Corporate Strategy
 -Creating Corporate Advantages –
           Gianvito Lanzolla




     Business strategy
     typicall...
“HOW”

                   “WHAT”




                                  “WHO”




   ...while corporate strategy spans
busi...
Corporate strategy vs. Business Strategy


  – Business Strategy is concerned with how a firm
    competes within a partic...
Corporate strategy vs. Business Strategy
               (continued)
• Business-Level Strategy
      – Unique Value Creatio...
Premises of Corporate Strategy

Competition occurs at the business unit level
   • Corporations don’t compete; only their ...
Implications from these Premises

Corporate Strategy cannot succeed unless it truly adds
value to business units:
   – by ...
1. Better-off Test



• Does the presence of the corporation in a given
  market improve the competitive advantage of
  ot...
2. Ownership Test



• Does ownership of the business unit produce a
  greater competitive advantage than an
  alternative...
Jointly these two test help addressing the
            fundamental equations:


           Savings from Synergies > Costs ...
The Dimensions of Corporate Strategy




   Business Diversification - Horizontal expansion
 Vertical Integration - Forwar...
1. Where do synergies come from in
     Horizontal Diversification?




 Does this horizontal diversification make
       ...
Horizontal Diversification: main drivers
              of Synergies

1.   Economies of scope:
               C(Y1, Y2) < C...
Example: automobile industry


                                    Cars




                  Stamping facilities can be
 ...
Cross-selling

• Cross-selling is more important:
  – in one-stop-shop situations
  – when brand is important




        ...
Exercise: Business Development at Nespresso




            http://www.nespresso.com/precom/home_ch_en.html?




         ...
Diversification among the US Fortune 500, 1949-74

                 70.2          63.5             53.7                53....
Other rationales for Horizontal
               Diversification

  –    Call Option on an emerging market opportunity
     ...
Group work - McDonalds: What’s next?


• Which business do you think would make most sense for
  McDonalds to diversify in...
Apple case

– Should Apple expand horizontally?
– Which product(s)?
– Why?




2. Where do synergies come from in
       V...
Vertical synergies across value chains


Upstream




                                            Downstream




 Where ca...
When should a paper producer integrate
                vertically?




Vertical Integration: Drivers of synergies


1. Rel...
Relationship-specific investments




Vertical Integration: Drivers of synergies


2. Downstream free-riding
  –   When fi...
Free-riding: should Giorgio Armani integrate
                into retailing?




Vertical Integration: Drivers of Synergie...
Example: GM and Fisher Body

• Fisher body had custom machines and dies to
  produce car bodies for GM
• GM’s chassis were...
Recent Trends in Vertical Relationships

• From competitive contracting to supplier partnerships, e.g. in
  autos
• From v...
3. Geographical Scope




                  International expansion




Horizontal Synergies
                             ...
Synergies across value chains




          Telenor - global presence




http://www.telenor.com/en/global-presence/#/expa...
Two fundamental Tests for the existence
          of corporate advantage


  1. Better-off test (necessary condition)
  2....
High
                          Portfolio of “relationships”

Low                           Long-term
                     ...
Why do M&A fail so often?

• Because of organizational complexity!

    1. Complexity in understanding the sources of
    ...
Collaboration failures




    Coordination failures             Cooperation failures

    Failures to predict &
    inter...
The ownership test around the world

• The institutional
  environment may shift
  the trade offs
  between ownership
  an...
A brief history of
     corporate Strategy




                                   Portfolio Planning Models:
             ...
Portfolio Planning Models:
                                                                                The BCG Growth-...
Do Portfolio Planning Models Help or
Hinder Corporate Strategy Formulation?

        ADVANTAGES                           ...
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Microsoft PowerPoint - 1c LANZOLLA Corporate Strategy

