Chapter 7- Corporate Strategy

What is the starting point of strategy?

"What business are we in?" defining a firm's identity

acquisitions

(the outright purchase of the assets of one firm by another) can be friendly if the price is right, often one firm desires to have complete control over the combined assets, resources and capabilities resulting in a hostile takeover.

mergers

(where firms desire to treat their arrangement as a combination of assets of joint benefit to both firms) are generally completed on friendly terms

Which of the three essential test is the best?

*better-off test dominates - Companies will seek to enter an unattractive industry where the costs of entry are discounted and the better-off test is met. This strategy is often used to acquire businesses in fragmented industry where the firm can work to improve the individual businesses and possibly build a brand that comes to dominate and provide a competitive advantage. - Beyond a certain threshold, high levels of diversification appear to be associated with lower profitability because of the level of organizational complexity that diversification creates. Divesting of diversified businesses to concentrate on a firm's core business generally increases profitability and yields a higher stock market valuation. - General trend toward growing turbulence in the external environment may have also increased the costs of managing diversified firms. Conglomerate firms (i.e., those highly diversified firms composed of multiple, unrelated acquisitions) have almost disappeared in Canada as well as in other mature markets (e.g., USA, Western Europe) while in other parts of the globe (e.g. Asia) they continue to dominate. This may be due to higher transaction costs in less sophisticated markets for labour, finance and information. - However, diversification may be returning to more mature markets due to technological advances and increasing importance of complementarities among various products. As the rate at which technologies and products become obsolete increases and competitive advantage in core businesses erode, so firms are finding it desirable to create (or acquire) 'growth options' in other industries.

What do mergers and acquisitions have in common

- Both mergers and acquisitions result in a different organization being created with resources, competencies and capabilities that improve competitiveness. - Disgruntled shareholders and management and incompatible corporate cultures can create problems in the transition of mergers or acquisitions

benefits of Vertical integration

- COST SAVINGS through physical integration of processes eliminating certain transactions costs in vertical exchanges; especially where there are: small numbers of firms, transaction-specific investments, limited information - SUPERIOR COORDINATION - dominant in industries where common ownership is necessary (steel production)

Transaction Costs

- Costs associated with participating in a market (e.g. search costs, negotiating and drawing up contracts, monitoring and enforcement, etc.) - If the transaction costs are greater than the administrative costs production activities will most likely be internalized and the firm grows in size and scope

The cost of corporate complexity

- Opposite of transaction costs aka administrative costs *impose limits to the firm's growth in size and scope - While vertical integration can reduce or eliminate certain transaction costs, internalizing business transactions adds its own costs through this increasing corporate complexity - Organizational complexity increases with the number of different business areas in which a firm engages as the different activities frequently require different organizational capabilities, different strategic planning & HRM approaches/systems, different top management skills/styles

Benefits of diversification

- Reasons include growth, risk reduction, and value creation - If it helps to achieve objectives (i.e., improve profitability, shareholder value) - Source of value creation is the exploitation of linkages between different businesses - Firms in low-growth, cash flow-rich industries are especially tempted to diversify ... in the absence of diversification, firms are prisoners of their industry - The primary beneficiaries of risk reduction through diversification tend to be managers as stable profits enhance job security. Shareholders are better off holding diversified portfolios rather than relying on a firm's business diversification.

What is an advantage of diversified firms?

- Their pool of employees who can respond to specific needs by transferring employees from one area of business to another, thus realizing efficiencies through such transfers (esp. managers and technical specialists) between divisions rather than having to hire and fire from the external market. - Diversified firms also offer employees a broader set of opportunities which can help to attract a higher calibre of employee ... would you rather build your career through Empire or a corner store?? - Internal transfers also increase informational advantages by building up detailed profiles of the competencies and characteristics of such employees and teams, thus leveraging the full potential of their human capital

