Download Strategic Management, chapter 7

Strategic Management, chapter 7
Strategic directions and Corporate-level strategy
Strategic Decisions
Ansoff’s matrix:
Products
Markets
Existing
A)
New
C)
Existing
Market Penetration
Consolidation
Market Development
B)
New
Product Development
D)
Diversification
This provides a simple way of generating four basic alternative directions for growth development.
According to the matrix, the org basically has a choice between penetrating still further within its
existing sphere (staying in box A); moving rightward by developing new products for its existing
markets (box B); moving downwards by bringing its existing products into new markets (box C); or
taking the most radical step of full diversification, with altogether new markets and new products (box
D). Consolidation is the fifth option, which involves protecting existing products and existing markets
and therefore belongs in box A.
Market penetration
The org takes increased share from its existing markets with its existing product range. It builds on
existing strategic capabilities and does not require the org to venture into uncharted territory. Greater
market share implies increased power vis-à-vis buyers and suppliers (in terms of the five forces), greater
economies of scale and experience curve benefits. Companies seeking greater market penetration may
face two constraints:
Retaliation from competitors
Increasing market penetration is likely to exacerbate industry rivalry as other competitors in the market
defend their share. Increased rivalry might involve price wars or expensive marketing battles, which
may cost more than any market share gains are actually worth. The dangers of provoking fierce
retaliation are greater in low growth markets, as any gains in volume will be much more at the expense
of other players. Where retaliation is a danger, orgs seeking market penetration need strategic
capabilities that give a clear competitive advantage. In low growth or declining markets, may be simpler
to acquire competitors.
Legal constraints
Greater market penetration can raise concerns from official competition regulators concerning excessive
market power. Most countries have regulators with the powers to restrain powerful companies or
prevent mergers and acquisitions that would create such power.
Consolidation
Where orgs focus defensively on their current markets with current products. It has two forms:
Defending market share
When facing aggressive competitors bent on increasing market share, orgs have to work hard and often
creatively to protect what they already have. Although market share should rarely be an end in itself, it is
important to ensure that it is sufficient to sustain the business in the long term. Differentiation strategies
in order to build consumer loyalty and switching costs are often effective.
Downsizing or divestment
Especially when the size of the market as a whole is declining, reducing the size of the business through
closing capacity is often unavoidable. An alternative is divesting (selling) some activities to other
businesses. Sometimes downsizing can be dictated by the needs of shareholders. Divesting or closing
peripheral businesses ca also make it easier to sell the core business to a potential buyer.
The term consolidation can also be used to describe strategies of buying up rivals in a fragmented
industry, particularly one in decline. By acquiring weaker competitors, and closing capacity, the
consolidating company can gain market power and increase overall efficiency.
Product development
Where firms deliver modified or new products/services to existing markets. Development here requires
greater degrees of innovation than market penetration. Product development can be an expensive and
high-risk activity for at least two reasons:
New strategic capabilities
Typically involves mastering new technologies that may be unfamiliar to the org, i.e.: online banking.
Success frequently depended on willingness to acquire new technological and marketing capabilities,
often with the help or specialised IT and e-commerce consultancy firms. Thus it involves heavy
investment and high risk of project failures.
Project management risks
Even with fairly familiar domains, product development products are typically subject to the risk of
delays and increased costs due to project complexity and changing project specifications over time. An
example would be the Airbus A380 double-decker airline, which due to high degrees of customer
customisation and incompatibilities in CAD software led to greater complexity than the project
management staff could handle (Delays of around a couple years).
Market development
This involves offering existing products to new markets. The extensions scope, again, is limited. Might
entail some product development, if only in terms of packaging or service. It might take three forms:
New segments
In the public services, a college might offer its educational services to older students than its traditional
intake, perhaps via evening courses.
New users
An example here would be aluminium, whose original users in packaging and cutlery manufacture are
now supplemented by users in aerospace and automobiles.
New geographies
The prime example of this is internalisation, but the spread of a small retailer into new towns would also
be a case.
