Corporate Level Strategy and Long Run profitability Chapter 7 Growth does not always lead a business to build on success. All too often it converts a highly successful business into a mediocre large business. Richard Branson The corporate strategies of most companies have dissipated instead of created shareholder value. Michael Porter First, a concept the vertical, industry value added chain 1
<black slide: draw vertical v added chain> Stages in the Value Added Chain (rendered here horizontally) The Value Added Chain in the Personal Computer Industry Now, in corporate level strategy the principle concern is to identify the industry or industries a company should participate in to maximize long run profitability 2
But, be aware, just as actions at the business unit level may be confused with strategy when they re not (strategy) so too, at the corporate level there are actions taken under the name of strategy that are not. First option: Concentration on a single industry (a single line of business) Here a company chooses to focus its resources and capabilities on competing successfully within the confines of a particular product market Examples of companies that pursue concentration: McDonalds Starbuck s Neiman Marcus Concentration on a Single Industry (cont d) Advantages Concentrates all resources and capabilities to strengthening its competitive position in one industry Disadvantages Vertical integration may be necessary May miss out on other opportunities to create more value and increase profitability 3
Horizontal Integration The process of acquiring or merging with industry competitors to achieve the competitive advantage that comes with large size Merger an agreement between two companies to pool their resources in a combined operation Acquisition Occurs when a company uses capital resources to purchase another company. An increase in horizontal integration = an increased level of concentration in an industry Horizontal Integration Advantages Lowers operating costs Increases product differentiation (can be accomplished through product bundling) Reduces rivalry within an industry Increases bargaining power over suppliers and buyers Disadvantages Problems with merging cultures, managers and operations. Problems with the Federal Fd Trade Commission if a company grows too large Sharing Resources (Activities) Corporations can also achieve synergy by sharing tangible and value creating activities across their business units Common manufacturing facilities Distribution channels Sales forces Sharing activities provide two payoffs Cost savings Revenue enhancements 4
Sharing Resources at Procter & Gamble Another option: Diversification into multiple lines of business A diversified company is one that operates in two or more industries in order to find ways to use distinctive competencies to increase the value of products in other industries to consumers and to increase long run profitability A company may choose to diversify when they have excess resources Diversification (cont d) A corporation s diversification action is one of two types Related, or Unrelated A diversification can help a company create value in 3 main ways: 1. Transferring competencies among businesses 2. Realizing economies of scope 3. Demanding superior internal governance (aka parenting ) 5
Related Diversification: Transferring Competencies Related Diversification/Economies of scope: Market Power Two principal means to achieve synergy through market power Pooled negotiating power Vertical integration Government regulations may restrict this power Pooled Negotiating Power Similar businesses working together can have stronger bargaining position relative to Suppliers Customers Competitors Abuse of bargaining power may affect relationships with customers, suppliers and competitors 6
Related Diversification/Economies of scope: Vertically integrating along the Value Added Chain Full and Taper Integration Related Diversification/Economies of scope: Vertical Integration Expanding operations into industries that produce inputs or into industries that use, distribute, or sell the company s product A company can enter a new industry to increase its long run profitability A company that concentrates on a single business may be missing out on the opportunity to create value through vertical integration 7
Related Diversification/Economies of scope: Vertical Integration Advantages Enables company to build barriers to new competition Facilitates investments in specialized assets Protects product quality Results in improved scheduling Disadvantages May actually increase cost of inputs Suppliers have less incentive to be efficient Ties a company into old, obsolescent, and high cost technology Unrelated Diversification: Parenting Most benefits from unrelated diversification are gained from vertical (hierarchical) relationships Parenting and restructuring of businesses Allocate resources to optimize Profitability Cash flow Growth Appropriate human resources practices Financial controls (carrot and stick) Corporate Parenting & Restructuring Corporate Parenting Parenting creating value within business units; depends on Experience of the corporate office Support of the corporate office Corporate Restructuring Find poorly performing firms With unrealized potential On the threshold of significant positive change Focus effort into those with potential exiting business areas without potential 8
A key part of restructuring the portfolio of the corporation s subs is to understand their role & potential Key Each circle represents one of the firm s business units Size of circle represents the relative size of the business unit in terms of revenue Why Restructure? Because the stock of highly diversified companies is often assigned a lower valuation relative to earnings than stocks of less diversified enterprises In otherwords words, There s a point in diversifying where the stockholders lose confidence that your management makes a positive difference in potential That makes it partly an attempt to boost returns to shareholders and partly an effort to manage impressions Restructuring (cont d) Restructuring can be beneficial when there are diminishing advantages in vertical integration or diversification Restructuring can be a reaction to: Managers pursuing too much diversification Diversification for the wrong reasons Failed Acquisitions 9
Restructuring (cont.) Corporate management must (internal risks) Have insight to detect undervalued companies or businesses with high potential for transformation Haverequisite skills and resources to turn the businesses around Restructuring can involve changes in Assets Capital structure Management Tactics to achieve Diversification While growing Acquisitions or mergers Pooling resources of other companies with a firm s own resource base through Joint ventures Strategic alliances Internal development toward New products New markets New technology While shrinking. Means of exit Divestiture Management buyouts Harvesting Liquidation Exit or end game Strategies (these are tactics, not strategies) Three main exit strategies: Divestment most favorable Harvest only works under specific conditions Liquidation least favorable 10
Divestment selling a business unit to the highest bidder. A company can sell to: Independent Investors The subsidiary s own managers Other Companies Management Buyout (a form of divestment) The managers of a business unit may be interested in purchasing it and assuming the high risk associated with the purchase Management often purchases a business unit through the sale of high yield bonds The very best takeovers are thoroughly hostile. I ve never seen a really good company taken over. I ve only seen bad ones. James Goldsmith 11
Harvesting Halting investments in order to maximize short to medium term cash flow If employees catch on, morale can sink very quickly and the strategy may fail Liquidation Shutting down the operation of a business or business unit Least attractive strategy because the company isrequired to write off its investments in the unit that is shutting down 12