Formulating Corporate-Level Strategy HCAD 5390
Distinguishing Corporations from Strategic Business Units (SBUs) Multi-SBU Corporations: • Sole separate legal entity • Authorized to execute contracts • Able to borrow money and sell equity • Produces no goods or services • Quite small staff • Primary function is to assemble and manage a portfolio of SBUs
Distinguishing Corporations from Strategic Business Units (SBUs) Strategic Business Units: • No separate legal existence • No separate ability to contract or raise capital • Produce goods and services • Compete in one or more markets • Relative autonomy to manage operations and strategy
Value-Adding Functions of the Corporate Center • Manage the Portfolio of SBUs • Raise Financial Capital for Allocation to SBUs • Allocate Resources and Services to SBUs • Facilitate Synergies Among SBUs • Choose Parenting Style for SBU Interactions • Participate in SBU Strategic Planning Process • Oversee and Monitor SBU Performance • Manage Corporate Relations With Stakeholders
Corporate Management of an SBU Portfolio (I) • In pursuit of a corporate vision • Acquires, merges with, or develops internally new SBUs • Divests existing, unwanted SBUs • Set performance goals for SBU management • Provide input to SBU strategic decisions • Count upon SBUs to perform unique strategic functions
Corporate Management of an SBU Portfolio (II) • Balance between central corporate direction and individual SBU autonomy • Control vs spontaneity • Hire good SBU managers, give them general guidelines, and let them loose … or … • Give detailed directions, watch closely, and intervene frequently
Model Portfolio Management Process • Choose strategic thrust of the corporation • Growth • Stability • Retrenchment • Choose geographic areas, markets, and products or services to offer in them • Decide how many SBUs in the portfolio and which businesses they will be
Texas Health Resources • Texas Health Resources (THR) is one of the largest faith-based, nonprofit health care delivery systems in the United States and the largest in North Texas in terms of patients served. The system's primary service area consists of 16 counties in north central Texas, home to more than 6.2 million people. THR was formed in 1997 with the assets of Fort Worth-based Harris Methodist Health System and Dallas-based Presbyterian Healthcare Resources. Later that year, Arlington Memorial Hospital joined the THR system. THR has 12 acute-care hospitals and one long-term care hospital that total 3,100 licensed hospital beds, employs more than 18,000 people, and counts more than 3,600 physicians with active staff privileges at its hospitals. THR is also a corporate member or partner in six additional hospitals and surgery centers.
Corporate-Level Strategic Options:Growth – Expand the Portfolio • Most common corporate-level strategy direction • Critical to maintaining share in a growing market • In pursuit of economies of scale and scope • Increase in experience and learning • Top executive egos to be satisfied
Adaptive Strategies Expansion Adaptive Strategy: • Orientation toward growth • Expand, cut back, status quo? • Concentrate within current industry, diversify into other industries? • Growth and expansion through internal development or acquisitions, mergers, or strategic alliances?
Growth By Concentration • All businesses start here • Dedicate all resources and competencies to one or a few products or services • Achieved in one of three ways: • Sell more of current products in current markets • Sell current products in new markets • Sell new products in current markets • To sell new products in new markets is diversification
Adaptive Strategies Basic Growth Strategies: Concentration • Current product line in one industry • Market Development • Product Development • Penetration Diversification • Into other product lines in other industries
Concentration on a Single Business Southwest Airlines SEARS Coca-Cola McDonalds
Advantages Operational focus on a single familiar industry or market. Current resources and capabilities add value. Growing with the market brings competitive advantage. Disadvantages No diversification of market risks. Vertical integration may be required to create value and establish competitive advantage. Opportunities to create value and make a profit may be missed. Concentration on a Single Business
Concentration No Longer Sufficient to Maintain Growth • Unlikely to capture a greater share of current market • Current market is stagnating, maturing, shrinking, or otherwise lacking growth potential • Excess cash on hand needs to be invested productively • Management has greater ambitions for further strategic achievement
Diversification • Related diversification • Entry into new business activity based on shared commonalities in the components of the value chains of the firms. • Unrelated diversification • Entry into a new business area that has no obvious relationship with any area of the existing business.
Growth By Related Diversification • Move beyond existing markets and products • Employ existing resources and competencies • New businesses are closely connected (“related”) to existing businesses • Directions of related diversification • Vertical forward integration (toward customers) • Vertical backward integration (toward suppliers) • Horizontal expansion
Forms of Relatedness • Products or services • Markets • Processes, systems, or other operating features • Manufacturing facilities, distribution channels, marketing media, or support services • Brand image, corporate reputation, creativity or innovation skills, or general managerial expertise
Vertical Integration • Forward or backward in the industry value chain • Moving “upstream” toward suppliers • Hospital acquiring a physician group practice • Moving “downstream” toward customers • Hospital acquiring a long-term care facility • Examples: physician-hospital organizations (failed), integrated delivery systems (succeeded)
Upstream Downstream Stages in the Raw-Material-to-Consumer Value Chain
Examples: Dow ChemicalUnion CarbideKyocera Examples:IntelSeagateMicron Examples:AppleHpDell Examples:Best BuyOffice Max Distribution Assembly Intermediatemanufacturer Raw materials End user Stages in the Raw-Material-to-Consumer Value Chain in the Personal Computer Industry
Decision Steps in Vertical Integration • Adequate resources and competencies to bring the new business operations in-house • Choose form of integration – full ownership, partial ownership, joint venture, or long-term contract • Consider impact on other stakeholders • Pay attention to share of industry value chain being brought in-house
Good Reasons for Vertical Integration • Reduce costs by eliminating redundancy throughout the value chain • Better coordination at interface between value chain components • Profit-taking at several levels in the chain is eliminated • Greater overall control of inputs (resources) and outputs (distribution channels) • Wider network of sources of competitive intelligence • Opportunity to reengineer the value chain
Vertical Integration Problems (I) • Does the value chain function as well after integration as it did before? • Excessive costs may be incurred in managing the new businesses and their interactions • Inability to use full capacity of acquired businesses so must … sell to competitors? • Must the business deal exclusively with its new integration partners?