In all cases, it is essential that market development strategies are based on products or services that meet
the critical success factors of the new market. In terms of strategic capabilities, market developers often
lack the right marketing skills and brands to make progress in a market with unfamiliar customers.
Diversification
This is strictly a strategy that takes the org away from both its existing markets and existing products. It
radically increases the org’s scope. A good deal of diversification in practise involves building on
relationships with existing markets or products. Frequently too, market penetration and product
development entail some diversifying adjustment of products or markets. Diversification is a matter of
degree.
Reasons for Diversification
There are three potentially value-creating reasons for diversification:
Efficiency gains
Can be made by applying the org’s existing resources or capabilities to new markets and products or
services. These are often described as economies of scope. If an org has under-utilised resources or
competences that it cannot effectively close or sell to other potential users, it can make sense to use
these resources by diversification into a new activity. There are economies to be gained by extending the
scope of the org’s activities. Economies of scope may apply to both tangible and intangible resources
and competences, such as brands or staff skills. Sometimes these scope advantages are referred to as the
benefits of synergy, by which is meant that activities or assets are more effective together than apart.
Stretching corporate parenting capabilities
This extends the point above about applying existing competences in new areas. This point highlights
corporate parenting skills that can otherwise be easily neglected. At the corporate parent level, managers
may develop a competence at managing a range of different products and services, which can be applied
even businesses which do not share resources at the operational unit level.
Increasing market power
With many businesses, an org can afford to cross-subsidise one business from the surpluses earned by
another, in a way that competitors may not be able to. This can give a competitive advantage for the
subsidised business, and the long-run effect may be to drive out other competitors, leaving the org with a
monopoly from which good profits can then be earned. Example would be General Electric’s $43bn bid
for electronic controls company Honeywell.
These next reasons are less obvious at value creating and sometimes serve managerial interests more
than shareholder’s interests.
Responding to market decline
This is one common but doubtful reason for diversification. Example would be Microsoft’s
diversification into the electronic games industry with Xbox.
Spreading risk
This would be done across a range of businesses, as it is another common justification for
diversification. Conventional finance theory is sceptical about risk spreading by business diversification,
as it argues that investors can diversify more effectively themselves in investing in a more diverse
portfolio of quite different companies. Whilst managers might like the security of a diverse range of
businesses, investors do not need each of the companies they invest in to be diversified as well- they
would prefer managers to concentrate on managing their core businesses as well as they can. However,
for private businesses, it can make sense to diversify risk across a number of activities as a large
proportion of their assets tied up in the business.
The expectations of powerful stakeholders
This includes top managers, and can sometimes drive inappropriate diversification, such as the case with
Enron where by satisfying the analysts short term, this boosted the share price and allowed top
management to stay in place.
Related Diversification
This can be defined as corporate development beyond current products and markets, but within the
capabilities or the value network of the org. two types of integration:
Vertical integration
Describes either backward or forward integration into adjacent activities in the value network.
Backward integration refers to development into activities concerned with the inputs into the company’s
current business.
Forward integration refers to development into activities which are concerned with a company’s outputs
(further forward in the value system).
Horizontal integration
It is a development into activities, which are complementary or adjacent to present activities.
It is important to recognise that capabilities and value links are distinct. A link through the value
network does not necessarily imply the existence of capabilities.
It is also important to recognise that relationships have potential disadvantages. Related diversification
can be problematic for at least to reasons:
Corporate-level time and cost- as top managers try to ensure that the benefits of relatedness are achieved
through sharing or transfer across business units.
Business unit complexity- as business unit managers attend to the needs of other business units, perhaps
sharing resources or adjusting marketing strategies, rather than focusing exclusively on the needs of
their own unit.
Unrelated diversification
It is the development of products and services beyond the current capabilities or value network.
Unrelated diversification is often described as a conglomerate strategy. Because there are no obvious
economies of scope between the different businesses, but there is an obvious cost of the headquarters,
unrelated diversified companies’ share prices often suffer from what is called the ‘conglomerate
discount’- in other words a lower valuation than the individual constituent businesses would have if they
stood alone.
