Strategy FormulationCorporate StrategyChapter 7Learni.docx

Strategy Formulation:
Corporate Strategy
Chapter 7
Learning Objectives
Understand the three aspects of corporate strategy
Apply the directional strategies of growth, stability and
retrenchment
Understand the differences between vertical and horizontal
growth as well as concentric and conglomerate diversification
Identify strategic options to enter a foreign country
Apply portfolio analysis to guide decisions in companies with
multiple products and businesses
Develop a parenting strategy for a multiple-business corporation
Copyright © 2015 Pearson Education, Inc.
7-2
After reading this chapter, you should be able to:
Understand the three aspects of corporate strategy
Apply the directional strategies of growth, stability and
retrenchment
Understand the differences between vertical and horizontal
growth as well as concentric and conglomerate diversification
Identify strategic options to enter a foreign country
Apply portfolio analysis to guide decisions in companies with
multiple products and businesses
Develop a parenting strategy for a multiple-business corporation
2
Corporate Strategy

Corporate strategy
the choice of direction of the firm as a whole and the
management of its business or product portfolio and concerns
7-3
3
Corporate strategy is primarily about the choice of direction for
a firm as a whole and the management of its business or product
portfolio.
Corporate Strategy
Directional strategy
the firm’s overall orientation toward growth, stability or
retrenchment
Portfolio analysis
industries or markets in which the firm competes through its
products and business units
7-4
4
Corporate strategy addresses three key issues facing the
corporation as a whole:
1. The firm’s overall orientation toward growth, stability or
retrenchment (directional strategy).
2. The industries or markets in which the firm competes through
its products and business units (portfolio analysis).
Corporate Strategy

Parenting strategy
the manner in which management coordinates activities and
transfers resources and cultivates capabilities among product
lines and business units
7-5
5
3. The manner in which management coordinates activities and
transfers resources and cultivates capabilities among product
lines and business units (parenting strategy).
Corporate Directional Strategies
7-6
Figure 7-1
6
Having chosen the general orientation (such as growth), a
company’s managers can select from several more specific
corporate strategies such as concentration within one product
line/industry or diversification into other products/industries.
(See Figure 7–1.)
Directional Strategy
Growth strategies
expand the company’s activities
Stability strategies
make no change to the company’s current activities
Retrenchment strategies
reduce the company’s level of activities

7-7
A corporation’s directional strategy is composed of three
general orientations (sometimes called grand strategies):
■ Growth strategies expand the company’s activities.
■ Stability strategies make no change to the company’s current
activities.
■ Retrenchment strategies reduce the company’s level of
activities.
7
Growth Strategies
Merger
a transaction involving two or more corporations in which stock
is exchanged but in which only one corporation survives
Acquisition
100% purchase of another company
7-8
8
A merger is a transaction involving two or more corporations in
which both companies exchange stock in order to create one
new corporation. An acquisition is a 100% purchase of another
company.
Concentration Strategies
Vertical growth
achieved by taking over a function previously provided by a
supplier or distributor

7-9
9
Vertical growth can be achieved by taking over a function
previously provided by a supplier or distributor.
Vertical integration
the degree to which a firm operates vertically in multiple
locations on an industry’s value chain from extracting raw
materials to manufacturing to retailing
7-10
Vertical growth results in vertical integration—the degree to
which a firm operates vertically in multiple locations on an
industry’s value chain from extracting raw materials to
manufacturing to retailing.
10
Vertical Integration
Backward integration
assuming a function previously provided by a supplier
Forward integration
assuming a function previously provided by a distributor
7-11
More specifically, assuming a function previously provided by a

supplier is called backward integration (going backward on an
industry’s value chain). Assuming a function previously
provided by a distributor is labeled forward integration (going
forward on an industry’s value chain).
11
Transaction cost economies
vertical integration is more efficient than contracting for goods
and services in the marketplace when the transaction costs of
buying on the open market become too great
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12
Transaction cost economics proposes that vertical integration is
more efficient than contracting for goods and services in the
marketplace when the transaction costs of buying goods on the
open market become too great.
Vertical Integration Continuum
7-13
13
Harrigan proposes that a company’s degree of vertical
integration can range from total ownership of the value chain
needed to make and sell a product to no ownership at all. (See
Figure 7–2.)

