Corporate Level Strategy

Corporate Level Strategy Week 5

Outline • Levels of diversification • Reasons for diversification • Related diversification • Unrelated diversification • Diversification: Incentives and resources

What is corporate level strategy? • Strategies that detail actions to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets • What business the firm should be in and how the corporate office should manage its group of business

Corporate Strategy • Developing and implementing multi-business strategies may be necessary for effective use of excess resources, capabilities and core competencies that have value across several businesses. • To enhance strategic competitiveness, & earn above average returns.

A Diversified Company has Two Strategy Levels Business-Level Strategy(Competitive Strategy) How to create competitive advantage in each business in which the company competes, using: • Low cost • Differentiation • Integrated low cost/differentiation • Focused low cost • Focused differentiation Corporate-Level Strategy(Companywide Strategy) How to create value for the corporation as a whole

Corporate Strategy concerns Two Key Questions: What businesses should the corporation be in? How should the corporate office manage the array of business units? Corporate strategy is what makes the corporate whole add up to more than the sum of it business-unit parts

Primary Approach Primary approach to corporate level strategy: • Diversification • Firms diversify when they have excess resources, capabilities and core competencies that have multiple uses

Levels of diversification Firms vary according to • Relatedness • Connections between and among business units • Levels of diversification • Low • Medium • High

Low levels of diversification • SingleMore than 95% of revenue comes from dominant business • Dominant • Between 70% & 95 % of sales in a single category eg Cadbury-Schweppes. • Tend to be vertically integrated.

Moderate Levels of Diversification • Related-constrained diversification • Less than 70% of revenue from dominant business and • Businesses share product, technological and distribution linkages • Related-linked diversification • Less than 70% of revenue comes from dominant business • Only limited links between businesses

High Levels of Diversification Unrelated diversification • Less than 70% of revenue from dominant business • No common links between businesses

Single and Dominant Business Strategies • Advantages • (70-95% from single business) • More understanding of competitive dynamics • managers develop specialised skills • narrower range of business strategies • managing synergies • Disadvantages • More affected by economic downturn

Diversified Position • Advantages • increased economies of scope • market power by blocking competitors through multi-point competition or vertical integration • financial economies • tax advantages

Operational & Corporate Relatedness Corporate Relatedness Low High Related Constrained Operational & Corporate Relatedness High Vertical integration Sharing: Operational Relatedness Diseconomies of scope Unrelated Related Linked Low Financial Economies Economies of Scope

Adding Value by Diversification Diversification most effectively adds value by one of two mechanisms: By developing economies of scope between business units in the firms, which leads to synergistic benefits By developing market power, which leads to greater returns

1 Sharing Activities 2 Transferring Core Competencies 3 Efficient Internal Capital Market Allocation 4 Restructuring Alternative Diversification Strategies Related Diversification Strategies Unrelated Diversification Strategies

1. - Sharing Activities • Sharing activities often lowers costs or raises differentiation • Sharing activities can lower costs if it: • Achieves economies of scale • Boosts efficiency of utilisation • Means more rapid movement through learning curve • Sharing activities can enhance potential for or reduce the cost of differentiation • Sharing activities must involve activities that are crucial to competitive advantage

Sharing Activities - Assumptions • Strong sense of corporate identity • Clear corporate mission that emphasises the importance of integrating business units • Incentive system that rewards more than just business-unit performance

2. - Transferring Core Competencies • Exploits interrelationships among divisions • Starts with value chain analysis: • Identify ability to transfer skills or expertise among similar value chains • Exploit ability to share activities • E.g. Two firms can share the same sales force, logistics network or distribution channels

2. - Transferring Core Competencies Assumptions • Transferring core competencies leads to competitive advantage only if the similarities among business units meet the following conditions: • Activities involved in the businesses are similar enough for expertise sharing to be meaningful • Transfer of skills involves activities that are important to competitive advantage • The skills transferred represent significant sources of competitive advantage for the receiving unit

3. - Efficient Internal Capital Market Allocation • Firms pursuing this strategy frequently diversify by acquisition: • Acquire sound, attractive companies • Acquire units that are autonomous • Acquire corporation to supply needed capital • Portfolio managers transfer resources from units that generate cash to those with high growth potential and substantial cash needs • Add professional management and control to sub-units • Sub-unit managers’ compensation is based on unit results

3. - Efficient Internal Capital Market Allocation Assumptions • Managers have more detailed knowledge of a firm relative to outside investors • The firm need not risk competitive edge by disclosing sensitive competitive information to investor • The firm can reduce risk by allocating resources among diversified businesses, although shareholders can generally diversify more economically on their own

4. - Restructuring • Seek out undeveloped, sick or threatened organisations or industries • Parent company (acquirer) intervenes and frequently: • Changes sub-unit management team • Shifts strategy • Infuses firm with new technology • Enhances discipline by changing control systems • Divests part of firm • Makes additional acquisitions to achieve critical mass • Unit will often be sold after one-time changes are made, since parent no longer adds value to ongoing operations

4. - Restructuring Assumptions • Requires keen management insight in selecting firms with depressed values or unforeseen potential • Must do more than restructure companies: • Need to initiate restructuring of industries to create a more attractive environment

Summary Model of the Relationship between Firm Performance and Diversification Resources Diversification Strategy Incentives Managerial Motives