However, the case against conglomerates can be exaggerated and there are certainly potential
advantages to unrelated diversification in some conditions:
Exploiting dominant logics, rather than concrete operational relationships, can be a source of
conglomerate value creation. As at Berkshire Hathaway, a skilled investor such as Warren Buffet, the
so-called Oracle of Omaha and one of the richest men in the world, may be able to add value to diverse
businesses within his dominant logic- Buffet focused on mature businesses that he can understand and
whose managers he can trust, he avoided buying high-tech companies during the e-business boom,
because they were outside his dominant logic.
Countries with underdeveloped markets can be fertile ground for conglomerates. Where external capital
and labour markets do not yet work well, conglomerates offer a substitute mechanism for allocating and
developing capital or managerial talent within their own organisational boundaries.
It is important also to recognise that the distinction between related and unrelated diversification is often
a matter of degree. As in the case of Berkshire Hathaway, although there are very few operational
relationships between the constituent businesses, there is a relationship in terms of similar parenting
requirements.
Diversification and Performance
Research studies of diversification have generally found some performance benefits, with related
diversifiers outperforming both firms that remain specialised and those, which have unrelated diversified
strategies. In other words, the diversification-performance relationship tends to follow an inverted Ushape. The implication is that some diversification is good- but not too much. However, these
performance studies, produces statistical averages. The conclusion from the performance studies is that,
although on average related diversification pays better than unrelated, any diversification strategy needs
rigorous questioning on its particular merits.
Value-adding and value-destroying activities of corporate parents
Any corporate parent needs to demonstrate that it creates more value than it costs. This applies to both
commercial and public sector organisations. For public sector organisations, privatisation or outsourcing
is likely to be the consequence of failure to demonstrate value. Companies who shares are traded freely
on the stock markets face a further challenge. They must demonstrate that they create more value than
any other rival corporate parent could create. Failure to do so is likely to lead to a hostile takeover or
break-up. If the rival’s bid is more attractive and credible than what the current parent can promise,
shareholders will back it at the expense of incumbent management.
Value-adding activities
Envisioning- the corporate parent can provide a clear overall vision or strategic intent for its business
units. This vision should guide and motivate the business unit managers in order to maximise corporatewide performance through commitment to a common purpose. The vision should also provide
stakeholders with a clear external image about what the organisation as a whole is about: this can
reassure stakeholders about the rationale for having a diversified strategy in the first place. Finally a
clear vision provides a discipline on the corporate parent to stop it wandering into inappropriate
activities or taking on unnecessary costs.
Coaching and Facilitating- the corporate parent can help business unit managers develop strategic
capabilities, by coaching them to improve their skills and confidence. It can also facilitate cooperation
and sharing across the business units, so improving the synergies from being within the same corporate
org. Corporate-wide management courses are the effective means of achieving these objectives, as
bringing managers across the business to learn management skills also provides an opportunity for them
to build relationships between each other and see opportunities for cooperation.
Providing central services and resources- the centre is obviously a provider of capital for investment.
The centre can also provide central services such as treasury, tax and human resource advice, which is
centralised can have sufficient scale to be efficient and to build up relevant expertise. Centralised
services often have greater leverage which can be helpful in brokering with external bodies, such as
government regulators, or other companies in negotiating alliances. The centre can also have an
important role in managing expertise within the corporate whole, for instance by transferring managers
across the business units or by creating share knowledge management systems.
Interviewing- the corporate parent can also intervene within its business units in order to ensure
appropriate performance. The corporate parent should be able to closely monitor business unit
performance and improve performance either by replacing weak managers or by assisting them in
turning around their businesses. The parent can also challenge and develop the strategic ambitions of
business units, so that satisfactorily performing businesses are encouraged to perform even better.
Value-destroying activities
Adding management costs- the staff and facilities of the corporate centre are expensive. The corporate
centre typically has the best-paid managers and the most luxurious offices. It is actual businesses that
have to generate revenues that pay for them. If their costs are greater than the value they create, then the
corporate centre’s managers are net value destroying.
