5. Corporate-level strategy

Corporate configuration

A firm can grow by selling more of the same product, developing new products or entering new markets. Some become multi-business corporations active in several businesses. Corporate-level strategy determines the best combination of businesses within one organisation and how they should work together: the corporate configuration. Two central questions:

• Corporate composition: in which business activities should the organisation be active? This includes corporate scope (the number of components: vertical or horizontal integration, but also divesting or letting a business fail) and corporate distribution (the relative size of each component, which gets more attention).
• Corporate management: how should these businesses be governed and organised?

Diversification

Diversification is expanding the firm, either by starting new activities (internal growth) or by buying other firms (acquisition, external growth).

• Vertical diversification/integration: moving backward or forward within your own industry chain. Backward: taking over the suppliers' part; forward: taking over the sales part.
• Horizontal: horizontal diversification means expanding outside your own industry; horizontal integration means integrating related businesses within your own industry, like a magazine publisher that also starts publishing educational material.

Reasons to diversify: resources (improving strategic competitiveness through economies of scope, market power and financial economies), incentives (pressure or opportunities from the firm's situation, such as low performance or uncertainty about future cash flows) and managerial motives (which tend to reduce value, for example reducing managers' employment risk or increasing their compensation).

Portfolio matrices

Multi-business firms use portfolio matrices such as the BCG matrix and the GE matrix, where each unit is a bubble plotted on competitive position (internal strength) and market attractiveness or growth (external opportunity). The BCG matrix uses market growth and relative market share:

A good portfolio (Reading 5.1) balances the categories; cash from cash cows funds stars and question marks.

Porter's three tests

1. Attractiveness test: the industry must allow a profitable competitive position; a business model must be possible.
2. Cost-of-entry test: the investments made to enter must be earned back.
3. Better-off test: the new business must add something to the corporation (1 + 1 = 3).

Synergy and relatedness

A strategic business unit (SBU) is strategic because each can have its own business-level strategy. Combining businesses under one corporate umbrella can create synergy: together they are worth more than apart (1 + 1 = 3). Three forms of relatedness:

Firms choose vertical integration when it improves operational coordination (right parts at the right time), reduces transaction costs, strengthens bargaining power, improves learning and efficiency because activities are close together, and makes system-wide changes easier.

The paradox of responsiveness and synergy

Business responsiveness means a unit can react quickly to market changes; each unit must fit its own market. In large corporations this is harder because of more layers and bureaucracy (higher costs), slower decision-making, poor alignment between corporate and unit strategies, lack of head-office knowledge about specific units, and lower motivation when units have little autonomy. Integration and central control create synergy but bring bureaucracy; autonomy creates responsiveness but reduces synergy.

Managers can manage the paradox by navigating (alternating focus), balancing (seeking an equilibrium) or resolving (systems that stimulate cooperation, such as rewards for joint performance, or franchises that combine local autonomy with a strong central brand).

Corporate management

Three mechanisms: centralisation, coordination and standardisation. Integration can be secured through control or cooperation. Three control styles: financial control (negotiating, setting and monitoring financial targets), strategic control (the same for strategic targets) and strategic planning (control through direct supervision).

Acquisitions and integration

Reasons for acquisition: increasing market power, overcoming entry barriers, lower cost and risk of new product development, faster speed to market, diversification and avoiding excessive competition. Four forms of post-acquisition integration:

Operational: processes, production and systems merged. Managerial: management integrated. Financial: financial systems combined. Collusive: joint strategy.

Readings

Reading 5.2 (Prahalad and Hamel, core competence): core competences are the key skills and knowledge that give sustainable advantage, arising from collective learning. They (1) provide access to a variety of markets, (2) make a significant contribution to customer value and (3) are hard to imitate. Advantage lies in the skills to develop products, not in one product: core competences form the basis for core products, which lead to end products. They must be developed and protected, because they are lost when firms focus only on existing products or underinvest in innovation.

Reading 5.3 (Campbell and Goold, seeking synergies): react directly to signals that synergy is not working rather than relying only on annual reviews. A four-step review: (1) map synergy opportunities (overlap in value chains, shared goals, new ideas from managers), (2) review the current approach (strategy, managers' beliefs, processes and structures), (3) assess its effectiveness (biases, blockers such as unit conflicts, poor rewards or a culture of not sharing, past successes and failures), (4) draw up an agenda for change. The five lenses analysis looks at managers' beliefs and knowledge, structure and processes, the role of staff departments, people's skills and biases, and the degree of authority delegated to units.

Textbook deepening: De Wit, Ch. 5 (Corporate level strategy)

The sections below add the theory from the textbook chapter on corporate level strategy to the lecture notes above.

Growth directions (Figure 5.1)

Within a single business a firm can grow by market penetration (selling more of current products in current segments), product development (extending the product range) and market development (neighbouring segments and geographic areas). Beyond that it becomes a multi-business firm through:

• Vertical integration: entering upstream (backward, supplier businesses) or downstream (forward, buyer businesses) within its own industry column.
• Horizontal integration: entering related businesses at the same tier of the industry column (a newspaper and magazine publisher moving into educational publishing).
• Horizontal diversification: expanding outside the current industry; the term "integration" is then no longer used.