Full integration
a firm internally makes 100% of its key supplies and completely
controls its distributors
Taper integration
a firm internally produces less than half of its own requirements
and buys the rest from outside suppliers
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14
Under full integration, a firm internally makes 100% of its key
supplies and completely controls its distributors.
With taper integration (also called concurrent sourcing), a firm
internally produces less than half of its own requirements and
buys the rest from outside suppliers (backward taper
integration).
Quasi-integration
a company does not make any of its key supplies but purchases
most of its requirements from outside suppliers that are under
its partial control
Long-term contracts
agreements between two firms to provide agreed-upon goods
and services to each other for a specific period of time
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15
With quasi-integration, a company does not make any of its key

supplies but purchases most of its requirements from outside
suppliers that are under its partial control (backward quasi-
integration).
Long-term contracts are agreements between two firms to
provide agreed-upon goods and services to each other for a
specified period of time.
Horizontal growth
expansion of operations into other geographic locations and/or
increasing the range of products and services offered to current
markets
Horizontal integration
the degree to which a firm operates in multiple geographic
locations at the same point on an industry’s value chain
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16
A firm can achieve horizontal growth by expanding its
operations into other geographic locations and/or by increasing
the range of products and services
offered to current markets.
Horizontal growth results in horizontal integration—the degree
to which a firm operates in multiple geographic locations at the
same point on an industry’s value chain
International Entry Options for Horizontal Growth
7-17

17
Some of the most popular options for international entry are as
follows:
Exporting
Licensing
Franchising
Joint Venture
Acquisitions
Green-Field Development
Production Sharing
Turn-Key Operations
BOT Concept
Management Contracts
Exporting
Licensing
Franchising
Joint Venture
Acquisitions
Green-Field Development
Production Sharing

Turn-Key Operations
BOT Concept
Management Contracts
Diversification Strategies
Concentric (Related) diversification
growth into a related industry when a firm has a strong
competitive position but attractiveness is low
Synergy
the concept that two businesses will generate more profits
together than they could separately
7-18

18
Growth through concentric diversification into a related
industry may be a very appropriate corporate strategy when a
firm has a strong competitive position but industry
attractiveness is low.
The search is for synergy, the concept that two businesses will
generate more profits together than they could separately.
Diversification Strategies
Conglomerate (Unrelated) diversification
diversifying into an industry unrelated to its current one
Management realizes that the current industry is unattractive.
Firm lacks outstanding abilities or skills that it could easily
transfer to related products or services in other industries.
7-19
19
When management realizes that the current industry is
unattractive and that the firm lacks outstanding abilities or
skills that it could easily transfer to related products or services
in other industries, the most likely strategy is conglomerate
diversification—diversifying into an industry unrelated to its
current one.
Controversies in
Directional Strategies
Is vertical growth better than horizontal growth?
Is concentration better than diversification?
Is concentric diversification better than conglomerate
diversification?
7-20

20
Is vertical growth better than horizontal growth? Is
concentration better than diversification? Is concentric
diversification better than conglomerate diversification?
Stability Strategies
Pause/Proceed with caution strategy
an opportunity to rest before continuing a growth or
retrenchment strategy
No-change strategy
decision to do nothing new—a choice to continue current
operations and policies for the foreseeable future
Profit strategies
decision to do nothing new in a worsening situation but instead
to act as though the company’s problems are only temporary
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21
A pause/proceed-with-caution strategy is, in effect, a timeout—
an opportunity to rest before continuing a growth or
retrenchment strategy.
A no-change strategy is a decision to do nothing new—a choice
to continue current operations and policies for the foreseeable
future.
A profit strategy is a decision to do nothing new in a worsening
situation but instead to act as though the company’s problems
are only temporary.

