in ways shareholders cannot achieve by owning a portfolio of stocks of companies in unrelated industries

◦ Is not something that happens “automatically” when a company diversifies into related businesses

Strategic fit benefits materialize only after management has successfully pursued internal actions to capture them

Test Your KnowledgeTest Your Knowledge

Which of the following is the best example of related diversification?

A. A manufacturer of golf shoes diversifying into the production of fishing rods and fishing lures

B. A homebuilder acquiring a building materials retailer

C. A steel producer acquiring a manufacturer of farm equipment

D. A producer of snow skis and ski boots acquiring a maker of ski apparel and accessories (outerwear, goggles, gloves and mittens, helmets and toboggans)

E. A publisher of college textbooks acquiring a publisher of magazines

UNRELATED DIVERSIFICATION

Involves diversifying into businesses with◦ No strategic fit◦ No meaningful value chain relationships◦ No unifying strategic theme

Basic approach – Diversify intoany industry where potential existsto realize good financial results

While industry attractiveness and cost-of-entry tests are important, better-off test is secondary

What Is Unrelated What Is Unrelated Diversification?Diversification?

Fig. 9.3: Unrelated Businesses Have Unrelated Value Chains and No Strategic

Fits

Acquisition Criteria For Acquisition Criteria For Unrelated Diversification Unrelated Diversification StrategiesStrategies

Can business meet corporate targets for profitability and ROI?

Is business in an industry with growth potential?

Is business big enough to contribute to parent firm’s bottom line?

Will business require substantialinfusions of capital?

Is there potential for union difficultiesor adverse government regulations?

Is industry vulnerable to recession, inflation, high interest rates, or shifts in government policy?

Attractive Acquisition Attractive Acquisition TargetsTargetsCompanies with undervalued assets

◦ Capital gains may be realized

Companies in financial distress

◦ May be purchased at bargain prices and turned around

Companies with bright growth prospects but short on investment capital

◦ Cash-poor, opportunity-rich companies are coveted acquisition candidates

Business risk scattered over different industries

Financial resources can be directed to those industries offering best profit prospects

If bargain-priced firms with big profit potential are bought, shareholder wealth can be enhanced

Stability of profits – Hard times in one industrymay be offset by good times in another industry

Appeal of Unrelated Appeal of Unrelated DiversificationDiversification

Building Shareholder Value Building Shareholder Value via Unrelated Diversificationvia Unrelated DiversificationCorporate managers must

◦Do a superior job of diversifying into new businesses capable of producing good earnings and returns on investments

◦Do an excellent job of negotiating favorable acquisition prices

◦Do a good job overseeing businesses so they perform at a higher level than otherwise possible

◦Shift corporate financial resources from poorly-performing businesses to those with potential for above-average earnings growth

◦Discern when it is the “right” time to sell a business at the “right” price

Key Drawbacks ofKey Drawbacks ofUnrelated DiversificationUnrelated Diversification

Demanding Demanding Managerial Managerial

RequirementsRequirements

LimitedLimitedCompetitive Competitive Advantage Advantage PotentialPotential

The greater the number and diversity of businesses, the harder it is for managers to

◦Discern good acquisitions from bad ones

◦Select capable managers to managethe diverse requirements of each business

◦Judge soundness of strategic proposalsof business-unit managers

◦Know what to do if a business subsidiary stumbles

Likely effect is 1 + 1 = 2, rather than 1 + 1 = 3!

Unrelated Diversification HasUnrelated Diversification HasDemanding Managerial Demanding Managerial RequirementsRequirements

Lack of cross-business strategic fits means unrelated diversification offers no competitive advantage potential beyond what each business can generate on its own

◦ Consolidated performance of unrelated businessestends to be no better than sum of individual businesses on their own (and it may be worse)

◦ Promise of greater sales-profit stability over business cycles is seldom realized

Unrelated Diversification OffersUnrelated Diversification OffersLimited Competitive Advantage Limited Competitive Advantage PotentialPotential

Test Your KnowledgeTest Your KnowledgeWhich of the following is the best example of unrelated diversification?

