Chapter 6 Notes 32

CHAPTER SIX
STRATEGY FORMULATION: CORPORATE STRATEGY
This chapter focuses on formulating strategy at the corporate level. Corporate strategy deals with the three key
issues facing the corporation as a whole: (1) the firm's overall orientation toward growth (directional strategy), ()
the industries or markets in which the firm competes through its products and !usiness units (portfolio strategy), and
(") the manner in which management coordinates activities, transfers resources and cultivates capa!ilities among
product lines and !usiness units (parenting strategy). #irectional strategy is composed of growth, sta!ility, and
retrenchment. $ertical and hori%ontal integration as well as concentric and conglomerate diversification are
discussed as e&amples of corporate growth strategies. 'nternational entry strategies are also listed as growth
strategies. (ortfolio analysis is e&plained as a techni)ue for managing various product lines and !usiness units for
their ma&imum cash flow. Corporate parenting is a resource*!ased approach, which attempts to use capa!ilities
found in various parts of the corporation to generate synergies across these units.
TOPICS COVERED
+ #irectional strategy is composed of growth, sta!ility, and retrenchment strategies.
+ ,rowth strategies: concentration in one industry via vertical or hori%ontal growth as well as concentric and
conglomerate diversification.
+ -ta!ility strategies: pause.proceed with caution, no change, and profit.
+ /etrenchment strategies: turnaround, captive company, sell off.divestment, and !ankruptcy.li)uidation.
+ Two popular types of portfolio analysis: the 0C, ,rowth*-hare 1atri& and the ,2 0usiness -creen.
+ 3ollowing a parenting strategy using the (arenting*3it 1atri&.
+ 4ori%ontal corporate strategy as a way to deal with multipoint competition.
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. How does o!"#o$%&' (!ow% d"))e! )!o* +e!%",&' (!ow% &s & ,o!-o!&%e s%!&%e(./ F!o* ,o$,e$%!",
d"+e!s")",&%"o$/
-tudents often confuse these three strategies. Horizontal growth is the e&panding of a firm's activities into other
geographic regions and.or !y increasing the range of products and services offered to current markets. 't often
involves the ac)uisition of another firm in the same industry (an e&ample of e&ternal growth), !ut it could also !e
through the e&pansion of a firm's products in its current markets (e.g., through line e&tensions) or e&pansion into
another geographic region (an e&ample of internal growth). 5ne e&ample of e&ternal hori%ontal integration would
!e if 6nheuser*0usch !ought Coors. 6n internal e&ample was Coors' e&pansion into the eastern 7.-. Vertical
growth, in contrast, involves a firm's taking over a function previously performed !y a supplier or a distri!utor. This
would typically involve the addition of activities in other industries either forward (downstream) or !ackward
(upstream) on the industry value chain of current products or services. The additions are primary 8ustified in terms
of support of the current product lines regardless of their !eing in other industries (and thus can !e argued to !e
diversification). Concentric diversification, in contrast, is the addition of products or divisions which are related to
the corporation's main !usiness, !ut are added !ecause of the attractiveness of other industries rather than !ecause
they support the activities of the current product lines. The additions may !e through ac)uisition or through internal
development. The firm !uys or develops another division which is similar to its present product*line. 6nheuser*
0usch's diversification into snack foods to complement its line of !eers was an e&ample of concentric
32
Chapter 6 Notes 33
diversification. The products are not alike, !ut have a 9common thread9 relating them. 'f Coca Cola !ought /C
Cola, it would !e an e&ample of hori%ontal integration. 'f it purchased its distri!utors, this would !e an e&ample of
forward vertical integration. 'ts ac)uisition of Taylor :ines, however, was an e&ample of concentric diversification.
0. W&% &!e %e %!&deo))s 1e%wee$ &$ "$%e!$&' &$d &$ e2%e!$&' (!ow% s%!&%e(./ W", &--!o&, "s 1es%
&s &$ "$%e!$&%"o$&' e$%!. s%!&%e(./
6s pointed out in the te&t, research suggests that there is no significant sales or profits advantage to either e&ternal or
internal growth. There are, however, some tradeoffs for each approach. 4ere are some of them:
'nternal ,rowth
(ros
1ore likely to !e !ased on some proprietary
development giving competitive advantage.
1ore likely to fit well with current !usiness
units.products.
Can finance slowly out of returned earnings.
'f plan no good, can always cut losses !efore in too
deep.