Costs of diversification

- can be highly destructive to shareholder value as shareholders prefer to receive returns from surplus cash flow and invest these elsewhere in promising growth companies (diversifying creates more choice for the company and less for the shareholders)

costs of Vertical integration

- incentive problems - limits flexibility—e.g., in responding to changes in demand and in technology. - compounding of risk (problems at one stage threaten production and profitability at all other stages) ex: if ecola comes out, you have to worry about the beef and the patty

Types of vertical relationships

- long-term contracts - vendor partnerships - franchising

Strategic Maneuvering (that allow firms to seek a strategic advantage)

- mergers - acquisitions - strategic alliances

Economies of scope

- the reductions in average costs that result from increasing the output of multiple products. - use of a resource across multiple activities consumes less when its carried out independently - offers potential for multi-business firms to leverage a cost advantage over specialized businesses - The greater the fixed costs of such resources, the greater the potential associated economies of scope - can also be leveraged through sale or licensing to other firms or renting of space in firm's facilities to complementary businesses (e.g. Pearson Airport's renting out space to specialist retailers and restaurants rather than running such businesses directly)

Key concepts for analyzing firm scope

-economies of scope -transaction costs -the cost of corporate complexity

Advantages of internal capital market

1. They can avoid the costs of using the external capital market 2. They have better access to information on the financial prospects of their various businesses than is available to external financiers

what are the two forms of economic organization in a capitalist/market economy?

1. market mechanism 2. administrative mechanism

Five reasons for a return to vertical integration

1. simplicity 2. efficiency 3. choice 4. speed 5. old-and new-worries

What does a diversified corporation have?

A diversified corporation has a pool of employees and can respond to the specific needs of any one business through transfer from elsewhere within the corporation

Mature Markets

A market is mature when it has reached a state of equilibrium. A market is considered to be in a state of equilibrium when there is an absence of significant growth, or a lack of innovation. When supply matches demand the price decided by the market forces of demand and supply is called equilibrium price.

Why is partnership selection a critical success factor in the success of a strategic alliance?

Because differences in corporate cultures can inhibit the development and maintenance of trust, communication and co-operation. Given their 'temporary' nature, management may not be fully committed to such partnerships but rather simply endure and play along without full engagement.

What do corporate strategic decisions encompass?

Both the breadth of the firm's product range (product scope) and the extent of its involvement in the industry value chain (vertical scope)

Her benefits of diversification in the slides

Growth: A powerful motive for managers—but growth without profitability does not create value for shareholders. Growth through acquisition is a major destroyer of shareholder value. Risk spreading: Diversification tends to reduce fluctuations in profits; but this does not necessarily create value for shareholders. Value creation: For diversification to create shareholder value it must exploit some linkage ("synergy") between the different businesses, e.g., by: -exploiting economies of scope, -operating an efficient internal capability market, -operating an internal labour market.

Product scope

How wide a range of products does the firm supply?

How do the vision and mission define the firm?

It defines it in very broad terms

They have moved from vertical integration to what?

Outsourcing and deintegration

when does diversification create value?

Porter has "three essential tests" in deciding whether diversification will truly create shareholder value: 1. the attractiveness test: the industry must be structurally attractive or capable of being made attractive 2. the cost-of-entry test: the cost of entry must not capitalize all the future profits 3. the better-off test: either the new unit must gain competitive advantage from its link with the corporation or vice versa

Economies of scale

Reductions in average costs resulting from increased output of a product

Vertical integration

What occurs when a firm extends its activities into preceding or succeeding stages of the production process. - The greater a firm's ownership extends over successive stages of the value chain for its product, the greater its degree of vertical integration - The more a firm makes rather than buys, the lower are it costs of bought-in goods/services relative to its final sales revenue

How can important sources of value be created?

When a firm can apply: - common management capabilities - strategic management systems - resource allocation processes to different businesses

Diversification and performance

When companies divest diversified businesses and concentrate on their core business, the result is typically increased profitability and higher stock valuation.

organizational capability

a company's ability to manage resources, such as employees, effectively to gain an advantage over competitors. The company's organizational capabilities must focus on the business's ability to meet customer demand.

spot contracts

a contract for the immediate sale and delivery of a commodity

franchising

a contractual agreement between the owner of a business system and trademark that permits the franchisee to produce and market the franchiser's P/S in a specified area

virtual corporation

a firm whose primary function is to coordinate the activities of a network of suppliers and downstream partners.