A.PepsiCo acquiring Tropicana and Procter & Gamble acquiring Gillette

B.Honda diversifying into the production of lawnmowers

C.Smuckers acquiring Jif peanut butter and Crisco (from Procter & Gamble)

D. Verizon Wireless acquiring Amazon.com

E.Harley Davidson acquiring the motorcycle business of Honda

Diversification and Diversification and Shareholder ValueShareholder ValueRelated Diversification

◦A strategy-driven approachto creating shareholder value

Unrelated Diversification

◦A finance-driven approachto creating shareholder value

COMBINATION OF RELATED & UNRELATED

DIVERSIFICATION

Dominant-business firms◦ One major core business accounting for 50 - 80

percent of revenues, with several small related or unrelated businesses accounting for remainder

Narrowly diversified firms◦ Diversification includes a few (2 - 5) related or

unrelated businessesBroadly diversified firms

◦ Diversification includes a wide collection of either related or unrelated businesses or a mixture

Multibusiness firms◦ Diversification portfolio includes several

unrelated groups of related businesses

Combination Related-Combination Related-Unrelated Diversification Unrelated Diversification StrategiesStrategies

For Discussion: Your For Discussion: Your OpinionOpinion

Newell Rubbermaid is in the following businesses:

◦ Cleaning and Organizations Businesses: Rubbermaid storage, organization and cleaning products, Blue Ice ice substitute, Roughneck storage items, Stain Shield and TakeAlongs food storage containers, and Brute commercial-grade storage and cleaning products—25% of annual revenues.

◦ Home and Family Businesses: Calphalon cookware and bakeware, Cookware Europe, Graco strollers, Little Tikes children's toys and furniture, and Goody hair accessories—20% of annual sales.

◦ Home Fashions: Levolor and Kirsch window blinds, shades, and hardware in the U.S.; Swish, Gardinia and Harrison Drape home furnishings in Europe—15% of annual revenues.

◦ Office Products Businesses: Sharpie markers, Sanford highlighters, Eberhard Faber and Berol ballpoint pens, Paper Mate pens and pencils, Waterman and Parker fine writing instruments, and Liquid Paper—25% of annual revenues.

Would you say that Newell Rubbermaid’s strategy is one of related diversification, unrelated diversification or a mixture of both? Explain.

For Discussion: Your For Discussion: Your OpinionOpinion

McGraw-Hill, the publisher of the textbook for this course, is in the following businesses:

◦ Textbook publishing (for grades K-12 and higher education)

◦ Financial and information services (it owns Standard & Poors —a well-known financial ratings agency and provider of financial data, Platts — a provider of energy information, and McGraw-Hill Construction — a provider of construction related information)

◦ Magazine publishing — its flagship publication is Business Week and it is also the publisher of Aviation Week

◦ TV broadcasting — it owns four ABC affiliate stations (in Indianapolis, Denver, San Diego, and Bakersfield)

◦ J.D. Power & Associates — which provides a host of services relating to product quality and consumer satisfaction

Would you say that McGraw-Hill’s strategy is one of related diversification, unrelated diversification or a mixture of both? Explain.

DIVERSIFIED COMPANY’S STRATEGY

Fig. 9.4: Identifying a Diversified Fig. 9.4: Identifying a Diversified Company’s StrategyCompany’s Strategy

How to Evaluate a How to Evaluate a Diversified Company’s Diversified Company’s StrategyStrategy

Step 1: Assess long-term attractiveness of each industry firm is in

Step 2: Assess competitive strength of firm’s business units

Step 3: Check competitive advantage potential of cross-business strategic fits among business units

Step 4: Check whether firm’s resources fit requirements of present businesses

Step 5: Rank performance prospects of businesses and determine priority for resource allocation

Step 6: Craft new strategic moves to improve overall company performance

Step 1: Evaluate Industry Step 1: Evaluate Industry AttractivenessAttractiveness

Attractiveness of eachindustry in portfolio

Each industry’s attractivenessrelative to the others

Attractiveness of allindustries as a group

Industry Attractiveness Industry Attractiveness FactorsFactorsMarket size and projected growthIntensity of competitionEmerging opportunities and threatsPresence of cross-industry strategic fits Resource requirementsSeasonal and cyclical factorsSocial, political, regulatory, and

environmental factorsIndustry profitabilityDegree of uncertainty and business

risk

Procedure: Calculating Procedure: Calculating Attractiveness Scores for Attractiveness Scores for Each IndustryEach IndustryStep 1: Select industry attractiveness

factors

Step 2: Assign weights to each factor (sum of weights = 1.0)

Step 3: Rate each industry on each factor, using a scale of 1 to 10

Step 4: Calculate weighted ratings; sum to get an overall industry attractiveness rating for each industry

Industries with a score much below 5.0 do not pass the attractiveness test

If a company’s industry attractiveness scores are all above 5.0, the group of industries the firm operates in is attractive as a whole

To be a strong performer, a diversified firm’s principal businesses should be in attractive industries—that is, industries with◦ A good outlook for growth and

◦ Above-average profitability

Interpreting Industry Interpreting Industry Attractiveness ScoresAttractiveness Scores