  1. 1. Corporate Strategy -Creating Corporate Advantages – Gianvito Lanzolla Business strategy typically involves a single business model (and a single value chain)…. Business Strategy’s Goal = Unique Value Creation (for Customer) 1
  2. 2. “HOW” “WHAT” “WHO” ...while corporate strategy spans business models/ value chain activities 2
  3. 3. Corporate strategy vs. Business Strategy – Business Strategy is concerned with how a firm competes within a particular market – Corporate strategy is concerned with where a firm competes Where does corporate strategy take place? Corporate Corporate Strategy Head Office Business Division A Division B Strategy R&D R&D HR HR Functional Finance Finance Strategies Production Production Marketing/Sales Marketing/Sales 3
  4. 4. Corporate strategy vs. Business Strategy (continued) • Business-Level Strategy – Unique Value Creation (for Customers) in order to maximize value (for Shareholders) • Corporate-Level Strategy (companywide strategy) – The goal of corporate strategy is to build corporate advantage so as to earn above normal returns (Collins and Montgomery 1997) A definition of Corporate Strategy Corporate Strategy is the way a company creates value through the configuration and coordination of its multi-market activities The definition has three important aspects: – Value Creation (for shareholders) - the generation of superior financial performance (rents) from multi-market activities that create corporate advantages1 – Configuration - the multi-market scope of the corporation (product/market diversification, geographic focus, and vertical boundaries) – Coordination - the management of activities and businesses that lie within the corporate hierarchy Source: Collis and Montgomery, Corporate Strategy, 1997 4
  5. 5. Premises of Corporate Strategy Competition occurs at the business unit level • Corporations don’t compete; only their business units do • Value is created at the business unit level, it is only added up at the corporate level • Successful corporate strategy must grow out of and reinforce business strategy Corporate Strategy inevitably adds costs and constraints to business units • Corporate overhead and costs of communication between HQ and SBUs • Bureaucratic costs, costs of coordination, costs of monitoring Shareholders can readily diversify themselves • Shareholders can diversify their own portfolios of stocks, and they can often do it more cheaply with less risk than corporations • Shareholders can buy shares at market prices and avoid paying large acquisition premiums Examples of different configurations Vertical Product Geographical Scope Scope Scope [A] Single V1 Integrated V2 P1 P2 P3 C1 C2 C3 Firm V3 [B] Several V1 Specialized P1 P2 P3 C1 C2 C3 V2 Firms linked by Markets V3 In situation [A] the business units are integrated within a single firm. In situation [B] the business units are independent firms linked by markets. 5
  6. 6. Implications from these Premises Corporate Strategy cannot succeed unless it truly adds value to business units: – by providing tangible benefits that offset costs of lost independence → BETTER OFF TEST • e.g. economies of scope in operations • e.g. economies of scale in administration and internal financing – add value to shareholders in a way that shareholders could not replicate by themselves → OWNERSHIP TEST Two fundamental Tests for the existence of corporate advantage 1. Better-off test (necessary condition) 2. Ownership test (not always sufficient condition) 6
  7. 7. 1. Better-off Test • Does the presence of the corporation in a given market improve the competitive advantage of other business units over and above what they could achieve on their own? Better-off Test synergies between businesses’ value chains Horizontal Synergies Vertical Synergies Between similar Value Between successive Value Chain Activities’ Chain Activities Management Synergies Supporting function Synergies 7
  8. 8. 2. Ownership Test • Does ownership of the business unit produce a greater competitive advantage than an alternative arrangement would produce? Ownership Test: ownership vs. “other” agreements M&A Non equity agreements – e.g. partnerships, alliances Other Equity agreements (e.g. JVs) 8
  9. 9. Jointly these two test help addressing the fundamental equations: Savings from Synergies > Costs of a Corporation Rate of (Corporate) Profit > Cost of Capital Some alternatives to corporations Financial investment ONLY Financial investment (equity) + (equity) Direct Management of the Businesses Investment banks Family office Venture capital Private banking Private equity Corporations Hedge Funds Sovereign Funds Pension Funds 9
  10. 10. The Dimensions of Corporate Strategy Business Diversification - Horizontal expansion Vertical Integration - Forward or backward expansion Geographic Scope - Geographic and/or global expansion Savings from Synergies > Costs of a Corporation Rate of (Corporate) Profit > Cost of Capital We will now explore the potential sources of synergies in horizontal, vertical and international expansion… 10
  11. 11. 1. Where do synergies come from in Horizontal Diversification? Does this horizontal diversification make sense? PURCHASE R&D MANUFAC. SALES & DIST. PURCHASE R&D MANUFAC. SALES & DIST. Synergies? 11