Diversification happens through internal growth or acquisition. Corporate scope can also shrink by divesting or closing activities. Corporate level strategy is about selecting an optimal set of businesses and determining how they should be integrated into the corporate whole.

Portfolio matrices: BCG versus GE business screen

In a portfolio matrix each business is a bubble whose size reflects revenue: the number of bubbles shows the corporate scope, their relative size the corporate distribution. All matrices plot external opportunity (attractiveness) against internal strength relative to rivals.

The added value of having businesses under one corporate umbrella is called multi-business synergy (Porter: making the corporate whole add up to more than the sum of its parts). Without it the activities could just as well, and with less overhead, be run by autonomous firms.

Corporate management: SBUs, integration mechanisms and control styles

Multi-business firms are usually organised into strategic business units, the M-form (Williamson). The differentiation into SBUs must be offset by integration (Lawrence and Lorsch). Three integration mechanisms:

• Centralization: bringing resources and activities physically together in one unit, at the corporate centre, in one business unit or elsewhere.
• Coordination: orchestrating work across business unit boundaries so the parts act as if they were one unit.
• Standardization: using similar resources, standardised activities and common product features across units, giving economies of scale and rapid competence development without centralising or continuously coordinating.

Two organizational means secure these mechanisms (Figure 5.3): control (someone with formal power enforces integration, by direct supervision or indirectly via objectives; authority ranges from full decision power to "coordinator" or "liaison officer") and cooperation (units integrate by mutual adjustment because it is in their interest or the corporate interest; the centre creates conditions for self-organization such as ties between units, cross-business careers and a corporation-wide culture). Goold and Campbell's three control styles:

The paradox of responsiveness and synergy: the Philips example

In 1996 CEO Cor Boonstra found Philips' 60 intertwined business units "a plate of spaghetti" (complexity, bureaucracy, turf wars, no accountability) and restructured it into "a plate of asparagus": independent units that could "hold up their own pants", gaining responsiveness but losing synergies. His successor Kleisterlee (2001) found the units too insular and made team working the priority. The challenge is to create more value through synergy than is destroyed through lost responsiveness.

Porter's three tests: original formulations

• Attractiveness test: the business "must be structurally attractive, or capable of being made attractive".
• Cost of entry test: "the cost of entry must not capitalize all the future profits". Many researchers argue firms on average significantly overpay for acquisitions (Sirower).
• Better off test: "either the new unit must gain competitive advantage from its link with the corporation or vice versa". Otherwise it would be better off independent or with another parent.

Relatedness in more detail

Rumelt: unrelated (conglomerate) diversification, such as a food company entering bicycle rental, is generally less profitable than related (concentric) diversification, such as a car maker entering car rental. But superficial relatedness does not guarantee synergy: Shell sold mining company Billiton after failing to create synergy between oil drilling and copper mining; ICI split into ICI (chemicals) and Zeneca (pharmaceuticals). Relatedness is therefore organised along the business model (Figure 5.4): leveraging resources (resource bases; money and software are easier to transfer than knowledge), aligning positions (product offerings: improving bargaining position towards buyers via broad packages with a common brand, and improving competitive position by avoiding internal fights, jointly attacking third parties, setting common standards and raising entry barriers) and integrating activities (value chains: sharing activities and shared services such as HRM, procurement, legal, R&D and finance; linking sequential activities in internal customer-supplier relationships).

Conditions favouring vertical integration (internalization): operational coordination; avoidance of transaction costs (Williamson: contracting costs such as negotiation, contracts, financial transfers, packaging, distribution and insurance; search costs to find and analyse partners; policing costs to check contract performance); increased bargaining power against a dominant supplier or buyer; learning curve advantages; and implementing system-wide changes (new technologies, methods, standards).

The demand for business responsiveness: five scope disadvantages

Responsiveness is the ability to respond to the competitive demands of a specific business area in a timely and adequate manner. Multi-business firms threaten it through:

1. High governance costs: management layers and bureaucracy.
2. Slower decision making: more layers, meetings, participants, conflicts of interest and political infighting.
3. Strategy incongruence: corporate synergy plans suit some businesses better than others, forcing units into a misfit with their market.
4. Dysfunctional control: the centre lacks business-specific know-how but still steers units, possibly in the wrong direction.
5. Dulled incentives: limited autonomy, unclear responsibilities, lack of accountability and "captive" internal customers reduce motivation to excel.

Synergy is a centripetal force pulling the firm together; responsiveness a centrifugal force pulling it apart into autonomous units (Ghoshal and Mintzberg). Corporations must be integrated and differentiated at the same time.