Difficulties in CalculatingDifficulties in CalculatingIndustry Attractiveness Industry Attractiveness ScoresScores

Deciding on appropriate weights for industry attractiveness factors◦ Different analysts may have different views about which

weights are appropriate for the industry attractiveness factors

◦ Different weights may be appropriate for different companies

Gaining sufficient command of an industry to assign accurate and objective ratings◦ Gathering statistical data to assign objective ratings is

straightforward for some factors – market size, growth rate, industry profitability

◦ Assessing the intensity of competition factor is more difficult due to the different types of competitive influences

Objectives

◦Appraise how well eachbusiness is positioned inits industry relative to rivals

◦Evaluate whether it is or can becompetitively strong enough tocontend for market leadership

Step 2: Evaluate Each Step 2: Evaluate Each Business-Business-Unit’s Competitive StrengthUnit’s Competitive Strength

Relative market shareCosts relative to competitorsAbility to match/beat rivals on key product

attributesAbility to benefit from strategic fits with sister

businessesAbility to exercise bargaining leverage with key

suppliers or customersCaliber of alliances and collaborative partnershipsBrand image and reputationCompetitively valuable capabilities Profitability relative to competitors

Factors to Use in Evaluating Factors to Use in Evaluating Competitive StrengthCompetitive Strength

Procedure: Calculating Procedure: Calculating Competitive Strength Scores Competitive Strength Scores for Each Businessfor Each BusinessStep 1: Select competitive strength factors

Step 2: Assign weights to each factor (sum of weights = 1.0)

Step 3: Rate each business on each factor, using a scale of 1 to 10

Step 4: Calculate weighted ratings; sum to get an overall strength rating for each business

Interpreting Competitive Interpreting Competitive Strength ScoresStrength Scores

Business units with ratings above 6.7 are strong market contenders

Businesses with ratings in the 3.3 to 6.7 range have moderate competitive strength vis-à-vis rivals

Business units with ratings below 3.3 are in competitively weak market positions

If a diversified firm’s businesses all have scores above 5.0, its business units are all fairly strong market contenders

Use industry attractiveness (see Table 9.1) and competitive strength scores (see Table 9.2) to plot location of each business in matrix

◦ Industry attractiveness plotted on vertical axis

◦ Competitive strength plotted on horizontal axis

Each business unit appears as a “bubble”

◦ Size of each bubble is scaled to percentage of revenues the business generates relative to total corporate revenues

Plotting Industry Attractiveness and Plotting Industry Attractiveness and Competitive Strength in a Nine-Cell Competitive Strength in a Nine-Cell MatrixMatrix

Fig. 9.5: A Nine-Cell Industry Attractiveness-Fig. 9.5: A Nine-Cell Industry Attractiveness-Competitive Strength MatrixCompetitive Strength Matrix

Businesses in upper left corner◦ Accorded top investment priority◦ Strategic prescription – grow and build

Businesses in three diagonal cells◦ Given medium investment priority◦ Invest to maintain position

Businesses in lower right corner◦ Candidates for harvesting or divestiture◦ May, based on potential for good earnings and

ROI, be candidates for an overhaul and reposition strategy

Strategy Implications of Strategy Implications of Attractiveness/Strength Attractiveness/Strength MatrixMatrix

Appeal of Appeal of Attractiveness/Strength Attractiveness/Strength MatrixMatrixIncorporates a wide variety of

strategically relevant variables

Strategy implications◦Concentrate corporate resources in

businesses that enjoy high degree of industry attractiveness and high degree of competitive strength

◦Make selective investments in businesses with intermediate positions on grid

◦Withdraw resources from businesses low in attractiveness and strength unless they offer exceptional potential

Test Your KnowledgeTest Your KnowledgeThe 9-cell industry attractiveness-competitive strength matrix

A. is a valuable tool for ranking a company’s different businesses from most profitable to least profitable.

B. shows which of a diversified company’s businesses have good/poor strategic fit.

C. indicates which businesses have the highest/lowest economies of scope.

D. is a helpful tool for allocating a diversified company’s resources—the basic idea is to give top investment priority to those businesses in the upper left portion of the matrix and to give low priority or perhaps even divest businesses in the lower right portion of the matrix.

