Chapter 6: Corporate Strategy (Barb) Flashcards
Business unit strategy
The search for competitive advantage
within a single industry, market, or
line of business.
Corporate strategy
The search for value and competitive
advantages through participation
in several different industries
and markets.
Vertical integration
Movement into adjacent markets by a firm along its own value chain. Movement in the direction of raw materials is backward integration. Movement in the direction of sales, service, or warranty operations is forward integration
Horizontal diversification (aka diversification)
The movement into an adjacent
market, one that is not along a
firm’s current value chain.
Managers diversify their firms through one of three methods:
1) greenfield or organic entry,
2) alliance,
3) acquisition
Single business
A firm earning
more than 95 percent of revenues
from a single line of business
Measured in terms of the four-digit NAICS code
Dominant vertical business
A firm that earns more than 70 percent of revenues from its main line of business and the rest from businesses located along the value chain.
Dominant business
A firm that earns more than 70 percent of revenue from its main line of business and the remainder from other lines across different value chains.
Related-constrained diversification
A firm that earns less than 70 percent of its revenue from its main line of business, and its other lines of business share product, technological, and distribution linkages with the main business.
Related-linked diversification
A firm that operates in related markets, but fewer linkages exist between the new and existing markets than the elements create separately.
Unrelated diversified firm
Competes in product
categories and markets with
few, if any, commonalities
between them.
Examples: 3M and General Electric (GE)
For diversification to add value in the real world, managers must answer the following acid
test questions:
(1) Why will the existing businesses be more valuable because we’ve entered an adjacent business? and
(2) Why will the new business activity be more valuable inside our corporation than operating alone?
Diversification adds value when expansion into an adjacent business either ______ the firm’s
valuable resources and capabilities or diversification _______ and grows the resource base
exploits
enhances
To provide more clarity to the notion of exploiting and expanding, you can divide a firm’s resources
and capabilities into two broad categories:
“front end,”: or customer-facing resources and
capabilities
“back end.”: technological and operational
“front end,” example
Procter & Gamble’s resources
such as brands, product lines, distribution channels, and capabilities in uncovering deep customer
needs represent the customer-facing part of the business
“back end.” example
Walmart’s resources in terms
of regional distribution centers and information systems and its capabilities in global supply
chain management and cost reduction belong in the “back-end” group.
_______ allows companies to exploit their existing customer-facing resources by
adding new operational resources and capabilities
Diversification
Adjacent market
A market or industry that is closely related
to markets or industries a firm
currently competes in.
Figure 6.1 Adding value though Diversification
Shows value from front-end, back-end, exploiting resources, and expanding resources
The Eight Ss
1) Employing Slack
2) creating synergy
3) leveraging shared knowledge
4) utilizing similar models for success
5) spreading human and financial capital to its best use
6) providing a stepping stone for the company to a completely new business sector
7) stopping or slowing competitors
8) staying even with technological change
Slack
Unused resource capacity.
1) Employing Slack
the ability of managers to handle more work
effectively over time
Employing slack usually creates value through
exploitation, although sometimes during an acquisition a company may acquire redundant
resources that expand slack
Management skill
The individual and collective abilities of a firm’s
management team to engage in value-creating activities.
Management skill
The individual and collective abilities of a firm’s
management team to engage in value-creating activities.
2) Creating Synergy
Disney competes in two adjacent entertainment markets, films and theme parks. The
two businesses create more brand value for Disney together than either would separately
Synergy also
increases the number and ways a company interacts with its customers, and that can expand
its capabilities to meet customer needs in the future.
Synergy
Action between different
elements of a system that creates
more value together than the
elements create separately.
3) Shared Knowledge
Diversification allows valuable knowledge
and skill to be shared between business units
Think of a diversified company as a tree: the leaves, twigs, and branches represent different product markets and industries, but the competitive advantage
comes from the common roots, processes, or knowledge.
Core competencies (aka shared knowledge)
Collective knowledge that can be distributed
throughout the organization to
create value.
4) Similar Business Models
when business unit success depends on
common characteristics, such as knowledge management, or
scale economies
eBay’s business model is to provide an electronic venue, or market,
where buyers and sellers can come together.
General Motors’ business model
involves transforming raw materials such as steel, rubber, and plastic into automobiles, all
done at very large scale
Business model
A method to
enable the creation and exchange
of value between companies and
their customers.
Dominant logic
A conceptualization of a business, or
a set of rules for competition, that
applies to seemingly unrelated
product markets or industries.
5) Spreading Capital
the headquarters of the corporation quickly allocates capital and other resources to their best use among business units
Rather than leaving resources within a business unit for its own growth, these strategic investments work to increase the corporate value by investing in
business units with greater potential growth in the future.
Internal capital market
The
movement of funds, talent, or
knowledge from unit to unit
directed by the leaders of the firm.
Adjacent markets have two characteristics:
(1) They allow the firm to exploit some of its resources and capabilities to create value, and
(2) they allow the firm to acquire related resources and capabilities to prepare for the next step.