Vertical Integration Problems (II) • Commitment to entire chain reduces strategic flexibility • Commitment may tie business to inefficient processes, poorly managed units, and obsolete technologies • Inability to coordinate added units may increase costs and limit opportunities to create value for customers
Horizontal Expansion • Moving sideways in the value chain, acquiring similar businesses in different geographic areas • Acquisition target may be a competitor • May create antitrust enforcement concerns • Examples: multistate hospital networks, nursing home chains, national health plan systems
Best Circumstances for Horizontal Expansion • Current market is growing, requiring additional capacity to meet demand • Target acquisition doing poorly – lacks resources or competencies possessed by the acquirer • Expanded size enables economies of scale leading to competitive advantage • Opportunity to create dominant market position by acquiring a competitor
Diversification Basic Diversification Strategies: • Concentric (Related) Diversification • Conglomerate (Unrelated) Diversification
Incentives to Diversify Internal Incentives: • Poor performance may lead some firms to diversify an attempt to achieve better returns • Firms may diversify to balance uncertain future cash flows • Firms may diversify into different businesses in order to reduce risk
Resources and Diversification • Besides strong incentives, firms are more likely to diversify if they have the resources to do so • Value creation is determined more by appropriate use of resources than incentives to diversify
Managerial Motives to Diversify Managers have motives to diversify • diversification increases size; size is associated with executive compensation • diversification reduces employment risk • effective governance mechanisms may restrict such motives
Related Diversification Concentric Diversification • Growth into related industry • Search for synergies
Related Diversification Marriott 3M Hewlett Packard
Advantages of Related Diversification (I) • Synergies among existing and acquired businesses • Lower overall corporate risk – balancing high and low-risk SBUs • Greater bargaining power vis-à-vis competitors, suppliers and customers
Advantages of Related Diversification (II) • Cross-subsidization among businesses at different life cycle stages • General increase in revenues and profits from acquired businesses • Opportunity to acquire new knowledge, competencies, and technologies • Enhance status, power, and compensation of top executives
Forms of Inter-SBU Synergy (I) • Share solutions to problems and ideas for improving operational efficiency • Use slack capacity to achieve economies of scale • Earn volume discounts and greater bargaining power with suppliers • Integration of computer systems and capabilities
Forms of Inter-SBU Synergy (II) • By sharing R&D facilities, reduce innovation costs and spread research risks • Share distribution channels • Leverage the use of influential brand names and images • Wide opportunities for knowledge transfer
Adaptive Strategies Unrelated (Conglomerate) Diversification • Growth into unrelated industry • Concern with financial considerations
Growth By Unrelated Diversification • Few similarities or commonalities among businesses in the portfolio • Operate in different industries/markets, serve different customers, face different competitors • Corporation composed of unrelated businesses may be called a “conglomerate” • What value is added by bringing unrelated businesses together into one corporation?
Unrelated Diversification Tyco Amer Group ITT
Relationship Between Diversification and Performance Performance Dominant Business Related Constrained Unrelated Business Level of Diversification
Bureaucratic Costs and the Limits of Diversification • Number of businesses • Information overload can lead to poor resource allocation decisions and create inefficiencies. • Coordination among businesses • As the scope of diversification widens, control and bureaucratic costs increase. • Resource sharing and pooling arrangements that create value also cause coordination problems. • Limits of diversification • The extent of diversification must be balanced with its bureaucratic costs.
Tools for Implementing Growth Strategies • Internal development • Internal new venture creation • Investments in new ventures • Acquisition • Merger • Joint venture, strategic alliance or partnership
Learn and develop new capabilities Reshape firm’s competitive scope Overcome entry barriers Increase diversification Acquisitions Cost of new product development Increase speed to market Increase market power Lower risk compared to developing new products Reasons for Making Acquisitions
Diversification and Corporate Performance: A Disappointing History • A study conducted by Business Week and Mercer Management Consulting, Inc., analyzed 150 acquisitions that took place between July 2000 and July 2005. Based on total stock returns from three months before, and up to three years after, the announcement: • 30 percent substantially eroded shareholder returns. • 20 percent eroded some returns. • 33 percent created only marginal returns. • 17 percent created substantial returns. • A study by Salomon Smith Barney of U.S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquiring firms have, on average, under-performed the S&P stock index by 14 percentage points and under-performed their peer group by four percentage points after the deals were announced. Sources: Lipin, S. & Deogun, N. 2000. Big merges of the 90’s prove disappointing to shareholders. Wall Street Journal, October 30: C1; A study by Dr. G. William Schwert, University of Rochester, cited in Pare, T. P. 1994. The new merger boom. Fortune, November 28:96; and Porter, M.E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3):43.