  12. 12. Horizontal Diversification: main drivers of Synergies 1. Economies of scope: C(Y1, Y2) < C(Y1, 0) + C(0, Y2) 2. Cross Selling: R(Y1, Y2) > R(Y1, 0) + R(0, Y2) Where: C = Cost function R = Revenue function Yi = Products Economies of Scope • Economies of scope are most frequently encountered when a corporation possesses a resource or capability that is not fully utilized in production of a single product – Such assets can be tangible, such as manufacturing plants or distribution channels, or intangible, such as skills or R&D 12
  13. 13. Example: automobile industry Cars Stamping facilities can be shared to produce: Trucks Example: paper industry Knowledge about efficient cardboard production can be shared to produce tissues 13
  14. 14. Cross-selling • Cross-selling is more important: – in one-stop-shop situations – when brand is important Examples: IBM & Honda IBM’s corporate strategy to provide a complete solution for a company’s IT needs (HW and SW) Honda producing cars, motorbikes and power equipments 14
  15. 15. Exercise: Business Development at Nespresso http://www.nespresso.com/precom/home_ch_en.html? Branson & the Virgin Companies: Making strategic sense of apparent entrepreneurial chaos KEY RESOURCES •Virgin brand •Branson DOMINANT LOGIC -charisma/image •Seek competitive advantage by start-up cos. --PR skills pursuing innovative differentiation in -networking skills underserved market with sleepy incumbents -entrepreneurial flair CHARACTERISTICS OF DESIGNING A CORPORATE STRATEGY MARKETSTHAT CONFORM & STRUCTURE TO THIS LOGIC • What’s the business model? •Consumer businesses (Does Virgin create value by •dominant incumbent being an entrepreneurial incubator, •scope for new approaches a venture capital fund, a to customer service diversified corporation, or what?) •high entry barriers to other • Which businesses to divest? start-ups • Criteria for future diversification •Branson/Virgin image • What type of structure?—Is there appeals to customers a need for greater formalization? 15
  16. 16. Diversification among the US Fortune 500, 1949-74 70.2 63.5 53.7 53.9 39.9 37.0 29.8 36.5 46.3 46.1 60.1 63.0 1949 1954 1959 1964 1969 1974 Percentage of Specialized Companies (single-business, vertically-integrated and dominant-business) Percentage of Diversified Companies (related-business and unrelated business) Note: During the 1980s and 1990s the trend reversed as large companies refocused upon their core businesses Diversification: The Evolution of Strategy and Management Thinking MANAGEMENT Addressing under- Creating •Competitive PRIORITIES Quest for Growth performance of shareholder advantage through widely-diversified value speed & flexibility firms •Creating opportunities for future growth •Emergence of •Refocusing on •Joint ventures Emphasis on DEVELOPMENTS conglomerates core and alliances “related’ & IN CORPORATE businesses •Creating growth •Diversification by “concentric” STRATEGY established companies diversification •Divesting options into related sectors diversified through focused businesses diversification •Financial analysis •Economies of •Maximization •Dynamic STRATEGY TOOLS •Diffusion of M form scope & synergy” of shareholder capabilities & CONCEPTS structures • Portfolio planning wealth •Transaction cost •Creation of models •Core analysis corporate planning • Capital asset competences •Real options depts. pricing model •Dominant logic 1960 1970 1980 1990 2000 2006 16
  17. 17. Other rationales for Horizontal Diversification – Call Option on an emerging market opportunity • Often there are cheaper alternatives – Risk spreading • Often there are cheaper alternatives – Growth or to escape stagnating markets • Tend to destroy shareholders’ value while maximising management’s ego Are they likely to create corporate advantage? Does this horizontal diversification make sense? PURCHASE R&D MANUFAC. SALES & DIST. PURCHASE R&D MANUFAC. SALES & DIST. Economies of scope and cross selling (brand & one stop-shop) 17
  18. 18. Group work - McDonalds: What’s next? • Which business do you think would make most sense for McDonalds to diversify into? Please quantify the extent of the potential synergies. – Frozen foods – Theme parks – Photo processing • Each group to pick ONE option – Explain why they support it – Also explain why they oppose the other options • Corporate advantage, over and above stand alone • No variable costs 18
  19. 19. Apple case – Should Apple expand horizontally? – Which product(s)? – Why? 2. Where do synergies come from in Vertical Integration? 19
  20. 20. Vertical synergies across value chains Upstream Downstream Where can we find synergies in vertical integration? 20
  21. 21. When should a paper producer integrate vertically? Vertical Integration: Drivers of synergies 1. Relationship-specific investments – Such synergies arise when business units in a vertical relationship tailor their assets to exchanges with each order in order to reduce production costs or enhance output 21
  22. 22. Relationship-specific investments Vertical Integration: Drivers of synergies 2. Downstream free-riding – When firms free ride on the efforts of their competitors? 22
  23. 23. Free-riding: should Giorgio Armani integrate into retailing? Vertical Integration: Drivers of Synergies 3. Double marginalization – When two firms in a vertical relationships each posses market power, integration creates more value for both the corporation and consumers 4. Vertical foreclosure – If a company buys an upstream supplier, it might enjoys lower input costs. Furthermore, by taking out a supplier, upstream competition decrease so they remaining upstream might increase their price. By doing so, other downstream companies will pay more their input factors (limited evidence of this effect) 23