5) Stepping stone to new markets
6) Stopping Competitors
where a firm moves to a new
industry through a set of small jumps and each jump allows the acquisition of key resources and skills
In markets with fierce competition and evenly matched competitors, strategic managers might
choose to diversify to forestall a competitor from entering, rather than to clearly exploit or
expand a current resource or capability.
pre–emptively moving into a new market space, or acquiring another firm, to deny a competitor access to that space
7) Staying Ahead of Technology
If a company competes in an industry where technology changes rapidly, then diversification,
primarily through acquisition, can shorten lead times and reduce the overall costs of technology development.
Corporate venture capital (CVC)
A venture capital fund owned and
managed by a corporation instead
of independent investors.
Why the 8 Ss?
The eight Ss show how and where managers can create value for shareholders of a diversified
firm; however, one relatively robust finding from scholars in corporate finance is that diversified
firms often trade at a discount versus undiversified rivals and that increasing diversification
(entering additional new lines of business) tends to destroy shareholder value
Value usually gets destroyed in one of five ways:
1) excessive pride,
2) sunk cost fallacy,
3) imitative diversification,
4) poor governance
5) incentives, or the lack of resource
commonality between the lines of business.
Hubris
Excessive pride, arrogance, or overconfidence.
ancient Greek word
Managers act with hubris when they diversify or
make acquisitions based on their own experience or their “gut feelings” rather than on solid
data and research
Sunk Cost Fallacy
The belief of managers that investment in a failed acquisition must continue because significant amounts have already been invested.
Executives are often reluctant to
abandon a project in which they have already invested so much time and capital; they often move
forward under the assumption that “things will turn around with a little more investment.”
Imitation
choosing to copy a competitor’s moves
rather than having a compelling strategic logic
Managers sometimes feel pressure to diversify their corporation when a competitor diversifies first.
Caught offguard, a firm might quickly look for a similar acquisition target or hurry to create a similar line
of business. In their rush to respond, managers fail to consider how attractive the target really is, or if they have the resources and capabilities that make the new market a value adding adjacency
Poor Governance and Incentives
simply running the new business poorly or failing to incentivize managers to attend to the business
When they become part of a diversified corporation, however, those managers sometimes move to
salary-based compensation that divorces their pay from their performance
Poor Management
The Boston Consulting Group’s growth share matrix represents one such tool.
Figure 6.2 illustrates the growth share matrix
The Boston Consulting Group’s growth share matrix
units contribute to corporate value creation in one of two ways; they either serve as engines of revenue growth or they generate cash flows for the firm to reinvest or distribute to shareholders
Cash cows
have high share but low growth and can generate large cash flows that can be used to fund growth
businesses.
-Companies typically like to minimize investments in cash cows because the goal is to milk the cow
Stars
combine high share with high growth, and smart managers should
invest heavily in these units to maintain or improve their position over time
-These businesses
typically represent the future of the company
Question marks
present a conundrum for management because they require significant investment and effective strategic
management if they are to become stars
-Can either become a star or a dog depending on how you manage it
Dogs
have low share and low growth and add little profitability to a company’s overall portfolio businesses.
The general rule is to divest the dogs.
Greenfield entry
Entry into an adjacent market by a firm that opens its own operation. (opposed to acquiring another company)
When to choose greenfield
-when companies have the front-end and backend
resources and capabilities they can immediately exploit to create value.
-when companies can afford to enter new arenas slowly and at small to moderate investment
When to choose acquisition
the preferred mode of entry when the firm needs to quickly expand its own resources and capabilities to effectively compete.
Acquisitions make sense when delay proves costly
makes sense if the industry favors competitors with large scale or is characterized by a steep learning or experience curve.
Acquisition
The purchase of another company, or its assets.
Table 6.1 Greenfield Entry Versus Acquisition
Table 6.1 Greenfield Entry Versus Acquisition
The Acquisition and Integration Process
1) List potential targets / identifying potential targets
2) Due diligence / selecting which to purchase
3) Doing the deal / how much will to pay
4) Integrating the acquisition after the deal closes
Poor reasons for acquisitions
-simply adding top line revenue growth or doing a deal just because a competitor recently did one
-
Due diligence
The process whereby managers closely
examine the target firm to understand its core processes, strengths, and weaknesses.
The acquisition premium creates two challenges for the acquiring firm
First, the larger the premium, the more value they must actually create to justify the acquisition.
Second, given the time value of money, the larger the premium, the quicker the acquirer must create that value.
Figure 6.3 Determining the Proper Degree of Integration
Figure 6.3 Determining the Proper Degree of Integration
Firms may follow one of four general integration strategies
They can bury the target through complete integration
Build a brand new entity with the combined entities
through tight integration
Blend in the target to the corporation using best practices from each,
Bolt on the target to the existing company only where it makes sense
Bury / Takeover
An acquisition where the acquiring firm absorbs the
target firm. The target firm ceases to exist.
Build / Merger
An acquisition with the goal of creating a new firm from
the components of the two pre-acquisition firms.
Blend
retaining and combining the best elements of both companies to compete more effectively
A blended acquisition results in a moderate degree of integration. The target firm retains its own identity, brand, and much of its culture and operating autonomy
Bolt On
The metaphor of bolting on an acquisition implies two separate entities joined at a single point through a very strong link. In a bolt-on acquisition, the two entities remain deliberately separate in order to monitor the performance of each unit
Integration team
A group of individuals from different functional areas of an acquiring firm that coordinate and manage the integration of the target company after the acquisition has closed.