Adding bureaucratic complexity- as well as these direct financial costs, there is the ‘bureaucratic fog’
created by an additional layer of management and the need to coordinate with sister businesses. These
typically slow down managers’ responses to issues and lead to compromises between the interest of
individual businesses.
Obscuring financial performance- one danger in a large diversified org is that the underperformance of
weak businesses can be obscured. Weak businesses might be cross-subsidised by the stronger ones.
Internally, the possibility of hiding weak performance diminishes the incentives for business unit
managers to strive as hard as they can for their businesses: they have a parental safety net. Externally,
shareholders and financial analysts cannot easily judge the performance of individual units within the
corporate whole. Diversified companies’ share prices are often marked down, because shareholders
prefer the ‘pure plays’ of stand-alone units, where weak performance cannot be hidden.
Corporate parents should keep on a close eye on centre costs, both financial and bureaucratic, ensuring
that they are no more than required by their corporate strategy. They should also do all they can to
promote financial transparency, so that business units remain under pressure to perform and
shareholders are confident that there are no hidden disasters.
Overall, there are many ways in which corporate parents can add value. It is, of course, difficult to
pursue them all and some are hard to mix with others. Business unit managers will concentrate on
maximising their own individual performance rather than looking out for ways to cooperate with other
business unit managers for the greater good of the whole. For this reason, corporate parenting roles tend
to fall into three main types, each coherent within itself but distinct from the others:
The Portfolio Manager
He operates as an active investor in a way that shareholders in the stock market are either too dispersed
or too inexpert to be able to do. He is acting as an agent on behalf of financial markets and shareholders
with a view to extracting more value from the various businesses than they could achieve themselves.
He might do this by, for example: acquiring another corporation, divesting low-performing businesses
within it and intervening to improve the performance of those with potential. Their role is not to get
closely involved in the routine management of the business, only to act over short periods of time to
improve performance. In term of value-creating activities, the portfolio manager concentrates on
intervening and the provision (or withdrawal) of investment.
They seek to keep the cost of the centre low by, for example, having a small corporate staff with few
central services, leaving the business units alone so that their chief executives have a high degree of
autonomy. They set clear financial targets for those chief executives, offering high rewards if they
achieve them and likely loss of position if they do not. Such corporate parents can, of course, manage
quite a large number of such businesses because they are not directly managing the everyday strategies
of those businesses. Rather they are acting from above, setting financial targets, making central
evaluations about the well-being and future prospects of such businesses, and investing, intervening or
divesting accordingly.
The Synergy Manager
Obtaining synergy is often seen as the prime raison d’être of the corporate parent. Synergies are likely to
be particularly rich in the case of related diversification. In terms of value-creating activities, the focus
of a synergy manager is threefold: envisioning to build a common purpose; facilitating co-operation
across businesses; providing central services and resources, i.e.: Steve Jobs’ vision of his personal
computers being the hub of the new digital lifestyle guides managers across the iMac computer business,
iTunes and iPod to ensure seamless connections between the fast developing offerings.
However, the problems in achieving such synergistic benefits are similar to those in achieving
the benefits of relatedness. Three problems are worth highlighting here:
Excessive costs- the benefits in sharing and cooperation need to outweigh the costs of undertaking such
integration, both direct financial costs and opportunity costs. Managing synergistic relationships tend to
involve expensive investment in management time.
Overcoming self interest- managers in the business units have to want to co-operate. especially where
managers are rewarded largely according to the performance of their own particular business unit, they
are likely to be unwilling to sacrifice their time and resources for the common good.
Illusory synergies- it is easy to overestimate the value of skills or resources to other businesses. This is
particularly common when the corporate centre needs to justify a new venture or the acquisition of a
new company. Claimed synergies often prove illusory when managers actually have to put them into
practise.
The failure of many companies to extract expected synergies from their businesses has led to growing
scepticism about the notion of synergy. Synergistic benefits are not as easy to achieve as would appear.
The Parental Developer
The parental developer seeks to employ its own capabilities as a parent to add value to its businesses.