The portfolio organization perspective in more detail

Each business has unique demands, so each SBU needs its own strategy, freedom from corporate interference and from cross-business coordination, with arm's-length financial control. The term "portfolio" comes from finance (a collection of shareholdings to spread risk). The centre is an active investor: selecting a promising portfolio, keeping tight financial control and reallocating cash from cash cows and dogs to stars and question marks; each unit gets a financial mission (grow, hold, milk or divest). Sources of financial synergy:

1. Economising on external financing: shifting funds internally avoids transaction costs and taxation of capital markets.
2. Less dependence on external capital providers, who may not finance new or risky ventures at acceptable cost.
3. Better bargaining position in financial markets through larger size, debt capacity and creditworthiness.
4. Risk balancing or co-insurance: revenue streams from different (ideally counter-cyclical) businesses reduce risk and make cash flows more stable and predictable.

Other synergies are not rejected but not accommodated either. The approach suits diversification through acquisition: acquired firms are easy to integrate ("plug and play") by linking them to financial reporting; "non-synergistic" acquisitions can be profitable by routing excess cash and shaking up underperforming management. Corporate centres should be modest ("the most difficult thing about business is minding your own", Groucho Marx). Example: Samsung's diversified chaebol, hedging bets across cyclical businesses; the Galaxy Note 7 recall did not affect its other businesses.

The integrated organization perspective in more detail

A corporation should be a tightly knit team around a common core, with a compelling logic that beats rivals operating business by business. Corporate strategists "lead from the centre" (Raynor and Bower) and develop joint strategy with business units, making units highly interdependent. The best-known form is the core competence centred corporation (Prahalad and Hamel), with their tree metaphor: the root system is the core competence, the trunk and major limbs are core products, the smaller branches are business units, and the leaves, flowers and fruit are end products. Investments in competences are spread over many businesses and refined through use (a virtuous learning circle); building competences is strategic, competing in specific markets is tactical. Other possible cores: core customers (PwC and Capgemini offering integrated service packages; Amazon clustering customers with machine learning), core processes (airlines flying planes for passengers and cargo) and core content (Disney leveraging characters across films, parks, merchandise and TV). The "glue" must be strong. Downside: acquisitions are hard to integrate ("grafting oak roots and elm branches onto an olive tree"), so internal growth is preferred. Example: Ocean Network Express (merger of NYK, MOL and K Line container activities).

Managing the paradox: details from the book

• Navigating: alternating ad hoc company-wide initiatives: first a synergy initiative ("One Firm", "All For One": core competences, shared service centres, leadership training), then a responsiveness initiative ("Client First", "Agility": visiting key clients, reducing overhead), then back again ("tacking").
• Balancing: in between initiatives, SBU managers push for autonomy and less "corporate bureaucracy", corporate managers push for synergy; the tension is permanent.
• Resolving: aligning reward and compensation schemes so managers are also rewarded for corporate synergies (not only unit revenue and profit); tools such as CRM software that strengthen client relations in one unit and reveal opportunities for other units; and the franchise, arguably the most effective combination: from German ale brewers (1840s) and Singer sewing machines to KFC, Burger King and McDonald's, which provides brand, purchasing power, training (Hamburger University), layouts and values while franchisees stay close to local customers.

Corporate level strategy in international perspective

• West (especially US): after hostile takeovers and poor conglomerate performance in the 1980s, the belief prevails that focused firms create more shareholder value; "divisionalise or divest"; conglomerates such as GE and McGraw-Hill were broken up.
• Germany: banks gained prominent positions by investing in home industries (Deutsche Bank and Krupp, Bayer, Daimler), creating strong ties between finance and industry (Finanzkapital, Hilferding).
• Japan: keiretsu, business groups linked by cross-shareholdings, successors of family-controlled zaibatsu. Horizontal (financial) keiretsu centre on a bank that may be both creditor and shareholder and gets involved in governance; vertical (industrial) keiretsu link suppliers, manufacturers and distributors of one industry in tiers. Since the 1991 crash they are less integrated.
• Emerging markets: family conglomerates (grupos económicos in Latin America, holding companies in Turkey, business houses in India) and South Korean chaebol (Samsung, LG, Hyundai), operating in many businesses and benefiting from government support, networks, capital access and market knowledge.
• Industry level: oil companies are vertically integrated "from source to gas station"; the computer industry moved from integrated IBM to Apple's network of specialists; Dell's "virtual integration" combined outsourced parts with tight buyer-supplier links.
• To the strategist: must synergies be realised under one parent, or can independent businesses cooperate as a "virtual corporation"?

Readings in the book's framing

Reading 5.1 (Hedley, BCG) represents the portfolio perspective: disaggregate the corporation into business units with separate strategies; the headquarters is a portfolio manager allocating scarce financial resources for the highest return at acceptable risk, giving units a mission to grow, hold or milk based on business growth rate and relative market share. Reading 5.2 (Prahalad and Hamel) represents the integrated perspective: "the primacy of the SBU is now clearly an anachronism"; the centre must set objectives for competence building and a strategic architecture. Reading 5.3 (Campbell and Goold, Seeking synergies) is the third reading on how to identify and realise synergies in practice.