10 Corporate Strategy: Diversification, Acquisitions, and Internal New Ventures

Corporate Strategy:

Diversification, Acquisitions, and

Internal New Ventures

Review Chapter 8

• Location economies – economic benefits that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be.– Can lower cost of value creation, helping

the company achieve a low-cost position.

– Can enable a company to differentiate its product offering, which gives it the option of charging a premium price or keeping price low and using differentiation as a means of increasing sales volume. P. 261

“Before executives can chart a new strategy, they must reach common understanding of the company’s current position.”

W. Chan Kim and Renee Mauborgne

Overview/Review Chapter 9

• Chapter focuses on three corporate-level strategies– Horizontal integration

• The process of acquiring or merging with industry competitors

• Acquisition and merger

– Vertical integration• Expanding operations backward into an industry that produces

inputs for the company or forward into an industry that distributes the company’s products

– Strategic outsourcing• Letting some value creation activities within a business be

performed by an independent entity

Chapter 9 - Drawbacks and Limits of Horizontal Integration

• Majority of mergers and acquisitions do not create value– Data suggests that the majority of mergers and

acquisitions do not create value and that many actually destroy value. P. 304

• Implementing a horizontal integration strategy is not easy

• Mergers and acquisitions often fail to produce the anticipated gains

Acquisitions, Ethics and Stockholders?

• The return on investment related to an acquisition must exceed the return that stockholders could get by investing that capital in a diversified portfolio of stocks and bonds

• Enron collapse – stockholder value evaporated and thousands of employees lost their jobs.– The collapse raises troubling

questions about corporate performance, corporate governance, and business ethics. P 367

– Losers were key Enron stakeholders: stockholders, creditors, and employees.

Chapter 10 - Overview

• Opening Case – Tyco International– Finally recognized that their growth had been bought at the price of

accumulating tremendous debt.– Growth on its own does not create value. Growth should be the byproduct, not

the objective, of a diversification strategy. P. 346• Diversification

– The process of adding new businesses to the company that are distinct from its established operations

• Vehicles for diversification– Internal new venturing

• Starting a new business from scratch– Acquisitions– Joint ventures

• Restructuring– Reducing the scope of diversified operations by exiting from business areas

Competencies vs. Core Competenciesvs. Distinctive Competencies

• A company competence is the product of organizational learning and experience and represents real proficiency in performing an internal activity

– A core competence is a well-performed internal activity that is central (not peripheral or incidental) to a company’s competitiveness and profitability

– A distinctive competence is a competitively valuable activity that a company performs better than its rivals

• How to achieve competencies?

Types of Core Competencies

• Expertise in building networks and systems to enable e-commerce

• Speeding new/next-generation products to market

• Better after-sale service capability

• Skills in manufacturing a high quality product

• Innovativeness in developing popular product features

Types of Core Competencies

• Innovativeness in developing popular product features

• Speed/agility in responding to new market trends

• System to fill customer orders accurately and swiftly

• Expertise in integrating multiple technologies to create families of new products

What Are Your Strengths?

•You don’t have to be good at everything, but what you are good at, use it.•Ask yourself now, “what am I good at”?•Important to know who you are, “Do you know who you are”?

– Ask yourself now, “Who am I”?

Your Core Skills

•Define for me now the following:– Ability

– Skill

•Can you have an abilities that have not yet become skills?

•What are your “core” skills– Give me now, three (3) examples of your core

skills.

•What skills do you need that you feel you don’t already have?

Core Competence – Corporation Can be Viewed as a Large Tree

• Trunk and major limbs are core products• Smaller branches are business units• Leaves, flowers, and fruit are end

products• Root system that provides nourishment,

sustenance, and stability is the core competence– Can miss strength of competitors by looking

only at their end products– Same way can miss strength of a tree if look

only at its leaves• Important point to remember: “Don’t

judge a firm’s competitiveness primarily in terms of the price and the performance of end products.”

Microsoft – Core Competencies

• Microsoft’s core competencies:– Creating high-volume software

products, working with other software companies, and providing customer service and support.

• Important re-engineering principle:– A firm should focus on its core

competencies and outsource everything else. Why?

Examples: Distinctive Competencies • Sharp Corporation

– Expertise in flat-panel display technology

• Toyota, Honda, Nissan– Low-cost, high-quality manufacturing capability and

short design-to-market cycles

• Intel– Ability to design and manufacture ever more

powerful microprocessors for PCs

• Motorola– Defect-free manufacture (six-sigma quality) of cell

phones

Expanding Beyond a Single Industry

• Advantages of staying in a single industry– Focus resources and capabilities on competing

successfully in one area– Focus on what the company knows and does best

• Disadvantages of being in a single industry– Danger of the industry declining– Missing the opportunity to leverage resources and

capabilities to other activities– Resting on laurels and not continually learning

A Company as a Portfolio of Distinctive Competencies

• Re-conceptualize the company as a portfolio of distinctive competencies rather than a portfolio of products

• Consider how those competencies might be leveraged to create opportunities in new industries

• Existing vs. competencies• Existing industries in which a company

competes vs. new industries

Establishing a Competency Agenda

Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright © 1994 by Gary Hamel and C. K. Prahalad. All

rights reserved.