Deintegration

a firm's attempt to refocus on core businesses - technology, cost efficiency

bilateral monopolies

a single seller (monopoly) and a single buyer (a monopsony) in the same market

Corporate strategy

concerned with where a firm competes ~ the scope of the firm's activities

Simplicity

customers will pay a premium for well integrated products that mean they can deal with one supplier and compatible components (think network effects)

forward vertical integration

firm acquires ownership and control of activities previously undertaken by its customers Ex: Instead of selling beef to mcdonald's to make patty's we make our own patty's

backward vertical integration

firm acquires ownership and control over production of its inputs Ex: instead of mcdonald's buying beef from a cattle farmer you just buy a cattle farm

Speed

getting to market quickly taps customer choice ahead of the competition (e.g. Zara) while less vertically integrated can find themselves left with yesterday's fashion trends on inventory (e.g. Gap, American Apparel)

Choice

increasing market choice can weaken customer loyalty; vertical integration can keep the brand and products in customers' minds (e.g. Netflix original productions)

what is the critical advantage?

investment allocation within a diversified firm is often a political process with strategic and financial considerations subordinate to turf wars and egos with the potential for poorly performing divisions to be subsidized rather than cash investments transferred to those with the best prospects.

long-term contracts

involve a series of transactions over a period of time with specified terms of sales and the responsibilities of each party

Horizontal diversification

involves a firm moving into the same stage of production (e.g., product scope as with Just Us! Coffee later moving into fair trade tea, chocolate and sugar)

Conglomerate diversification

involves diversification into unrelated products or areas of business (e.g. furniture manufacturer starts to open coffee shops)

Concentric diversification

involves expansion of business activities into related areas (e.g. car manufacturer starts to also manufacture trucks)

strategic alliances

less formal agreements to collaborate on activities that involve the contribution of resources and capabilities by each firm for some established period of time in order to achieve the objectives of each firm

relational contracts

no written contract at all

Efficiency

reducing the number of suppliers along the value chain enhances overall efficiency in production - security of supply and quality (especially with specialized components)

Scope

refers to the range of products and market activities undertaken by a firm

full vertical integration

smaller wineries that grow their own grapes and sell direct to consumers

shared service organization

supply common administrative and technical services to the operating businesses.

architectural capabilities

the ability of a firm to innovate at a product or systems level; i.e. to change the way in which component parts fit together

component capabilities

the capabilities of various partners and contractors to whom a firm has outsourced their supply of component parts or sub-systems

Internal capital market

the corporate allocation of capital between different businesses through the capital expenditure budget - the flow of money in your diversified companies Ex: Walmart's doing well and bar isn't. take Walmart's profit to the bar (shareholders won't be happy)

Diversification

the expansion of an existing firm into new product line(s) or field of operation.

Vertical scope

the number of stages/activities that the firm does

common ownership

the shared possession of assets

Geographical scope

what is the geographical spread of the firm's activities? Does it compete locally or globally?

Vertical diversification

when a firm undertakes successive stages in the production of a good or service (e.g., a building contractor who opens a building supplies business to ensure a reliable supply of materials for her business as well as generating sales revenue from other contractors and the general public)

administrative mechanism

where decisions concerning production and resource allocation are made by managers and imposed through hierarchies

market mechanism

where individuals and firms, guided by market prices, make independent decisions to buy and sell goods and services

Vendor partnerships

where it is difficult to specify complete long-term contracts, parties revert to relational contracts based on mutual trust and understanding to provide the security, flexibility and incentives necessary to assure each party that commitments will be honoured without opportunism even when circumstances may alter

partial vertical integration

wineries that grow some of their own grapes but also supplement with grapes from other producers and sell direct as well as through distributors

Old-and new- worries

worries about geopolitical uncertainty and environment impacts on supply chain activities