They focus on the resources or capabilities they have as parents which they can transfer downwards to
enhance the potential of business units. For example, a parent could have a valuable brand or specialist
skills in financial management or product development. If such parenting capabilities exist, corporate
managers then need to identify a parenting opportunity: a business which is not fulfilling its potential but
which could be improved by applying the parenting capability, such as branding or product
development. Such parent opportunities are therefore more common in the case of related rather than
unrelated diversified strategies and are likely to involve exchanges of managers and other resources
across the businesses. Key value-creating activities for the parent will be the provision of central
services and resources.
Managing an org on this basis does, however, pose at least four challenges:
Identifying parental capabilities- a big challenge for the corporate parent is being sure about just how it
can add value to business units. If the value adding capabilities of the parent are wrongly identified then
its contribution will be only counter-productive. There needs to be some hard evidence of such valueadding capabilities.
Parental focus- if the corporate parent identifies that it has value-adding capabilities in particular and
limited ways, the implication is that it should not be providing services in other ways, or if it does they
should be provided at minimal cost. Corporate executives should focus their energy and time on
activities where they really do add value. Some central services could be outsourced to specialist
companies who can do it better.
The ‘crown jewel’ problem- some diversified companies have business units in their portfolios which are
performing well but which the parent adds little value. These can become ‘crown jewels’, to which
corporate parents become excessively attached. The logic of the parental development approach is if the
centre cannot add value. It is just a cost and therefore destroying value. Parental developers should
divest businesses they do not add value to, even profitable ones. Fund raising by selling a profitable
business can be reinvested in businesses where the parent can add value.
Sufficient ‘feel’- if the logic of the parental developer is to be followed then the executives of the
corporate parent must also have ‘sufficient feel’ or understanding off the businesses within the portfolio
to know where they can add value and where they cannot.
Portfolio Matrices
The growth/share (or BCG matrix)
Here market share and market growth are critical variables for determining attractiveness and balance.
High market share and high growth are attractive, however, it also warns that high growth demands
heavy investment. There needs to be a balance within the portfolio, so that there are some low growth
businesses that are making sufficient surplus to fund the investment needs of higher growth businesses.
Market Share
High
Market
Growth
Stars
Low
Question Marks
Cash cows
Dogs
Low
Star- business unit with a high market share in a growing market. The business unit may be spending
heavily to keep up with growth, but high market share should yield sufficient profits to make it or more
less self-sufficient in terms of investment needs.
Question mark- business unit in a growing market, but not yet with high market share. Developing
question marks into stars, with high market share, takes heavy investment. Many question marks fail to
develop, so the BCG advises corporate parents to nurture several at a time. It is important to make sure
that some question marks develop into stars, as existing stars eventually become cash cows and cash
cows may decline into dogs.
Cash cow- business unit with a high market share in a mature market. As growth is low, investment
needs are less, while high market share means that the business unit should be profitable. The cash cow
should then be a cash provider, helping to fund investments in question marks.
Dogs- business units with a low share in a static or declining markets and are thus the worst of all
combinations. They may be a cash drain and use up a disproportionate amount of company time and
resources. The BCG usually recommends divestment or closure.
BCG matrix has several advantages. It provides a good way of visualising the different needs and
potential of all the diverse businesses within the corporate portfolio. It warns corporate parents of the
financial demands of what might otherwise look like a desirable portfolio of high-growth businesses. It
also reminds corporate parents that starts are likely to eventually to wane. Finally, it provides a useful
discipline to business unit managers, underlining the fact that the corporate parent ultimately owns the
surplus resources they generate and can allocate them according to what is best for the corporate whole.
However, there are three potential problems with the BCG matrix:
Definitional vagueness- it can be hard to decide what high and low growth or share mean in particular
situations. Managers are often keen to define themselves as ‘high share’ by defining their market in a
particular narrow way.
Capital market assumptions- the notion that a corporate parent needs a balanced portfolio to finance
investment from internal sources (cash cows) assumes that capital cannot be raised in external markets.
The notion of a balanced portfolio may be more relevant in countries where capital markets are
underdeveloped or in private companies that wish to minimise dependence on external shareholders or
banks.