Retrenchment Strategies
Retrenchment strategies
used when the firm has a weak competitive position in some or
all of its product lines from poor performance
7-22
22
A company may pursue retrenchment strategies when it has a
weak competitive position in some or all of its product lines
resulting in poor performance—sales are down and profits are
becoming losses.
Turnaround strategy
emphasizes the improvement of operational efficiency when the
corporation’s problems are pervasive but not critical
Contraction
effort to quickly “stop the bleeding” across the board but in size
and costs
Consolidation
stabilization of the new leaner corporation
7-23
23
Turnaround strategy emphasizes the improvement of operational
efficiency and is probably most appropriate when a
corporation’s problems are pervasive but not yet critical.
Contraction is the initial effort to quickly “stop the bleeding”

with a general, across-the-board cutback in size and costs.
The second phase, consolidation, implements a program to
stabilize the now-leaner corporation.
Captive company strategy
company gives up independence in exchange for security
Sell-out strategy
management can still obtain a good price for its shareholders
and the employees can keep their jobs by selling the company to
another firm
Divestment
sale of a division with low growth potential
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24
A captive company strategy involves giving up independence in
exchange for security. The sell-out strategy makes sense if
management can still obtain
a good price for its shareholders and the employees can keep
their jobs by selling the entire company to another firm. If the
corporation has multiple business lines and it chooses to sell off
a division with low growth potential, this is called divestment.
Bankruptcy
company gives up management of the firm to the courts in
return for some settlement of the corporation’s obligations
Liquidation

management terminates the firm
7-25
25
Bankruptcy involves giving up management of the firm to the
courts in return for some settlement of the corporation’s
obligations. In contrast to bankruptcy, which seeks to
perpetuate a corporation, liquidation is the termination of the
firm.
Portfolio Analysis
Portfolio analysis
management views its product lines and business units as a
series of investments from which it expects a profitable return
7-26
26
In portfolio analysis, top management views its product lines
and business units as a series of investments from which it
expects a profitable return
BCG Growth—Share Matrix
7-27
Figure 7-3

27
Using the BCG (Boston Consulting Group) Growth-Share
Matrix depicted in Figure 7–3 is the simplest way to portray a
corporation’s portfolio of investments. Each of the
corporation’s product lines or business units is plotted on the
matrix according to both the growth rate of the industry in
which it competes and its relative market share.
BCG Matrix
Question marks
new products with the potential for success but need a lot of
cash for development
Stars
market leaders that are typically at or nearing the peak of their
product life cycle and are able to generate enough cash to
maintain their high share of the market and usually contribute to
the company’s profits
7-28
28
Question marks (sometimes called “problem children” or
“wildcats”) are new products with the potential for success, but
they need a lot of cash for development.
Stars are market leaders that are typically at or nearing the peak
of their product life cycle and are able to generate enough cash
to maintain their high share of the market and usually contribute
to the company’s profits.
BCG Matrix
Cash cows
products that bring in far more money than is needed to
maintain their market share

Dogs
products with low market share and do not have the potential to
bring in much cash
7-29
29
Cash cows typically bring in far more money than is needed to
maintain their market share.
Dogs have low market share and do not have the potential
(because they are in an unattractive industry) to bring in much
cash.
BCG Matrix—Limitations
Use of highs and lows to form categories is too simplistic.
Link between market share and profitability is questionable.
Growth rate is only one aspect of industry attractiveness.
Product lines or business units are considered only in relation to
one competitor.
Market share is only one aspect of overall competitive position.
7-30
30
Unfortunately, the BCG Growth-Share Matrix also has some
serious limitations:
■ The use of highs and lows to form four categories is too
simplistic.
■ The link between market share and profitability is
questionable
■ Growth rate is only one aspect of industry attractiveness.

