Corporate-Level Strategy - Principles of Management

So far we have been discussing strategy at the business level. Now it is time to consider corporate-level strategy, which is concerned with deciding what businesses and national markets an enterprise should participate in. The business options are to focus on a single business; vertically integrate into adjacent businesses, forming a supply chain from raw materials to consumers; and diversify into other businesses.

The national market options are to focus on thefirm’s home market or expand internationally. Corporate-level strategy also encompassesdecisions about how to enter new businesses and markets—whether through acquisitions and mergers or by establishing new ventures. As always, the goal of management in pursuing these strategies is to boost the overall performance of the enterprise measured by profitability and profit growth.

FOCUS ON A SINGLE BUSINESS

Focusing on a single business makes sense if a firm is growing rapidly, consuming all available capital resources and the time and energy of its managers. Almost all enterprises start out focusing on a single industry. So long as that business continues to grow, they are often advised to continue doing so. Expanding into other businesses becomes an option when the growth rate in the core business is decelerating, as can occur when the market the firm serves is saturated and overall industry growth has slowed down.

The strategic question managers must answer then is whether to enter new businesses or simply return the cash generated by the existing business to shareholders in the form of higher dividend payouts. This was the question managers at Microsoft were contemplating in 2004.

The growth rate in the company’s core software business had slowed down due to maturation of the personal computer market, but the company was generating huge cash flows (by mid-2004 it had some $64 billion in cash). Microsoft’s managers had to decide whether to use that cash to fund additional diversification efforts (such as the company’s move into the video game businesses with Xbox) or to return it to shareholders.

Because they could not find enough profitable opportunities outside their existing business, they chose to return over $30 billion to shareholders in a huge special dividend payout. Basically Microsoft’s managers were saying that they could not see opportunities for profitably redeploying those funds to other businesses, so they decided to let investors enjoy the fruits of their ownership of the company.

Sometimes, however, managers may see opportunities for boosting the overall performance of a firm by vertically integrating into adjacent activities, diversifying into new businesses, or expanding internationally to enter new markets.

VERTICAL INTEGRATION

Vertical integration involves moving upstream into businesses that supply inputs to the firm’s core business or downstream into businesses that use the outputs of the firm’s core business. An example of upstream vertical integration would be for Dell Computer to enter the memory chip business, making the memory chips that go into its personal computers(currently Dell purchases these chips from independent suppliers). An example of downstreamvertical integration is the 2001 decision by Apple Computer to enter the retail business with its Apple Store. The stores sell Apple products and third-party products, and as of 2006 there were close to 150 of these stores.

Vertical integration makes sense if it improves the competitive position of the firm’s core business. For this to be so, vertical integration must enable the firm’s corebusiness either to lower its costs or to better differentiateits product offering. Apple’s entry into retailing, for example, is designed to provide better point-of-sales service to customers wishing to purchase an Apple product than can be had from independent stores. By helping to raise the overall level of differentiation associated with Apple’s offering, the strategy is designed to strengthen Apple’s competitive position.

Although vertical integration might look good on paper, many enterprises that have vertically integrated upstream have found themselves locked into high-cost businesses that detract from their competitive advantage. A common problem is that in-house suppliers lack a strong incentive to drive down costs because they have a guaranteed buyer for their products—their own firm.

As a result, over time in-house suppliers can become less efficient, making vertical integration a liability rather than an asset. General Motors, for example, was until recently highly vertically integrated, making many of the components that go into GM cars. Unfortunately for GM, high labor costs in its unionized inhousesupply operations raised input costs above those enjoyed by rivals like Toyota, putting GM at a competitive disadvantage. In the late 1990s GM rectified this situation by selling its in-house suppliers, effectively deintegrating. This strategic action gave GM greater freedom to purchase components from independent suppliers that had a lower cost structure and could offer GM lower prices.

DIVERSIFICATION

The strategy of diversification involves entry into new business areas. Microsoft’s entry into the video game business with its Xbox offering is an example of diversification, as is General Electric’s move into network broadcasting with the acquisition of NBC. The Microsoft case is an example of what is called related diversification: The new business is related to the existing business activities of the enterprise by distinct similarities in one or more activities in the value chain.

The video game business is a software-based business, so Microsoft could use its established software engineering skills to develop both an operating system for the Xbox (which is actually based on Windows) and the video games themselves. The General Electric case is an example of unrelated diversification: Thenew business, NBC, was not related to the existing activities of the enterprise by similarvalue chain activities.