E. pinpoints which of a diversified company’s businesses are resource-rich and which are resource-poor.

Objective

◦ Determine competitive advantage potential of cross-business strategic fits among portfolio businesses

Examine strategic fit based on

◦ Whether one or more businesseshave valuable strategic fits withother businesses in portfolio

◦ Whether each business meshes wellwith firm’s long-term strategic direction

Step 3: Check Competitive Step 3: Check Competitive Advantage Potential of Cross-Advantage Potential of Cross-Business Strategic FitsBusiness Strategic Fits

Identify businesses which have value chain match-ups offering opportunities to

◦Reduce costs Purchasing Manufacturing Distribution

◦Transfer skills / technology / intellectual capital from one business to another

◦Share use of a well-known, competitively powerful brand name

◦Create valuable new competitive capabilities

Evaluate Portfolio for Competitively Evaluate Portfolio for Competitively Valuable Cross-Business Strategic Valuable Cross-Business Strategic FitsFits

Fig. 9.6: Identifying Competitive Advantage Fig. 9.6: Identifying Competitive Advantage Potential of Cross-Business Strategic Fits Potential of Cross-Business Strategic Fits

Objective

◦ Determine how well firm’s resourcesmatch business unit requirements

Good resource fit exists when

◦ A business adds to a firm’s resource strengths,either financially or strategically

◦ Firm has resources to adequately support requirementsof its businesses as a group

Step 4: Check Resource FitStep 4: Check Resource Fit

Determine cash flow and investmentrequirements of business units◦ Which are cash hogs and which are

cash cows?

Assess cash flow of each business◦ Highlights opportunities to shift financial

resources between businesses ◦ Explains why priorities for resource allocation

can differ from business to business◦ Provides rationalization for both

invest-and-expand and divestiturestrategies

Check for Financial Resource Check for Financial Resource FitsFits

Internal cash flows are inadequate to fully fund needs for working capital and new capital investment

◦ Parent company has to continually pump in capitalto “feed the hog”

Strategic options

◦ Aggressively invest in attractive cash hogs

◦ Divest cash hogs lacking long-term potential

Characteristics of Cash Hog Characteristics of Cash Hog BusinessesBusinesses

Generate cash surpluses over what is needed to sustain present market position

Such businesses are valuable because surplus cash can be used to ◦Pay corporate dividends◦Finance new acquisitions◦ Invest in promising cash hogs

Strategic objectives◦Fortify and defend present market position◦Keep the business healthy

Characteristics of Cash Cow Characteristics of Cash Cow BusinessesBusinesses

Other Tests of Resource FitsOther Tests of Resource FitsDoes the business adequately contribute to

achieving companywide performance targets?

Does the company have adequate financial strength to fund its different businesses and maintain a healthy credit rating?

Does the company have or can it develop the specific resource strengths and competitive capabilities needed to be successful in each of its businesses?

Are recently acquired businesses acting to strengthen a company’s resource base and competitive capabilities or are they causing its competitive and managerial resources to be stretched too thin?

Good financial fit exists when a business◦ Contributes to achievement of corporate

objectives

◦ Enhances shareholder value

Poor financial fit exists when a business◦ Soaks up disproportionate share of financial

resources

◦ Is an inconsistent bottom-line contributor

◦ Experiences a profit downturn that could jeopardize entire company

◦ Is too small to make a sizable contribution to total corporate earnings

Good vs. Poor Financial Good vs. Poor Financial Resource FitResource Fit

Trying to replicate a firm’s success in one business and hitting a second home run in a new business is easier said than done

Transferring resource capabilities to new businesses can be far more arduous and expensive than expected

Management can misjudge difficultyof overcoming resource strengths ofrivals it will face in a new business

A Note of Caution: WhyA Note of Caution: WhyDiversification Efforts Can Diversification Efforts Can FailFail

Step 5: Rank Business Units Based onStep 5: Rank Business Units Based onPerformance and Priority for Resource Performance and Priority for Resource Allocation Allocation

Factors to consider in judgingbusiness-unit performance

◦ Sales growth

◦ Profit growth

◦ Contribution to company earnings

◦ Return on capital employed in business

◦ Economic value added

◦ Cash flow generation

◦ Industry attractiveness and business strength ratings

Objective

◦ “Get the biggest bang for the buck”in allocating corporate resources

Approach

◦ Rank each business from highest to lowest priority for corporate resource support and new capital investment

◦ Steer resources from low-to high-opportunity areas

◦ When funds are lacking, strategic uses of resources should take precedence

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Determine Priorities for Determine Priorities for Resource AllocationResource Allocation

Fig. 9.7: The Chief Strategic and Financial Options forAllocating a Diversified Company’s Financial Resources

Stick closely with existing business lineupand pursue opportunities it presents

Broaden company’s business scope by making new acquisitions in new industries

Divest certain businesses and retrench to a narrower base of business operations

Restructure company’s business lineup, putting a whole new face on business makeup

Pursue multinational diversification, striving to globalize operations of several business units

