Module 8 - Strategic Analysis of Diversified Companies

Module 8

Strategic Analysis of

Diversified Companies

Module Outline

• Identifying Present Corporate Strategy

• Matrix Techniques for Evaluating Diversified

Portfolios

• Comparing Industry Attractiveness

• Comparing Business Unit Strength

• Comparing Business Unit Performance

• Strategic Fit Analysis

• Ranking Business Unit on Investment Priority

• Crafting a Corporate Strategy

• Guideline for Managing Corporate Strategy

Formation Process

Building Shareholder Value

Three questions to be addressed:

1. How attractiveness is group of business firm is in?

2. How good is overall performance outlook over next 5 years?

3. If previous 2 answers are not satisfactory, what should firm do to

• Get out of some businesses,

• Strengthen positions of remaining ones, and

• Acquire new businesses to boost prospects for better performance?

How to Evaluate a Diversified

Company’s Strategy

Rate performance units on basis of

historical performance and future

prospects

Step 5:

Compare competitive strength of firm’s

business unit

Step 4:

Compare long-term attractiveness of

each industry firm has diversified into

Step 3:

Use business portfolio matrixes to

analyze firm’s business portfolio

Step 2:

Identify present corporate strategyStep 1:

Decide if new strategic moves are

needed to improve overall performance

Step 8:

Rank business units in terms of priority

for new capital investment and decide on

general strategic posture

Step 7:

Assess each business unit’s compatibility

with corporate strategy and determine

value of strategic fit relationships

Step 6:

How to Evaluate a Diversified

Company’s Strategy

Step 1: Identifying Present Corporate

Strategy

• Extent to which fir is diversified

• Whether portfolio is keyed to related or

unrelated diversification or both

• Whether scope of operations is mostly

domestic or increasingly global

• Nature of recent moves to boost

performance of key business units

Step 1: Identifying Present Corporate

Strategy

• Moves to add new businesses and build

positions in new industries

• Moves to divest weak / unattractive

businesses

• Moves to pursue strategic fit benefits and

use diversification to create competitive

advantage

• Capital expenditures for each different

business unit

Step 2: Drawing Business Portfolio

Matrixes

Basic Concept

• A 2-dimensional graphical display of comparative strategic positions of different businesses

• Strategically relevant variables used in matrixes

– Industry growth rate

– Market share

– Long-term industry attractiveness

– Competitive strength

– Stage of product / market evolution

Types of Business Portfolio Matrixes

1. Four-Cell Growth-Share Matrix

2. Industry Attractiveness-Business Strength

Matrix

3. Industry Life Cycle Matrix

The BCG Growth-Share Business

Portfolio Matrix

Stars Question Marks

Cash Cow Dog

HIGH LOW

HIGH

LOW

Relative Market Share Position

BCG Growth-Share Matrix

Two variables used:

1. Industry Growth Rate

• Plotted on vertical axis

2. Relative Market Share

• Plotted on horizontal axis

Constructing a BCG Growth-Share

Matrix

• Industry Growth Rate

– “High growth” businesses are in industries

growing faster than economic

– “Low growth” businesses are in industries

growing slower than economy

Constructing a BCG Growth-Share

Matrix

• Relative Market Share

– Calculated by dividing firm’s market share by market share of firm’s largest rival

– “Typical” dividing line between “high” and “low”relative market share businesses placed at .75 or .8

– Businesses on left are market share leaders

– Businesses on right are in below-average relative market share positions

• Each business is a “bubble” with size scaled to portions of total corporate revenues generated

Question Marks / Problem Children /

Cash Hogs

Basic Concept

Internal cash flows are inadequate to fund needs

for working capital and new capital investment

• Operate in a high growth market but have low

relative market share – Upper right cell of matrix

• Rapid industry market growth makes businesses

attractive, but low relative share positions raise

questions about future potential

• Cash needs are high and internal cash generation

is low, making them cash hogs

Question Marks / Problem Children /

Cash Hogs

Strategy Prescriptions

• Aggressive invest-and-expand strategy

– Most attractive question marks

• Divestiture

– Weak question marks

Stars

Basic Concept

Star Businesses

• Have strong competitive positions in rapidly

growing industries

• Are major contributors to corporate revenue

and profit growth

• May or may not be cash hogs

Stars

• Market leaders situated in high growth

market with high relative market share –

Upper left cell of matrix

• Offer excellent growth opportunities

• Offer excellent profit opportunities

• Vary as to whether they are

– Self-sustaining, or

– Require infusions of investment funds from

corporate parent

Cash Cows

• Situated in low growth market but have high relative market share – Lower left cell of matrix

• Can generate cash surpluses over and above that needed for reinvestment and growth in business

• Valuable portfolio holding because they can be “milked” for cash to

– Pay corporate dividends and overhead

– Finance new acquisition

– Invest in young stars or problem children

Cash Cows

• Should not be “harvested” but maintained in

healthy position for long-term cash flow

• Weak cash flow may become candidates for

harvesting and eventual divestiture

The goal is to fortify and defend a cash

cow’s market position while efficiently

generating dollars to reallocate to business

investment elsewhere!