As with vertical integration, the key to successful diversification is that it should increase the performance of one or more businesses beyond what could be achieved if each enterprise were an independent business in its own right. 16 If this does not happen, there is no value to different businesses being part of the same organization.

Leveraging Core Competencies One way in which diversified enterprises boost the performance of their constituent units is by leveraging valuable core competencies and applying them to a new line of business. Thus Microsoft used its valuable skills in software engineering to enter the video game business with Xbox. The aim here is to create a competitive advantage in the new business activity by leveraging the competencies that enabled the original business activity to gain a competitive advantage.

A good example of a firm that has done this consistently for decades is 3M, which among other things leveraged its skills in adhesives, originally developed to hold the grit on sandpaper, to create new businesses. These new businesses have included masking tape, medical tape, and the ubiquitous Post-it notes.

Economies of Scope Another way of improving performance through diversification is to realize what are called economies of scope, which are the cost reductions associated with sharing resources across businesses. Firms that can share resources across businesses have to invest proportionally less in the shared resource than companies that cannot share. For example, Procter & Gamble makes both disposable diapers and paper towels. Both of these paper-based products are valued for their ability to absorb liquid without disintegrating. Because both products need the same attribute—absorbency—Procter &Gamble can share the R&D costs associated with producing an absorbent paper-based product across the two businesses.

Similarly, because both products are sold to the same customer set (supermarkets), P&G can use the same sales force to sell both products. In contrast, competitors that make just paper towels or just disposable diapers cannot achieve the same economies and will have to invest more in both R&D and maintaining a sales force. The net result is that other things being equal, P&G will have lower expenses and higher profitability than firms that lack the ability to share resources.

Superior Internal Governance A final way in which diversification can improve theperformance of the enterprise is through superior internal governance skills. 18 Internalgovernance skills are the ability of senior managers to elicit high levels of performancefrom the constituent businesses of a diversified enterprise.

Senior managers can do this viaorganization architecture that creates incentives for the managers and employees runningthe businesses to work productively; by selecting highly skilled managers to run theconstituent businesses; by coaching those managers, helping them to upgrade theirmanagerial skills; by helping them to diagnose problems within their businesses andidentify ways of improving performance; and by pushing managers to search for ways toimprove the performance of their units.

Jack Welch, the longtime CEO of General Electric, was a master at internal governance.Welch said he spent 70 percent of his time on people issues and that his greatest contributionto General Electric was finding and coaching great managers and pushing thosemanagers to improve the performance of their units and share best practices acrossbusinesses.

Diversification Failures Although diversification can improve the profitability and profit growth of an enterprise, the opposite can also be the case. There are many examples of diversification efforts that failed. In some cases these diversification efforts involved the acquisition of an established business in another industry, as opposed to organic expansion like that of 3M or Microsoft’s entry into the video game business.

There are several problems with such diversification. First, there is evidence that acquiring enterprises pay too much for the companies they acquire (they overvalue them). Second, acquiring firms often let acquired businesses continue to operate as stand-alone enterprises. Managers of the acquiring firm take no action to transfer core competencies, realize economies ofscope, or improve performance through the application of superior governance skills. When no steps are taken to improve the performance of the acquired business, it is hardly surprising that the diversification move fails to improve performance.

Finally, even when proactive efforts are made to improve the performance of the newly acquired business, many unexpected problems can stymie attempts to do this. Often these problems stem from differences in organization architecture and cultures. After an acquisition, many acquired businesses experience high management turnover, possibly because their employees do not like the acquiring company’s way of doing things. Evidence suggests that the loss of management talent and expertise in the acquired enterprise can materially harm the performance of the acquired unit.

INTERNATIONAL EXPANSION

International expansion is the final corporate strategy we consider here. International expansion can be a good way to increase the performance of a firm. Historically managers have turned their attention to international expansion after their business has become established in its home market. More recently, however, with the emergence of global markets managers are starting to think about international expansion even at an early point in the development of their enterprise.

Nowadays even some small enterprises have a global presence. Here we note briefly that international expansion can enlarge the market for a firm’s products, thereby boosting profit growth; enable a firm to realize scale economies from serving a large global market, which can lower unit costs and boost profitability; enable a firm to realize location economies and increase profitability by basing different business activities where they can be performed most efficiently; and boost both profitability and profit growth by transferring skills between different national subsidiaries, a process known as global learning.


All rights reserved © 2018 Wisdom IT Services India Pvt. Ltd DMCA.com Protection Status

Principles of Management Topics