The Multibusiness Model

• Develop a business model for each industry in which the company competes

• Develop a higher-level multibusiness model that justifies entry into different industries in terms of profitability

Increasing Profitability Through Diversification

• Transferring competencies– Taking a distinctive competence developed in one

industry and applying it to an existing business in another industry

– The competencies transferred must involve activities that are important for establishing competitive advantage

Transfer of Competencies at Philip Morris

Increasing Profitability Through Diversification (cont’d)

• Leveraging competencies– Taking a distinctive competency developed by a

business in one industry and using it to create a new business in a different industry

• Sharing resources: economies of scope– Cost reductions associated with sharing resources

across businesses

Sharing Resources at Proctor & Gamble

• Managing rivalry: multipoint competition– Diversifying into an industry in order to hold a

competitor in check that has either entered its industry or has the potential to do so

– Multipoint competition: companies competing against each other in different industries

• Exploiting general organizational competencies– Competencies that transcend individual functions

or businesses and reside at the corporate level in the multibusiness enterprise

– Entrepreneurial capabilities– Effective organization structure and controls– Superior strategic capabilities

Types of Diversification

• Related diversification– Entry into a new business activity in a different

industry that is related to a company’s existing business activity, or activities, by commonalities between one or more components of each activity’s value chain

• Unrelated diversification– Entry into industries that have no obvious

connection to any of a company’s value chain activities in its present industry or industries

The Limits of Diversification

• Related diversification is only marginally more profitable than unrelated diversification

• Extensive diversification tends to depress rather than improve profitability

Bureaucratic Costs and Diversification Strategy

• The costs increases that arise in large, complex organizations due to managerial inefficiencies

• Number of businesses in a company’s portfolio– Information overload

• Coordination among businesses– Inability to identify the unique profit contribution

of a business unit that shares resources with another unit

Coordination Among Related Business Units

Bureaucratic Costs and Diversification Strategy (cont’d)

• Limits of diversification– Bureaucratic costs place a limit on the amount of

diversification that can profitably be pursued

• Related or unrelated diversification?– Related diversified companies can create value in

more ways than unrelated companies, but they have to bear higher bureaucratic costs

Diversification That Dissipates Value

• Diversifying to pool risks– Stockholders can diversify their own portfolios at

lower costs than the company can– Research suggests that corporate diversification is

not an effective way to pool risks

• Diversifying to achieve greater growth– Growth on its own does not create value

Entry Strategy: Internal New Ventures—Attractions

• To execute corporate-level strategies when a company has a set of valuable competencies in its existing businesses that can be leveraged to enter the new business area

• When entering a newly emerging or embryonic industry

Entry Strategy: Internal New Ventures—Pitfalls

• Scale of entry– Large-scale entry is initially more expensive than

small-scale entry, but it brings higher returns in the long run

Scale of Entry, Profitability, and Cash Flow

Entry Strategy: Internal New Ventures—Pitfalls (cont’d)

• Commercialization– Technological possibilities should not overshadow

market needs and opportunities

• Poor implementation– Demands on cash flow– Clear strategic objectives are needed– Anticipating time and costs

Guidelines for Successful Internal New Venturing

• Structured approach to managing internal new venturing– Research research aimed at advancing basic science and

technology

– Development research aimed at finding and refining commercial applications for the technology

– Foster close links between R&D and marketing; between R&D and manufacturing

– Selection process for choosing ventures

– Monitor progress

Entry Strategy: Acquisitions—Attractions

• To achieve horizontal integration• To achieve diversification when the company

lacks important competencies• To move quickly• Perceived as less risky than internal new

ventures• When the new industry is well established and

enterprises enjoy protection from barriers to entry

Entry Strategy: Acquisitions—Pitfalls

• Difficulty with postacquisition integration

• Overestimating economic benefits

• The expense of acquisitions

• Inadequate preacquisition screening

Guidelines for Successful Acquisition

• Target identification and preacquisition screening

• Bidding strategy– Hostile vs. friendly takeover

• Integration

• Learning from experience

Entry Strategy: Joint Ventures—Attractions

• Helps avoid the risks and costs of building a new operation up from the ground floor

• Teaming with another company that has complementary skills and assets may increase the probability of success

Entry Strategy: Joint Ventures—Pitfalls

• Requires the sharing of profits if the new business succeeds

• Venture partners must share control; conflicts on how to run the joint venture can cause failure

• Runs the risk of giving critical know-how away to joint venture partner

Restructuring

• Reducing the scope of the company by exiting business areas

• Why restructure?– Diversification discount: investors see highly diversified

companies as less attractive • Complexity and lack of transparency in financial statements

• Too much diversification or for the wrong reasons

– Response to failed acquisitions

– Innovations have diminished the advantages of vertical integration or diversification

Restructuring Strategies

• Exit strategies– Divestment

• Spinoff

• Selling to another company

• Management buyout (MBO)

– Harvest– Liquidation

10 Corporate Strategy: Diversification, Acquisitions, and Internal New Ventures

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