Dogs

• Situated in low growth market and have low

relative market share – Lower right cell of

matrix

• Have weak competitive position and low

profit potential

• Unable to generate attractive cash flows on a

long-term basis

Dogs

Strategy Prescriptions

• Harvest

• Divest or spin off

• Liquidate or close down

Strategy Implications of Growth-Share

Matrix

• Draws attention to cash flow and investment characteristics of various type of businesses

• Encourages strategist to view diversified firm as collection of cash flows and cash requirements

• Explain why priorities for corporate resource allocation can be different for each business

• Success sequence – Question mark to young star to self-supporting star to cash cow

• Two disaster sequences– Star’s position erodes to problem child and then falls to a dog

– Cash cow losses leadership and becomes a dog

Present Versus Future Positions in the

Portfolio Matrix

A

B

E

D

C

F

G

Stars Question Marks

Cash Cow Dog

HIGH LOW

HIGH

LOW

Relative Market Share Position

Weaknesses of Growth-Share Matrix

• Four-cell matrix fact that many businesses

– Are in “average” growth rate markets, and

– Have “average” relative market share positions

• Misleading simplification to categorize

businesses into just four types

• Matrix doesn’t identify which businesses offer

best investment opportunities

• Being a leader in a slow-growth industry

does not guarantee cash flow status

Weaknesses of Growth-Share Matrix

• Assessment of relative long-term

attractiveness of business units requires

examining more than

– Industry growth, and

– Relative market share

• Connection between relative market share

and profitability is not as tight as experience

curve effects implies

– Many firms with small relative market shares are

very profitable!

General Electric’s Industry Attractiveness –

Business Strength Matrix

• Market Share

• Core Competencies

• Profit Margin vs. Competitors

• Ability to Match Price / Service

• Relative Costs

• Knowledge

• Technological Ability

• Management Caliber

• Market Size

• Growth Rate

• Profit Margin

• Competitive Intensity

• Seasonality

• Cyclicality

• Technology & Capital

• Social Impact

• Regulation

• Environment

• Opportunities & Threats

• Barriers to Exit / Entry

Industry

Attractiveness

Business Strength

High

Medium

Low

Strong Average Weak

Industry Attractiveness – Business

Strength Matrix

Two variables used:

1. Long-Term Industry Attractiveness

• Plotted on vertical axis

2. Business Strength – Competitive Position

• Plotted on vertical axis

Constructing Attractiveness – Business

Strength Matrix

• Quantitative measures of industry

attractiveness and business strength used to

– Plot each business unit’s location in matrix

• Each business unit appears as a “circle”

– Area of circle is proportional to size industry

– Pie slices within circle reflect business’s market

share in industry

Procedure: Rating Industry

Attractiveness

Calculate weighted ratings; sum to get an

overall industry attractiveness rating for

each industry

Step 4:

Rate each industry on each attractiveness

factor, using scale of 1 to 10

Step 3:

Assign weighs to each attractiveness

factor

Step 2:

Select factors to compare long-term

attractiveness of each industry

Step 1:

Procedure: Rating Business Position /

Competitive Strength

Calculate weighted ratings; sum to get an

overall business unit attractiveness rating

for each business

Step 4:

Rate each business on each competitive

strength factor, using scale of 1 to 10

Step 3:

Assign weighs to each competitive

strength factor

Step 2:

Select factors to compare competitive

strength of each business unit

Step 1:

Strategy Implication of Attractiveness /

Strength Matrix

• Businesses in three cells at upper left of matrix

– Accorded top investment priority

– General strategic prescription is “grow and build”

• Business in three diagonal cells

– Given medium investment priority

– If a business has an attractive opportunity, it can win

higher investment priority

• Business in lower right of matrix

– Strong candidate for harvesting or divestiture

– May be candidates for an “overhaul and reposition”

strategy

Advantages of Attractiveness / Strength

Matrix

• Allows for intermediate rankings between

high and low, and between strong and weak

• Incorporates wider variety of strategically

relevant variables

• Stresses channeling of corporate resources

to businesses with greatest potential for

– Competitive advantage, and

– Superior performance

Weaknesses of Attractiveness /

Strength Matrix

• No real guidance on specific of business

strategy

• Most to be concluded is general strategic

posture

• Leaves issue of strategic coordination across

businesses wide open, as well as

– Issue of specific competitive approaches and

actions to take at business-unit level

• Tends to obscure businesses about to

emerge as winners

The Life Cycle Portfolio Matrix

Early

Development

Industry

Takeoff

Rapid

Growth

Shake

Out

Maturity Market

Saturation

Decline

Stage in Life Cycle

Weak

Average

Strong

Life-Cycle Matrix

Two variables used:

1. Industry’s Stage in Life Cycle

– Plotted in vertical axis

– Development, takeoff / grown, competitive shakeout,

maturity / saturation, decline

2. Business Unit’s Competitive Position

– Plotted on horizontal axis

– Strong, average, weak

• Each business unit appear as a “circle”

– Area of circle is proportional to size of industry

– Pie slices within circle reflect business’s market share in

industry

Life-Cycle Matrix

The power of the life-cycle matrix is the story

it tells about the distribution of the firm’s

businesses across the stages of industry

evolution!