■ Product lines or business units are considered only in relation
to one competitor: the market leader. Small competitors with
fast-growing market shares are ignored.
■ Market share is only one aspect of overall competitive
position.
Advantages and Limitations of Portfolio Analysis
Advantages
Encourages top management to evaluate each of the
corporation’s businesses individually and to set objectives and
allocate resources for each
Stimulates the use of externally oriented data to supplement
management’s judgment
Raises the issue of cash flow availability to use in expansion
and growth
7-31
31
Portfolio analysis is commonly used in strategy formulation
because it offers certain advantages:
■ It encourages top management to evaluate each of the
corporation’s businesses individually and to set objectives and
allocate resources for each.
■ It stimulates the use of externally oriented data to supplement
management’s judgment.
■ It raises the issue of cash-flow availability for use in
expansion and growth.
■ Its graphic depiction facilitates communication.
Advantages and Limitations of Portfolio Analysis
Limitations
Defining product/market segments is difficult
Suggest the use of standard strategies that can miss

opportunities or be impractical
Value-laden terms such as cash cow and dog can lead to self-
fulfilling prophecies
Lack of clarity on what makes an industry attractive or where a
product is in its life cycle
7-32
32
Portfolio analysis does, however, have some very real
limitations that have caused some companies to reduce their use
of this approach:
Defining product/market segments is difficult.
It suggests the use of standard strategies that can miss
opportunities or be impractical.
It provides an illusion of scientific rigor, when in reality
positions are based on subjective judgments.
Its value-laden terms such as cash cow and dog can lead to self-
fulfilling prophecies.
It is not always clear what makes an industry attractive or where
a product is in its life cycle.
Naively following the prescriptions of a portfolio model may
actually reduce corporate profits if they are used
inappropriately.
Tasks Necessary for Managing a Strategic Alliance Portfolio
Developing and implementing a portfolio strategy for each
business unit and a corporate policy for managing all the
alliances of the entire company
Monitoring the alliance portfolio in terms of implementing
business units’ strategies and corporate strategy and policies

7-33
33
A study of 25 leading European corporations found four tasks of
multi-alliance management that are necessary for successful
alliance portfolio management:
Developing and implementing a portfolio strategy for each
business unit and a corporate policy for managing all the
alliances of the entire company
Monitoring the alliance portfolio in terms of implementing
business units’ strategies and corporate strategy and policies
Tasks Necessary for Managing a Strategic Alliance Portfolio
Coordinating the portfolio to obtain synergies and avoid
conflicts among alliances
Establishing an alliance management system to support other
tasks of multi-alliance management
7-34
Also necessary are:
Coordinating the portfolio to obtain synergies and avoid
conflicts among alliances
Establishing an alliance management system to support other
tasks of multi-alliance management
34
Corporate Parenting
Corporate parenting
views a corporation in terms of resources and capabilities that
can be used to build business unit value as well as generate

synergies across business units
7-35
35
Corporate parenting, or parenting strategy, in contrast, views a
corporation in terms of resources and capabilities that can be
used to build business unit value as well as generate synergies
across business units.
Corporate Parenting
Generates corporate strategy by focusing on the core
competencies of the parent corporation and the value created
from the relationship between the parent and its businesses
7-36
Corporate parenting generates corporate strategy by focusing on
the core competencies of the parent corporation and on the
value created from the relationship between the parent and its
businesses
36
Developing a Corporate
Parenting Strategy
Examine each business unit in terms of its strategic factors
Examine each business unit in terms of areas in which
performance can be improved
Analyze how well the parent corporation fits with the business
unit

7-37
37
The search for appropriate corporate strategy involves three
analytical steps:
Examine each business unit in terms of its strategic factors
Examine each business unit in terms of areas in which
performance can be improved
Analyze how well the parent corporation fits with the business
unit
Horizontal Strategy and
Multipoint Competition
Horizontal strategy
cuts across business unit boundaries to build synergy across
business units and to improve competitive position in one of
more business units
7-38
38
A horizontal strategy is a corporate strategy that cuts across
business unit boundaries to build synergy between business
units and to improve the competitive position of one or more
business units
Horizontal Strategy and