Cons
1ay take a long time to develop a new product or
new concept.
1ay !e hard to get current managers to try
something new.
1ay ignore other uses of money with )uicker return.
3avored program may take time away from current
!usinesses.
2&ternal ,rowth
(ros
Can grow )uickly.
,ood way to use financial leverage to !oost 2(-.
#on't have to !uild anything from scratch.
Can generate a lot of e&citement on :all -treet and
!oost stock price.
Cons
6ll or nothing gam!le.
;eed a lot of money and.or financial mo&ie to do it
right.
Can purchase someone else's pro!lems.
<=> of all ac)uisitions fail to achieve the
purchaser's o!8ective.
33
The same list of pros and cons fit an international entry strategy. 'nternal growth in the form of a green*field
development has an additional con of sometimes going against a particular country's laws. 2&ternal growth in the
form of ac)uisitions has an additional con of running up against a country's laws against foreigners purchasing total
control of a company important to national interests.
3. Is s%&1"'"%. !e&''. & s%!&%e(. o! "s "% 45s% & %e!* )o! $o s%!&%e(./
6n argument can !e made that sta!ility is not really a strategy in itself, !ut is 8ust a pause !etween strategies. -ince
one way to view strategy is as a direction the corporation is taking in order to reach its o!8ectives, standing still has
no direction and thus is not a strategy. The te&t takes the position, however, that sta!ility is a strategy in itself. ?ust
as no decision is the same as making a decision, it is argued that even though sta!ility may !e viewed as not
choosing a strategy, it is therefore a strategy !y default. -ta!ility may !e a very appropriate long*term strategy for a
small !usiness in which the owner.manager does not want the corporation to grow !eyond his.her a!ilities to
manage it personally and is very happy with the level of lifestyle the !usiness provides. Typically, however, sta!ility
is perceived only as a via!le short*term strategy while strategic managers are waiting for key factors needed for
growth to fall into place. ;evertheless, to the e&tent that sta!ility helps e&plain the movement of a corporation
toward its o!8ectives, it deserves to !e called a strategy.
6. Co*-&!e &$d ,o$%!&s% SWOT &$&'.s"s w"% -o!%)o'"o &$&'.s"s.
'n comparing these two approaches, they are alike in a num!er of ways. They are !oth attempts to summari%e the
key strategic factors coming out of an in*depth analysis of the e&ternal and internal environment of a corporation or
!usiness unit. They are also easy to remem!er !u%%*words for use in the situational analysis. Terms like -.:.5.T.,
cash cows, and dogs help remind the student that the !asis of strategic management is environmental assessment.
'n contrasting these two approaches, they are different in terms of what they stand for. -.:.5.T. is merely an
acronym for -trengths, :eaknesses, 5pportunities, and Threats. 't is not really a techni)ue to aid in situation
analysis. 't merely is a !u%%word to help a person remem!er to search for strategic varia!les. (ortfolio analysis, in
contrast, is a term for a whole series of different techni)ues for analy%ing internal and e&ternal environmental
factors. ;either is really a su!stitute for the other and can actually complement each other.
7. How "s ,o!-o!&%e -&!e$%"$( d"))e!e$% )!o* -o!%)o'"o &$&'.s"s/ How "s "% &'"8e/ Is "% & 5se)5' ,o$,e-% "$
& ('o1&' "$d5s%!./
The !asic difference !etween these two approaches to corporate strategy lies in the )uestions they attempt to answer.
6ccording to the te&t, portfolio analysis attempts to answer the following two )uestions:
+ 4ow much of our time and money should we spend on our !est products and !usiness units in order to
ensure that they continue to !e successful@
+ 4ow much of our time and money should we spend developing new costly products, most of which will
never !e successful@
The !asic theme of portfolio analysis is its emphasis on cash flow. (ortfolio analysis puts corporate head)uarters
into the role of an internal !anker. 'n -o!%)o'"o &$&'.s"s, top management views its product lines and !usiness units
as a series of investments from which it e&pects to get a profita!le return. The product lines.!usiness units form a
portfolio of investments which top management must constantly 8uggle to ensure the !est return on the corporation's
invested money.
Corporate parenting attempts to answer two similar, !ut different )uestions:
+ :hat !usinesses should this company own and why@
+ :hat organi%ational structure, management processes, and philosophy will foster superior performance
from the company's !usiness units@
(ortfolio analysis attempts to answer these )uestions !y e&amining the attractiveness of various industries and !y
managing !usiness units for cash flow, that is, !y using cash generated from mature units to !uild new product lines.