Incentives • Economies of scope • Sharing of activities • Transferring core competencies • Market Power • Blocking competitors • Vertical integration • Financial economies • Efficient internal capital allocation • Business restructuring

Resources & Incentives • Incentives & Resources with neutral effects • Anti-trust regulation • Tax laws • Low performance • Uncertain future cash flows • Risk reduction • Tangible resources • Intangible resources

Incentives to Diversify Internal Incentives • Poor performance may lead some firms to diversify in an attempt to achieve better returns • To balance uncertain future cash flows • In order to reduce risk

Reasons for diversification • Managerial motives • Diversifying managerial employment risks • Increasing managerial compensation • Effective governance mechanisms may restrict such abuses

Diversification and Firm Performance Performance Dominant Business Related Constrained Unrelated Business Level of Diversification

Summary Model of the Relationship between Firm Performance and Diversification Resources Diversification Strategy Firm Performance Incentives Managerial Motives

Capital Market Intervention and Market for Managerial Talent Firm Performance Internal Governance Strategy Implementation Summary Model of the Relationship between Firm Performance and Diversification Resources Diversification Strategy Incentives Managerial Motives

Issues to Consider Prior to Diversification • What resources, capabilities and core competencies do we possess that would allow us to outperform competitors? • What core competencies must we possess in order to succeed with a new product or geographical market? • Is it possible to leapfrog competitors? • Will diversification break up capabilities and competencies that should be kept together? • Will we only be a player in the new product or geographical market, or will we emerge as a winner? • What can the firm learn through its diversification? • Is it organised properly to acquire such knowledge?

Acquisition and restructuring strategies

Outline • Mergers, acquisitions and takeovers • Reasons for acquisitions • Effective acquisitions • Restructuring • downsizing • downscoping • leveraged buyouts • restructuring outcomes

Merger • MergerTwo firms agree to integrate operations on a relatively equal basis because they have resources and capabilities that create stronger competitive advantage • AcquisitionA transaction where one firm buys another firm with the intent of more effectively using a core competency by making the acquired firm a subsidiary within its portfolio of businesses • TakeoverAn acquisition where the target firm did not solicit the bid.

Reasons for Acquisitions • Increased market powerAn acquisition intended to reduce the competitive balance of the industry • Overcome barriers to entryAcquisitions overcome costly barriers to entry that may make ‘start-ups’ economically unattractive • Costs\risks of new product developmentBuying established businesses reduces the risk involved in start-up ventures

Reasons for Acquisitions (cont.) • Increased speed to marketClosely related to barriers to entry … allows market entry in a more timely fashion • DiversificationA quick way to move into businesses when a firm lacks experience and depth in an industry • Avoiding excessive competitionFirms may acquire businesses in which competitive pressures are less intense than in their core business

Poor Performance of Acquisitions • Integration difficultiesDiffering cultures can make integration of firms problematic • Inadequate evaluation of targetWinners curse’ bid causes acquirer to overpay for firm • Large or extraordinary debtCostly debt can create onerous burden on cash outflows

Poor Performance of Acquisitions (cont.) • Inability to achieve synergyJustifying acquisitions can increase estimate of expected benefits • Too much diversificationThe acquirer does not have the expertise required to manage unrelated businesses • Managers overly focussed on acquisitionsManagers lose track of the core business by expending too much effort on acquisitions • Combined firm becoming too largeLarge bureaucracy reduced innovation and flexibility

Effective Acquisitions • Assets are complementaryBuying firms with assets that meet current needs to build competitiveness • Careful selection ProcessDeliberate evaluation and negotiations are more likely to lead to easy integration and building synergies Targets are selected and ‘groomed’ prior to acquisition etc. • Acquisition is friendlyFriendly deals make integration go more smoothly

Effective Acquisitions (cont.) • Maintain Financial SlackProvide enough additional financial resources so that profitable projects are not foregone • Low to Moderate DebtMerged firm maintains financial flexibility • FlexibilityFirm has experience at managing change and is flexible and adaptable. Both firms are adaptable • InnovationContinue to invest in R&D as part of the firm’s overall strategy

Restructuring • Changes in the composition of the firms set of businesses and/or financial structure • Often in response to poor performance and over-diversification • Forms • Downsizing- reduce costs by laying off employees or eliminating operating units • Downscoping- reduce the level of unrelatedness in the firm –leads to greater focus • Leveraged buyout

Leveraged Buyouts • Purchase involving mostly borrowed funds • Generally occurs in mature industries where R&D and innovation are not central to value creation • High debt load commits cashflows to repay debt, creating strong discipline for management • Increases concentration of ownership • Focuses attention of management on shareholder value • Greater oversight by ‘active investor’ board members • Leads to more value-based decision making

Outcomes of restructuring • Downsizing reduces labour costs, but also leads to loss of human capital and lower performance? • Downscoping reduces debt costs and reestablishes emphasis on strategic controls resulting in higher performance • Leveraged buyouts provide emphasis on strategic controls but increased debt costs, long term result is increased performance but greater risk

Loss of Human Capital Reduced Labour Costs Downsizing Reduced Debt Costs Lower Performance Downscoping Higher Performance Emphasis on Strategic Controls Leveraged Buyout High Debt Costs Higher Risk Restructuring and Outcomes Short-Term Outcomes Long-Term Outcomes Alternatives

Corporate Level Strategy