Step 6: Craft New StrategicStep 6: Craft New StrategicMoves – Strategic OptionsMoves – Strategic Options

Fig. 9.8: A Company’s Four Main Strategic Alternatives After It Diversifies

Conditions making this approach attractive

◦ Slow grow in current businesses

◦ Vulnerability to seasonal or recessionary influences or to threats from emerging new technologies

◦ Potential to transfer resources and capabilities to other related businesses

◦ Rapidly-changing conditions in one or more core industries alter buyer requirements

◦ Complement and strengthen market position of one or more current businesses

Strategies to Broaden aStrategies to Broaden aDiversified Company’s Diversified Company’s Business BaseBusiness Base

Strategic options

◦Retrench to a smaller but more appealing group of businesses

◦Divest unattractive businesses

Sell it

Spin it off as independent company

Liquidate it (close it downbecause no buyers can be found)

Retrench ?

Divest ?

Sell ?

Close ?

Divestiture Strategies Aimed at Divestiture Strategies Aimed at RetrenchingRetrenchingto a Narrower Diversification Baseto a Narrower Diversification Base

Retrenchment StrategiesRetrenchment StrategiesObjective

◦ Reduce scope of diversification to smaller number of “core “ businesses

Strategic options involvedivesting businesses that◦ Are losing money◦ Have little growth potential◦ Have little strategic fit

with core businesses◦ Are too small to contribute

meaningfully to earnings

Diversification efforts have become too broad, resulting in difficulties in profitably managing all the businesses

Deteriorating market conditions in a once-attractive industry

Lack of strategic or resource fit of a businessA business is a cash hog with questionable

long-term potentialA business is weakly positioned in its industryBusinesses that turn out to be “misfits”One or more businesses lack compatibility of

values essential to cultural fit

Conditions That Make Conditions That Make Retrenchment AttractiveRetrenchment Attractive

Options for Accomplishing Options for Accomplishing DivestitureDivestiture

Sell it

◦ Involves finding a company which views the business as a good deal and good fit

Spin it off as independent company

◦ Involves deciding whether or not to retain partial ownership

Liquidation

◦ Involves closing down operations and selling remaining assets

◦ A last resort because no buyer can be found

Strategies to Restructure a Strategies to Restructure a Company’s Business LineupCompany’s Business LineupObjective

◦Make radical changes in mixof businesses in portfolio via both

Divestitures and

New acquisitions

to put a whole new face on the company’s business makeup

Too many businesses in unattractive industries

Too many competitively weak businesses

Ongoing declines in market shares of oneor more major business units

Excessive debt load

Ill-chosen acquisitions performing worse than expected

New technologies threaten survival of one or more core businesses

Appointment of new CEO who decides to redirect company

“Unique opportunity” emerges and existing businesses must be sold to finance new acquisition

Conditions That Make Conditions That Make Portfolio Restructuring Portfolio Restructuring AttractiveAttractive

Multinational Diversification Multinational Diversification StrategiesStrategies

Distinguishing characteristics

◦ Diversity of businesses and

◦ Diversity of national markets

Presents a big strategy-making challenge

◦ Strategies must be conceived and executed for each business, with as many multinational variations as appropriate

◦ Cross-business and cross-country collaboration opportunities must be pursued and managed

Appeal of Multinational Appeal of Multinational Diversification StrategiesDiversification Strategies

Offer two avenues for long-termgrowth in revenues and profits

◦Enter additional businesses

◦Extend operations ofexisting businesses intoadditional country markets

Opportunities to Build Competitive Opportunities to Build Competitive Advantage via Multinational Advantage via Multinational DiversificationDiversificationFull capture of economies of scale and experience

curve effects

Capitalize on cross-business economies of scope

Transfer competitively valuable resources from one business to another and from one country to another

Leverage use of a competitively powerful brand name

Coordinate strategic activities and initiatives across businesses and countries

Use cross-business or cross-countrysubsidization to out-compete rivals

Competitive advantage potential is based on

◦Using a related diversification strategy based on

Resource-sharing and resource-transferopportunities among businesses

Economies of scope and brand name benefits

◦Managing related businesses to capture important cross-business strategic fits

◦Using cross-market or cross-business subsidization sparingly to secure footholds in attractive country markets

Competitive Strength of a Competitive Strength of a DMNC in Global MarketsDMNC in Global Markets

A DMNC has a strategic arsenal capable of defeating both a domestic-only rival or a single-business rival by competing in

◦ Multiple businesses and

◦ Multiple country markets

Can use its multiple profit sanctuaries and can employ cross-subsidization tactics if need be

Competitive Power of a Competitive Power of a DMNC in Global MarketsDMNC in Global Markets

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