7nfortunately, portfolio analysis fails to deal with the )uestion of what industries a corporation should enter or with
how a corporation can attain synergy among its product lines and !usiness units. 6s suggested !y its name, portfolio
analysis tends to primarily take a financial point of view and views !usiness units and product lines as if they were
separate and independent investments. Corporate parenting, in contrast, views the corporation in terms of resources
and capa!ilities that can !e used to !uild !usiness unit value as well as generate synergies across !usiness units. The
central 8o! of corporate head)uarters is not to !e a !anker, !ut to coordinate diverse units to achieve synergy. This
is especially important in a glo!al industry in which a corporation must manage interrelated !usiness units for glo!al
advantage. Corporate parenting is similar to portfolio analysis in that it attempts to manage a set of diverse product
lines.!usiness units to achieve !etter overall corporate performance.
ADDITIONAL DISCUSSION QUESTIONS
A1. How does %!&$s&,%"o$ ,os% e,o$o*",s &--'. %o +e!%",&' (!ow%/ To ,o$,e$%!", +e!s5s ,o$('o*e!&%e
d"+e!s")",&%"o$/
Transaction cost economics is especially applica!le to the )uestion of vertical growth versus outsourcing, i.e., the
classic make or !uy decision. 't argues that vertical growth is more efficient than contracting for goods and services
in the marketplace when the transaction costs of !uying goods on the open market !ecome too great. The
transaction costs !ecome too great when the transactions (a) involve a high level of uncertainty, (!) involve highly
speciali%ed assets, and (c) must occur fre)uently. 4owever, when highly integrated firms !ecome e&cessively large
and !ureaucratic, the costs of managing the internal transactions may !ecome greater than simply purchasing the
goods on the open market * thus 8ustifying outsourcing over vertical growth.
The second part of the )uestion is a 9mind stretcher.9 -ince the te&t does not apply transaction cost economics to
either concentric or conglomerate diversification, this )uestion really forces the student to have to think.
Transaction cost economics might suggest that diversification of any kind is more efficient than 8ust concentrating in
one industry when the costs of one firm's operating in two industries are lower than are the summed costs of two
separate firms. This phenomenon can occur when synergies e&ist to provide economies of scale or scope. ,iven
that such synergies are more likely to e&ist when a firm engages in concentric diversification, transaction cost
economics would propose that concentric diversification should !e generally more efficient than conglomerate
diversification. (Try out this )uestion on your grad students to see what they can do with itA)
A0. M5s% & ,o!-o!&%"o$ &+e & ,o**o$ %!e&d !5$$"$( %!o5( "%s *&$. &,%"+"%"es "$ o!de! %o 1e
s5,,ess)5'/ W. o! w. $o%/
The concept of a corporate mission implies that throughout a corporation's many activities, there should !e a
9common thread9 or unifying theme, and that those corporations with such a common thread are !etter a!le to direct
and administer their many activities. This is one way to achieve a 9strategic fit9 so that overall corporate
effectiveness and efficiency are achieved. There are, however, a num!er of corporations, which do not have a
common thread connecting their divisions, yet are successful. These corporations are often referred to as
conglomerates !ecause they are an assem!lage of separate firms having different products in different markets !ut
operating together under one corporate um!rella. 5perating in effect as holding companies, they typically have no
real common thread other than return on investment (i.e., financial synergy). Transamerica Corporation and 'TT are
8ust two of the many e&amples of successful conglomerates. They can !e very successful !ecause their operations in
many diverse !usinesses allow them to spread their risks over many different markets. ?ust as the common thread
concept implies a heavy marketing orientation, the conglomerate approach implies a heavy finance orientation. The
lack of concern for a common thread ena!les a conglomerate to ac)uire and sell off divisions without regard to any
synergy other than financial. Corporate strategy makers are thus a!le to focus entirely on /5'. They only need to
involve themselves in divisional (!usiness) strategies to the e&tent that funds are re)uested to support the strategies.
The pro!lem with this approach, however, is that corporate top management typically does not understand divisional
pro!lems in any sense other than financial and is thus strongly tempted to sell off trou!led divisions rather than help
them recover. 5ne could therefore conclude that a common thread is not necessary for corporate success, at least in
the short run. The classic article !y 4ayes and 6!ernathy (91anaging 5ur :ay to 2conomic #ecline,9 40/, ?uly*
6ugust, 1BC=) does imply, however, that such a heavy financial orientation leads to short*run thinking and may
actually cause long*run decline.
