Module 6 - Corporate Strategies

LEARNING OBJECTIVES:

At the conclusion of this lesson, students should be familiar with:

• The responsibilities of corporate-level managers.

• The types of corporate strategies, including concentration, vertical integration, and the
different types of diversification.
• The advantages and disadvantages of internal development, acquisitions, and joint ventures
as tools to diversity.
• The appropriate use and interpretation of portfolio models.

CHAPTER TOPICS:

Corporate strategy focuses on the selection of businesses in which the organization will compete and
on the tactics used to enter and manage those businesses. This module discusses multibusiness
strategies including vertical integration, related diversification, and unrelated diversification. It also
discusses acquisition, strategic alliances, and portfolio management approaches.

LECTURE OUTLINE:

I. Opening Vignette—Tata Group

Founded in 1868, Tata Group is an Indian conglomerate with significant operations in Europe, Asia
Pacific, China, Africa, the United Kingdom, the Middle East, and North and South America. Tata
companies operate in seven business sectors: communications and information technology,
engineering, materials, services, energy, consumer products, and chemicals. The major Tata
companies are Tata Steel, Tata Motors, Tata Consultancy Services (TCS), Tata Power, Tata
Chemicals, Tata Tea, Indian Hotels, and Tata Communications. Tata Steel is the sixth-largest
steelmaker, Tata Tea is the second-largest branded tea company, and Tata Motors is among the top
five commercial vehicle manufacturers in the world. The company employs approximately 350,000
people globally, and over 60% of its revenues come from business outside India.

Each of Tata’s business enterprises operates independently, with its own board of directors and
shareholders. In all, there are 27 publicly-listed Tata enterprises with a combined market capitalization
of around $60 billion and 3.2 million shareholders. In spite of their independent operations, Tata
companies do share resources. For instance, its consultancy group, TCS, provides services to external
companies such as British Airways and the Dutch bank ABN Amro, but it also helps Tata companies.
TCS shares revenues from the new products and services it jointly creates with its sister companies.

Despite the diversity of its operations, the company is trying to instill an innovative spirit across the
company. Throughout its history, the company created India’s first steel mill, power plant, airline, and
domestically produced car. Tata Chemicals is working on an electricity-free, low-cost antimicrobial
water system, and Tata Power is about to unveil an advance in smart electricity grid technology.
However, the innovation that has recently created the most stir is Tata Motor’s $2000 car, the Nano.
The car features numerous innovative features. Tata’s premier automotive research center is not in
India but in the United Kingdom. In addition to growth through internally produced innovations and
market penetration, the company has pursued a vigorous acquisition strategy.

II. Development of Corporate Strategy

A. The three broad approaches to corporate strategy are concentration, vertical integration, and
diversification.

B. Most organizations begin with a single or small group of products and services and a single
market, referred to as a concentration strategy.

1. Concentration strategies have sometimes been found to be more profitable than other types of
corporate, or multi-business, strategies. The profitability of a concentration strategy is largely
dependent on the industry in which a firm is involved.

2. A single-business approach allows an organization to master one business and industry

environment.

3. Since all resources are directed at doing one thing well, the organization may be in a better
position to develop the resources and capabilities necessary to establish a sustainable competitive
advantage.

4. A concentration strategy can prevent the proliferation of management levels and staff functions
that are often associated with large multibusiness firms, and that add overhead costs and limit the
flexibility of business units.

5. A concentration strategy allows a firm to invest profits back into the business, rather than
competing with other corporate holdings for the investment funds.

6. The risks of a concentration strategy include: overdependency on one product or business

area, which may change dramatically; product obsolescence and industry maturity; uneven cash flow
and profitability; and insufficient challenge and stimulation for management.

7. Many successful organizations abandon their concentration strategies at some point due to
market saturation, increased competition, or some other reason.

C. Vertical integration is the term used to describe the extent to which a firm is involved in several
stages of the industry supply chain.