Multipoint Competition
Multipoint competition
large multi-business corporations compete against other large
multi-business firms in a number of markets
7-39
In multipoint competition, large multi-business corporations
compete against other large multi-business firms in a number of
markets. These multipoint
competitors are firms that compete with each other not only in
one business unit, but also in a number of business units.
39
7-40
Lecture Notes
You will receive the greatest benefit from the following Lecture
and Research Update if you first read this narrative, review the
lesson, study the Required Readings, then come back to this
section and carefully re-read this Lecture and Research Update.
The “lecture” portion of this narrative focuses on issues from
the textbook that need further explanation, while the “research
update” portion integrates supportive information from recent
professional academic and trade articles with the textbook
information.
At this point, we have devoted most of our effort to the
assessment of internal and external conditions affecting a firm
and its strategy. Now as we turn our focus to the firm's financial
performance, we will attempt to understand which financial

policies and financial conditions are conducive to which
strategy. This is essential because it enables us as future
managers to make sound decisions that move us towards our
goal of value maximization. We have explored external
analysis, both in general terms as well as from the firm’s
perspective, using Porter’s Five Forces model. From that
technique, we know that if we understand threats posed by the
environment, we can position ourselves better to overcome
those threats. Then, we focused on the firm’s internal strengths
and on gaining and sustaining a competitive advantage. In order
for a firm to outperform its competitors, it must hold unique and
valuable resources that cannot be immediately replicated by
others.
Resource-Based View and the VRIO Approach
The Resource-Based View of the firm and the VRIO approach
provided us with the theoretical and practical tools to identify a
firm’s competitive advantage. At this point, you should
understand the complementarities of external and internal
analysis. It would be of little benefit to a firm to have a firm
grasp of the overall economy, its industry, and its competitive
environment, but possess little understanding of how its own
resources and capabilities can be employed toward a
competitive advantage. For example, a firm may develop a
strategy to become the largest producer of its product, but that
strategy is meaningless unless that firm possesses the financial
strength and capability to raise the capital necessary to attain
and retain that size. Likewise, a firm may hold valuable, rare,
and inimitable resources, but it may not be able to employ them
effectively if it fails to understand its environment or if it lacks
the requisite financial capability.
Effectiveness of Strategy
Once you have determined a strategy for a firm based on its
competitive position and its resources, you must monitor the
effectiveness of that strategy. While there are several methods
to measure the performance and financial condition of a firm,
analysis of financial statements is a logical place to begin in

assessing a corporation’s overall financial position and
competitiveness, as manifested in its financial performance.
Financial statements are used by the corporation's directors as
one tool for evaluating management and for decision-making,
by taxation authorities to determine the firm's tax liability, and
by investors to determine the quality of the firm's securities.
Publicly held firms, in addition to sending periodic reports to
their stockholders, also are required to submit audited financial
statements in a specified format, as well as other information
about their operations and strategy, to the Securities and
Exchange Commission (SEC). The SEC requirements are to
protect existing and prospective investors and to gain and
maintain confidence in publicly-issued securities, and,
consequently, the financial markets.
By studying SEC reports, investors are able to make informed
decisions about their investments. Earlier, we saw how internal
governance can sometimes create problems with the
transparency of the reporting process. The regulatory system,
while flawed, still enabled such cases as Enron and Global
Crossing to be exposed and allowed both the government and
the accounting profession to take action. We have already
covered governance issues, a discussion that we do not need to
duplicate here, but it is essential to understand the reporting
obligations imposed on traded firms as part of the system to
protect investors and maintain the integrity of financial markets.
Managers and directors must be aware of the SEC regulations
and reporting requirements for public firms and fully comply
with them. The passage of the Sarbanes-Oxley Act in 2002,
charging directors and management with more direct
responsibility for financial controls and for the accuracy of
financial reports, has added another costly burden to businesses.
In addition, the accounting profession has established the Public
Company Accounting Oversight Board (PCAOB), subjecting
firms to more rigorous scrutiny. Awareness and understanding
of the more stringent requirements is an integral part of the
operating environment of all firms in the contemporary