Unkind to animals- both cash cows and dogs receive ungenerous treatment, the first being simply
milked, the second terminated or cast out of the corporate home. This treatment can cause motivational
problems, as managers in these units see little point in working hard of the sake of other businesses.
There is also the danger of the self-fulfilling prophecy. Cash cows will become dogs even more quickly
than the model expects if they are simply sold or closed down, it also assumes that there are no ties to
other business units in the portfolio, whose performance might depend in part on keeping the dog alive.
The Directional policy (GE-McKinsey) matrix
This categorises business units into those with good prospects and those with less good prospects. This
policy positions business units according to i) how attractive the relevant market is in which they are
operating, and ii) the competitive strength of the SBU in this market. Some analysts also choose to show
graphically how large the market is for a given business unit’s activity, and even the market share of that
business unit.
The matrix also provides a way of considering appropriate corporate-level strategies given the
positioning of the business units. It suggests that the businesses with the highest growth potential and the
greatest strength are those in which to invest for growth. Those that are the weakest and in the least
attractive markets should be divested or ‘harvested’.
This matrix is more complex than the BCG matrix, however it can have two advantages. Unlike the
simpler 4 box BCG, the nine cells of the directional policy acknowledge the possibility of a difficult
middle ground. Managers have to be carefully selective. In this sense, it is less mechanistic than the
BCG matric, encouraging open debate on less clear-cut cases. Second, the two axes of the directional
policy matrix are not based on single measures (that is, market share and market growth). Business
strength can derive from many other factors than market share, and industry awareness does not just boil
down to industry growth rates.
It however, does share some of the same problems as the BCG matrix such as vague definitions, capital
market assumptions, motivation and self-fulfilling prophecy. Overall, however, the value of the matrix is
to help managers invest in the businesses which are most likely to pay off.
The Parenting Matrix
It was developed by Michael Goold and Andrew Campbell, and it introduces parental fit as an important
criterion for including businesses in the portfolio. Businesses may be attractive in terms of the BCG or
directional policy matrices, but if the parent cannot add value, then the parent ought to be cautious about
acquiring or retaining them. There are two key dimensions of the matrix:
‘Feel’- this is a measure of the fit between each business unit’s critical success factors and the
capabilities (in terms of resources and competences) of the corporate parent. Does the corporate parent
have the necessary ‘feel’ or understanding for the businesses it will parent?
‘Benefit’- this measures the fit between the parenting opportunities, or needs, of business units and the
capabilities of the parent. Parenting opportunities are about the upside, areas in which good parenting
can benefit the business. For the benefit to be realised, the parent must have the right capabilities to
match the parenting opportunities.
The power of using these two dimensions are as follows. It is easy to see that a corporate parent should
avoid businesses that it has no feel for. What is less clear is that parenting should be avoided if there is
no benefit. This challenges the corporate parenting of even businesses for which the parent has high feel.
Businesses for which a corporate parent has high feel but can add little benefit should either be run with
a very light touch or be divested.
Four kinds of business along these two dimensions of feel and benefit:
Heartland- business units, which the parent understands well and can continue to add value to. They
should be at the core of future strategy.
Ballast- business units are ones the parent understands well but can do little for. They would probably be
at least as successful as independent companies. If not divested, they should be spared as much
corporate bureaucracy as possible.
Value trap- these business units are dangerous. They appear attractive because there are opportunities to
add value but they are deceptively attractive, because the parent’s lack of feel will result in more harm
than good (that is, the parent’s lacks the right marketing skills). The parent will need to acquire new
capabilities if it is to be able to move value trap businesses into the heartland. It might be easier to divest
to another corporate parent who could add value, and will pay well for the chance.
Alien- these business units are clear misfits. They offer little opportunity to add value and the parent
does not understand them anyway. Exit is definitely the best strategy.
This approach to considering corporate portfolios places the emphasis firmly on how the parent benefits
the business units. It requires careful analysis of both parenting capabilities and business unit parenting
needs. It can therefore assist hard decisions where either high feel or high parenting opportunities tempt
the corporate parent to acquire or retain businesses. Parents should concentrate on actual or potential
heartland businesses, where there is both high feel and high benefit.