1. A typical industry supply chain involves extraction, primary manufacturing, final product
manufacturing, wholesaling, and retailing.

2. Firms may pursue vertical integration for a variety of reasons, including increased control over
the quality of supplies or the way a product is marketed, better or more complete information about
supplies or markets, greater opportunity for product differentiation through a coordinated effort, or
simply because they believe they can enhance profits through assuming one of the functions that were
previously performed by another company.
3. Transaction cost economics, which is the study of economic exchanges and their costs,
provides a cost perspective on vertical integration that helps explain when vertical integration may be
appropriate.

4. Research has not generally found vertical integration to be a highly profitable strategy relative
to the other corporate-level strategies. Vertical integration can “lock firms in” to unprofitable adjacent
businesses.

5. Vertical integration may be associated with reduced administrative, selling, and R&D costs, but
higher production costs, which may be a result of a lack of incentive on the part of internal suppliers
to keep their costs down.

6. Vertical integration often requires substantially different skills than those currently possessed
by the firm, making it similar to unrelated diversification.

D. Diversification strategies are of two types: related and unrelated.

1. Firms that pursue unrelated diversification are often called conglomerates.

2. Research has demonstrated that unrelated firms have lower profitability and higher levels of
risk than firms pursuing other corporate-level strategies.

3. Unrelated diversification places significant demands on corporate-level executives due to

increased complexity and technological changes across industries, which may reduce the
effectiveness of management.

E. Related diversification involves diversifying from an original core business into other
businesses that are similar or related.

1. Related diversification is based on similarities that exist among the products, services, markets,
or resource conversion processes of two businesses. These similarities are supposed to lead to
synergy, which means that the whole is greater than the sum of its parts.

2. Most of the research on diversification strategies indicates that some form of relatedness
among diversified businesses, rather than unrelatedness, leads to higher financial performance.

3. Relatedness comes in two forms, tangible and intangible. Tangible relatedness means that the
organization has the opportunity to use the same physical resources for multiple purposes.

a. Examples of synergy resulting from tangible relatedness include (1) using the same marketing
or distribution channels for multiple related products, (2) buying similar raw materials for related
products through a centralized purchasing office to gain purchasing economies, (3) providing
corporate training programs to employees from different divisions that are all engaged in the same
type of work, (4) advertising multiple products simultaneously, and (5) manufacturing in the same
plants.

4. Intangible relatedness occurs any time capabilities developed in one area can be applied to
another area. When executed properly, intangible relatedness can result in managerial synergy.
a. Synergy based on intangible resources such as brand name or management skills and
knowledge may be more conducive to the creation of a sustainable competitive advantage since
intangible resources are hard to imitate and are never used up.

5. Even if relatedness is evident, synergy has to be created, which means that the two related
businesses must fit together and that organizational managers must work at creating efficiencies from
the combination process.

a. Strategic fit refers to the complementary matching of strategic organizational capabilities. If two
organizations in two related businesses combine their resources, but both of them are strong in the
same areas and weak in the same areas, then the potential for synergy is diminished.

b. Organizational fit occurs when two organizations or business units have similar
management processes, cultures, systems, and structures. The organizational fit makes organizations
compatible, which facilitates resource sharing, communication, and transference of knowledge and
skills.

III. Diversification Methods

A. Once an organization has decided to diversify, it can pursue one of three basic approaches: an
internal venture to develop the new business on its own, an acquisition, or a joint venture.

B. An internal venture depends on the research and development activities of an organization.

Since only the core organization is involved, management has greater control over the progress of the
venture. However, the risks of failure are high and even successful ventures take many years to
become profitable.

C. As an alternative to corporate venturing, some organizations choose to buy diversification in

the form of acquisitions. Mergers occur any time two organizations combine into one. An acquisition
is when one organization buys a controlling interest in the stock of another organization or buys it
outright.