Step 3: Comparing Long-Term Industry

Attractiveness

• Judged from three perspectives

1. Attractiveness of each industry in portfolio

2. Each industry’s attractiveness relative to others

3. Attractiveness of all industries as a group

Step 4: Comparing Business Unit

Competitive Strength

• Involves comparing specific criteria

– Relative market share

– Ability to compete on price and / or quality

– Technology and innovation capabilities

– How well business unit’s skills and competencies

match industry KSFs

– Profitability relative to competitors

– Other pertinent measures of competitive strength

Strategic Management Principle

Shareholder interests are generally best

served by concentrating corporate resources

on businesses that can contend for market

leadership in their industry!

Step 5: Comparing Business Unit

Performance

• Involves comparing historical performance

with future performance prospects of each

business unit

• Most important performance yardsticks

– Sales growth

– Profit growth

– Contribution to company earnings

– Return on assets employed in business

– Cash flow generation

Strategic Fit Analysis

First

– Analyze value chains of each business to identify

opportunities for cost sharing, skills transfer, and

/ or differentiation enhancement

Second

– Identify important interrelationships between

firm’s present businesses and other industries

not in portfolio

Third

– Decide if existing and potential strategic fit

relationships can lead to an attractive advantage

Translating Strategic Fit Into

Competitive Advantage

Key Point

• It is very difficult to build shareholder value in

a diversified enterprise unless diversification

involves a deliberate effort to pursue the

competitive advantage opportunities of

strategic fit!

Translating Strategic Fit Into

Competitive Advantage

• Absent meaningful strategic fit opportunities,

strategists must try to build shareholder

value by

– Doing an exceptionally good job of portfolio

management

– Doing such a good job of helping to manage

various businesses they perform at a higher level

– Providing such inspirational leadership that all

employees are motivated to perform “over their

heads”

Step 7: Ranking Business Units on

Investment Priority

Objective

To draw conclusions about where the corporation

should be investing its financial resources

• Consists of

– Ranking business units in terms of priority for new capital

investment

– Developing a general strategic direction for each

business unit

• Determine how resources can be used to enhance

competitive standing and financial performance of

business units

Step 8: Crafting a Corporate Strategy

Key Strategy-Making Considerations

• Does portfolio contain enough business in every

attractive industries?

• Does portfolio contain too many marginal

businesses?

• Is proportion of mature or declining businesses so

great corporate growth will be sluggish?

• Does firm have enough “cash cows” to finance

stars and emerging winners?

• Do core businesses generate dependable profits

and / or cash flow?

Step 8: Crafting a Corporate Strategy

Key Strategy-Making Considerations

• Is portfolio overly vulnerable to seasonal or

recessionary influences?

• Does firm have too many businesses it really

does not need to be in or needs to divest?

• Does firm have some businesses that are

industry leaders or is it burdened with too

many average-to-weak businesses?

• Does makeup of business portfolio put firm in

good future position?

The Performance Test

The best test of the overall attractiveness of

a company’s business portfolio is whether

the firm can attain its performance objectives

with its current lineup of businesses!

• If answer is yes, no major corporate strategy

change are indicated

• If a performance shortfall is likely, actions

can be taken to close gap

The Performance Test

• Actions to be taken if performance shortfall is

indicated

– Alter strategic plans for one, or all, of businesses

– Add new businesses to portfolio

– Divest weak-performing or money-losing

businesses from portfolio

– Form alliances

– Lower corporate performance objectives

Finding Additional Diversification

Opportunities

Unrelated Diversification Strategies

– Find companies offering attractive financial

returns irrespective of industry they are in

Related Diversification Strategies

– Locate an attractive industry having good

strategic fit with one or more of firm’s present

businesses

– Look for industries whose value chains relate to

present businesses in portfolio

Deploying Corporate Resources

Principle

– Achieving ever-higher levels of performance

from a diversified business portfolio depends on

doing an effective job of corporate resource

allocation

Key to Success

– Steering resources out of low opportunity areas

into high opportunity areas

Deploying Corporate Resources

Options for Allocating Funds

1. Invest in maintenance and expansion of

existing businesses, starting with those having

highest ROI potential

2. Make new acquisitions

3. Fund long-range R&D ventures

4. Pay off existing long-term debt

5. Increase dividends

6. Repurchase company’s stock

How Corporate Strategies Form?

• Managers approach major strategic

decisions a step at a time, starting from

broad concepts and then fine-tuning, and

modifying them as

– More information is gathered

– Formal analysis confirms or modifies

– Confidence and consensus build for strategic

moves to be made

• Strategy usually doesn’t result from a big

brainstorming session – Except in a crisis!

End of Module 8