A3. W&% "s %e +&'5e o) -o!%)o'"o &$&'.s"s/ I%s d&$(e!s/
(ortfolio analysis is a popular approach to aid the integration and evaluation of environmental data. 't is 8ust as
useful for a single !usiness corporation with a num!er of separate products as it is for a large corporation with
autonomous operating divisions. 0y carefully e&amining !oth market or industry factors and !usiness strengths or
market share, it is possi!le to pinpoint factors of strategic importance to corporate or divisional success. (ortfolio
analysis thus serves as a convenient techni)ue for comparing e&ternal opportunities and threats with internal
strengths and weaknesses. The advantages and limitations of portfolio analysis are listed on pages 1<1*1<.
A6. Is %e GE 95s"$ess S,!ee$ *&%!"2 45s% & *o!e ,o*-'",&%ed +e!s"o$ o) %e 9CG (!ow%:s&!e *&%!"2/
W. o! w. $o%/
The answer to this )uestion should !e yes and no. 6t a !asic level, the answer is certainly affirmative. 0oth the ,2
and the 0C, matri&es list the e&ternal environment on one a&is of a matri& and the internal environment on the
other. The ,2 matri& e&pands the num!er of cells from four to nine and uses a series of measures instead of 8ust
one to specify the value of the varia!le given for each a&is. The terms given to each cell are very compara!le to
those given to the cells in the 0C, matri&.
6t a deeper level of analysis, the answer may also !e negative. The ,2 0usiness -creen is much more than 8ust a
complicated version of the 0C, growth*share matri&. :hereas the 0C, matri& is !ased on some assumptions
concerning the e&perience curve and the link of market share with cash flow and profita!ility, the ,2 matri&
contains no such assumptions. 'n fact, one is given the opportunity to use whatever assumptions one feels are valid
to generate the various criteria, weights, and ratings to calculate the value for each a&is of the ,2 matri&. 't makes
no statement, as does the 0C, matri&, that market share is the same as competitive position (with all that that
assumes) or that a product line's growth rate is the same as industry attractiveness (with all that that assumes).
A7. W&% ,o$,e-%s o! &ss5*-%"o$s 5$de!'"e %e 9CG (!ow%:s&!e *&%!"2/ A!e %ese ,o$,e-%s +&'"d/
W. o! w. $o%/
The product life cycle and the experience curve underlie the 0C, growth*share matri&. The development of
)uestion marks into stars and then into cash cows suggests the introduction, growth, and maturity stages of the
product life cycle. #ogs appear to !e those products or units on the decline stage of the product life cycle. The
e&perience curve discussed in Chapter D is certainly key to understanding the implications of the 0C, matri&. The
e&perience curve is !ased on the idea that unit production costs decline !y some fi&ed percentage as the accumulated
volume of production in units dou!les. 'n order in make a )uestion mark product a star, the suggested
manufacturing strategy is to !uild capacity ahead of demand in order to achieve the lower unit costs that develop
from the e&perience curve. 5n the !asis of some future point on the e&perience curve, the idea is to price the
product very low to preempt competition and )uickly increase market demand and thus market share. The resulting
high num!er of units sold and high market share should result in high profits when overall market growth slows and
the company reduces its investment in the product * thus a cash cow is !orn.
0oth of these concepts are well*known and useful ways to conceptuali%e the useful lives of specific products and of
the relation of unit costs to volume. 7nfortunately, they lose some of their value when they are taken too much at
face value and generali%ed too far. #ifferent products have different product life cycles. :hat applies to one
product pro!a!ly will not apply to another. 2&amples can !e shown of companies which have supported their
products to e&tend their lives !y 9putting a tail9 on the maturity part of the curve. The e&perience curve of the
industry as a whole or of one company might not hold true for a particular company. The e&perience curve does not
98ust happen9E a firm has to invest a lot of time and money into getting that e&perience. The trend toward
computeri%ed ro!ot technology and fle&i!le manufacturing mean that learning times (and thus e&perience time) are
!ecoming shorter and products can now !e economically manufactured in small, customi%ed !atches instead of in
large assem!ly*line production. This potential )uick movement down the e&perience curve coupled with the a!ility
to target an increasing num!er of market niches may mean that the strategy of !uilding large mass*production
facilities ahead of demand may !e doomed to failure. 3uture market share may !e composed of a series of market
segments * each with their own speciali%ed (and thus low volume) product. 'n this instance, the prescriptions of the
0C, matri& will not !e useful and may in fact hurt a company if applied as given.
SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE
What is the future of Internet publishing?
6fter a !rief summary of the pu!lication of the first 'nternet !ook, -tephen FingGs Riding the Bullet, this e&ercise
asks students to form into small discussion groups to discuss the future of 'nternet pu!lishing. The e&ercise
proposes some )uestions as discussion guides, such as what are the pros and cons of 'nternet pu!lishing.
The issue of 'nternet pu!lishing is an important one for the pu!lishing industry. 't has the potential to affect
newspapers, periodicals, and !ooks. 't is already changing the music industry. 3or a pu!lisher, its corporate strategy
must include the 'nternet. 5ne could use the (arenting*3it 1atri& to assess the fit of a new 'nternet !usiness unit
with a pu!lisherGs more traditional print*oriented units. 't appears that the fit !etween parenting opportunities and
parenting characteristics may !e high. There are many 'nternet opportunities to disseminate knowledge and the
parent has access to the copyrighted knowledge that is desired !y the marketplace. 7nfortunately, there appears to
!e a high likelihood of a mismatch !etween the strategic factors and the parenting characteristics. Computeri%ation
is a strategic factor for 'nternet !usinesses, !ut has !een traditionally unimportant for the traditional pu!lisher. 3or
one thing, most of the pu!lishing housesG !acklist are not computeri%ed. 2ven for their current lists of !ooks, every
pu!lisher uses its own com!ination of packaged and in*house software. 6s a result, there are pro!a!ly ,===
different formats in use for storing !ooks electronically. This is compounded !y the fact that most pu!lishers
outsource printing to speciali%ed printers who use their own software with speciali%ed formatting.
1oving to 'nternet pu!lishing could !e viewed as part of a hori%ontal growth strategy. 6s defined on page 1D,
hori%ontal growth can !e achieved !y e&panding a firmGs products into other geographic locations and.or !y
increasing the range of products and services offered to current markets. 't could easily !e argued that the 'nternet is
8ust another distri!ution channel for a companyGs current products. The pro!lem with this view is that some items
may do well on the 'nternet, while others may not. The issue is which items should !e made 'nternet*accessi!le.
Currently, most people do not like reading on their computer screens. (roducts are !eing invented which may
overcome that resistance. ;evertheless, paper !ooks have many advantages over electronic !ooks. This !ecomes
very clear when students are asked to decide if their te&t!ooks should !e electronic or in paper form. They should
first understand that there is thus far no real financial savings for !uying an electronic over a paper !ook. Consider
that the typical cost of an electronic te&t!ook is a!out the same as that of a used te&t!ook. 2ven if the cost of the e*
!ook is slightly less than that of a used paper !ook, the paper !ook has some resale valueE whereas, the e*!ook has
none. The mystery writer, (atricia Cornwell, proposed that e*!ooks will not replace paper !ooks. -he states, H' see
it as an enhancement to the li!rary I a more porta!le way to have your li!rary with youJ.'magine if you could
carry all your te&t!ooks to class in a little handheld computer.K (H(atricia Cornwell on 2*0ooks,K C !agazine,
6ugust, ==1, p. "=)
?ason 5hler, in his article, HTaming the Technological 0east,K (?anuary*3e!ruary, ==1 issue of "he #uturist)
proposes a useful e&ercise to evaluate a new technology. 4e asks students to assume that they are employed !y a
fictitious -cience and Technology 6dministration and that their 8o! is to analy%e the effects of a technology !efore it
is released to the pu!lic. 4e applies his analytical approach to the e*!ook. 5hler points out, HThe e*!ook is a
splendidly mysterious and engaging technology !ecause of its wild*card status. 't continues some traditions,
modifies others, creates entirely new ones, and in general promises to wreak a slow havoc on life as we know it.K
4e sums up the advantages and disadvantages in a chart on page 1B of the ?anuary*3e!ruary, ==1 #uturist. 6mong
the e*!ook advantages are: environmentally friendly, easier to carry, personali%es the reading e&perience, easier to
swap, harder to censor, and more adapta!le to different reading styles. 'ts disadvantages include the need for an
e&pensive technological infrastructure, increases eyestrain, more e&pensive, sacrifices depth for !readth of
e&perience, more difficult to enforce copyrights and compensate authors, and displaces workers in traditional
pu!lishing.