1. Mergers/acquisitions are a relatively quick way to (1) enter new markets, (2) acquire new
products or services, (3) learn new resource conversion processes, (4) acquire needed knowledge
and skills, (5) vertically integrate, (6) broaden markets geographically, or (7) fill needs in the corporate
portfolio.

2. Mergers and acquisitions are not, on average, financially beneficial to the shareholders of the
acquiring firm.

3. Unsuccessful mergers are associated with a large amount of debt, overconfident or

incompetent managers, poor ethics, changes in top management or the structure of the acquiring
organization, and diversification away from the core area in which the firm is strongest.

4. The successful mergers were related to low-to-moderate amounts of debt, a high level of
relatedness leading to synergy, friendly negotiations (no resistance), a continued focus on the core
business, careful selection of and negotiations with the acquired firm, and strong cash or debt position.
5. The largest shareholder gains from mergers occurred when the cultures and the top
management styles of the two companies were similar (organizational fit).

D. A strategic alliance is formed by two or more organizations to develop new products or services,
enter new markets, or improve resource conversion processes. When the arrangement is contractual
and the alliance operates independently of the organizations that form them, then the alliance is
typically called a joint venture.

1. Strategic alliances and joint ventures can help organizations achieve many of the same
objectives that are sought through mergers and acquisitions.

2. Since joint ventures involve more than one company, they can draw on a much larger resource
base. The resources that are most likely to be transferable through a joint venture are marketing,
technology, raw materials, finances, management, and political commitments.

3. Joint ventures can enhance the speed of entry into a new field or market because of the
expanded base of resources from which ventures can draw, and spread the risk of failure among all
of the participants.

4. Joint ventures are limiting in that each organization has only partial control over the venture
and enjoys only a percentage of the growth and profitability it creates. Other weaknesses include high
administrative costs, concerns about lack of organizational fit, and risk of opportunism by venture
partners.

5. Successful joint ventures and alliances require careful planning and execution.

IV. Portfolio Management

A. Portfolio management refers to managing the mix of businesses in the corporate portfolio,
including decisions about the division of organizational resources and where to invest new capital.

B. In spite of their use in many organizations, portfolio management techniques are the subject of
a considerable amount of criticism.

C. Boston Consulting Group (BCG) Matrix is based on two factors, industry growth rate and relative
market share. Industry growth rate is the growth rate of the industry in which a particular business unit
is involved. Relative market share is calculated as the ratio of the business unit’s size to that of its
largest competitor.

1. The two factors are used to plot all of the businesses in which the organization is involved,
represented as Stars, Question Marks (also called Problem Children), Cash Cows, and Dogs.

2. Cash Cows tend to generate more cash than they can effectively reinvest, while Question
Marks require additional cash to sustain rapid growth, and Stars generate about as much cash as they
use, on average.

3. The standard BCG prescription is this: achieve high market share leadership and become a
Star or a Cash Cow.

4. There are several serious limitations to the BCG model.

a. The problem with this standard strategy prescription is that it may be valid only for firms
pursuing a low-cost leadership strategy. The use of market share as a measure of competitive strategy
carries with it the implicit assumption that size has led to economies of scale and learning effects, and
that these effects have resulted in competitive success through the creation of a low-cost position.

b. Differentiation and focus competitive strategies are not incorporated into the model. Companies
that are successful in pursuing focus strategies (through low cost or differentiation) in low-growth
industries may be classified as Dogs even though their profit streams are strong.

c. Only two factors are considered and only two divisions, high and low, are used for each factor.
Also, the growth rate is inadequate as the only indicator of the attractiveness of an industry. For
example, some fast-growing industries have never been particularly profitable. Market share is also
an insufficient indicator of competitive position.

d. The BCG Matrix is based on past information rather than assessments of current and future
conditions.

D. The General Electric Business Screen employs measures of industry attractiveness and
business strengths that are defined by the organization.

E. The GE Business Screen, in particular, is flexible enough to accommodate a wide variety of

indicators of industry attractiveness and competitive strength.