environment.
Balance Sheet and Income Statement
Two major accounting statements report the financial position
of a company: the balance sheet and the income statement. The
balance sheet reports the assets and liabilities of the firm as of a
given date. The income statement (once called profit and loss
statement) reports all revenues and expenses for the firm for a
given accounting period, resulting in a bottom line of net
income or loss for that period. While this information is useful,
analysis of these statements enables greater insight to be gained
on the financial performance and on the broader financial and
competitive position of a company.
Statement of Cash Flows
An important step is to determine the sources and applications
of cash for the firm for a particular period by constructing the
statement of cash flows, sometimes called the summary of net
changes in financial position. As you will learn, the balance
sheet reports, among other accounts, the cash on hand as of a
certain date, but does not trace how that cash position changed
or came about since the previous reporting period. The
importance of cash inflows and outflows of the firm is that it
enables decision makers to detect possible problems in both the
finances and operations of the firm. If you need a review of the
various accounts in financial statements, consult a basic
accounting textbook.
Financial and Nonfinancial Ratios
Another way the balance sheet and income statement can be
analyzed is by the calculation of financial ratios. Financial
ratios help to evaluate a firm’s performance because they
provide a normalized indication of the company’s financial
condition and current operating results. Possibly more
important, however, is analysis over several periods to
determine trends, either favorable or unfavorable, and to enable
comparisons with competing or comparable firms, or even with
the entire industry.
Financial Ratio Analysis consists of:

1. Liquidity Ratio
2. Profitability Ratios
3. Activity Ratios
4. Leverage Ratios
5. Other Ratios
Ratios for most firms and industries are publicly available. As
one example, let us say we have calculated the Inventory
Turnover Ratio (ITR) for BestBuy and find that their average
turnover is 20 days in 2015 (The ITR provides a measure of the
effectiveness of the company’s logistics, as each extra day of
inventory can add significantly to the firm’s costs.). That
number means little in isolation, but if we calculate the same
ratio for the previous five years and find that the ITR had
improved from 60 days to 20 days, we will be inclined to think
positively about the current figure. Now, let us say we
determine the ITRs for BestBuy’s competitors and find that
their average ratio was 35 days. At this point, we might begin to
believe that BestBuy holds a competitive advantage in its
inventory management operations, which in turn may provide
some indicators about BestBuy's strategy.
Every time a question arises or a trend is indicated, you should
attempt to dig further into these ratios so that you understand
the reasons for your observation. Equally important, you will
learn that mastery of financial analysis techniques enables you
to make realistic projections about future operations.
Finally, there are nonfinancial indicators that also influence a
firm's long-term profitability and ultimately its competitiveness.
These include such factors as customer loyalty, brand
recognition, and employee satisfaction (low employee turnover).
Such measures have a major influence on a company's strategy
and must be considered in addition to those techniques used for
assessing financial strength. Again, a caution is offered for
thought: no single factor can be used to draw a conclusion about
the firm’s overall condition. All ratios and indicators must be
integrated into a whole.
Financial Analysis

From this background and with the mastery of ratio techniques,
it becomes possible to employ financial analysis in the
determination of a firm's strategy and in the assessment of the
firm’s ability to support its strategy. The key point about the
field of financial analysis is that it must be undertaken for a
purpose. No analyst can conduct a meaningful ratio analysis
without being told what the purpose is. Accordingly, there must
be some indication of how much that strategy will require in
financial resources, integrated with the other, nonfinancial
indicators listed above. While objective financial calculations
are useful, it should be understood that human judgment is also
essential. You should feel free to incorporate your own
judgments into any analysis to implement and support a
strategy.
Lecture and Research Update Bibliography
Wheelen, T. L., Hunger, J. D., Hoffman, A. N. And Bamford, C.
E. (2016). Strategic Management and Business Policy (14th
ed.). NJ: Prentice Hall.
PowerPoint Lecture Notes
Use the lecture notes available in PowerPoint as you study this
chapter by CLICKING THE LINK BELOW. These notes will
help you identify main concepts and ideas presented in this
chapter.
If you do not have PowerPoint on your computer, you can
download a free viewer from Microsoft by clicking here.
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