  24. 24. Example: GM and Fisher Body • Fisher body had custom machines and dies to produce car bodies for GM • GM’s chassis were likewise customized for Fisher’s bodies. • There was upstream and downstream market power (double marginalization problem) • GM acquires Fisher body The value chain for steel cans Canning of Iron ore Steel Steel strip Can mining production food, drink, production making oil, etc. VERTICAL VERTICAL INTEGRATION, INTEGRATION AND MARKET CONTRACTS MARKET MARKET CONTRACTS CONTRACTS What factors explain why some stages are vertically integrated, while others are linked by market transactions? 24
  25. 25. Recent Trends in Vertical Relationships • From competitive contracting to supplier partnerships, e.g. in autos • From vertical integration to outsourcing (not just components, also IT, distribution, and administrative services). • Diffusion of franchising • Technology partnerships (e.g. IBM- Apple; Canon- HP) • Inter-firm networks General conclusion:- boundaries between firms and markets becoming increasingly blurred. An Emerging Model: the Distributed Organization The Distributed Organization …yet increases the scope of reduces the scope of what it what it does! owns… 25
  26. 26. 3. Geographical Scope International expansion Horizontal Synergies Vertical Synergies Between similar Value Between successive Value Chain Activities’ Chain Activities Management Synergies Supporting function Synergies 26
  27. 27. Synergies across value chains Telenor - global presence http://www.telenor.com/en/global-presence/#/expanded 27
  28. 28. Two fundamental Tests for the existence of corporate advantage 1. Better-off test (necessary condition) 2. Ownership test (not necessarily a sufficient condition) The ownership test • Ownership vs. Contractual arrangements Acquisition Greenfield 28
  29. 29. High Portfolio of “relationships” Low Long-term contracts Franchises Joint ventures Agency Formalization agreements Spot sales/ purchases Informal Supplier/ supplier/ customer Ownership customer partnerships relationships Low Low Degree of Commitment High Failure rates • Acquisitions: 50%-70% • Alliances: 60% -70% – Simple rules for making alliances work By Jonathan Hughes and Jeff Weiss, Harvard Business Review 2007 • Organic growth: 40%-70% – Is it real? Can we win? Is it worth doing? By George Day, Harvard Business Review 2007 29
  30. 30. Why do M&A fail so often? • Because of organizational complexity! 1. Complexity in understanding the sources of value creation- i.e. synergies 2. Complexity in understanding how to collaborate to leverage synergies Effective Collaboration • It’s all about creating the right incentives (non-monetary or monetary). Right? • No! • Collaboration between competent individuals who are highly motivated to work together may still fail. 30
  31. 31. Collaboration failures Coordination failures Cooperation failures Failures to predict & interpret each others Failures to align interests….. actions……. Resulting in misunderstanding, Resulting in hold-up, lack of synchronization, delays shirking, poaching, free-riding The fundamental paradox of information • The value of information is often embedded in the information itself • When I disclose it, its value goes to 0! How do we deal with this paradox? 31
  32. 32. The ownership test around the world • The institutional environment may shift the trade offs between ownership and contractual agreements – That’s way in emerging countries it is more likely to see corporations with a broad scope… Corporate strategy at Alghanim 32
  33. 33. A brief history of corporate Strategy Portfolio Planning Models: The GE/ McKinsey Matrix Business unit position Low Medium High Industry Attractiveness T Low VES HAR D Medium HOL D High BUIL Industry Attractiveness Criteria Business Unit Position • Market size • Market share (domestic, global, and relative) • Market growth • Competitive position • Industry profitability • Relative profitability • Inflation recovery 33
  34. 34. Portfolio Planning Models: The BCG Growth-Share Matrix HIGH Earnings : high stable, growing Earnings : low, unstable, growing Cash flow : neutral Cash flow : negative Annual real rate of market growth (%) Strategy : invest for growth Strategy : analyze to determine whether business can be grown into a star, or will degenerate into a dog Earnings : high stable Earnings : low, unstable Cash flow : high stable Cash flow : neutral or negative Strategy : milk Strategy : divest LOW HIGH Relative market share LOW Portfolio Planning Models: Applying the BCG Matrix to a Foods company 10 Annual real rate of market growth (%) Frozen food 8 division Health foods 6 division 4 2 Fruit juices 0 division Bakery division -2 2 1.5 1 0.5 0.1 Relative market share Current position Previous position. Area of circle proportional to $ sales. 34
  35. 35. Do Portfolio Planning Models Help or Hinder Corporate Strategy Formulation? ADVANTAGES DISADVANTAGES • Simplicity & Big picture • Sensitive to market definition • Analytically versatile • Ignores synergy • Ignores financing from capital markets Corporate Restructuring to Create Value: The McKinsey Pentagon Current market value 1 Current perceptions Maximum raider gap opportunity Company Optimal value as is 2 RESTRUCTURING 5 restructured value FRAMEWORK Strategic and Total company operating opportunities opportunities 3 4 Potential value Disposal/acquisition Potential value with internal opportunities with external improvements improvements 35

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