June 29, 2022

Directions Using an article from a business publication (Forbes, Wall Street Journal, Businessweek, Fortune, FastCompany), find a company that has expanded by diversificati

Directions

Using an article from a business publication (Forbes, Wall Street Journal, Businessweek, Fortune, FastCompany), find a company that has expanded by diversification.

Describe the type of diversification and how the diversification created value. What issues or challenges is the diversification likely to cause? Do you think the diversification is sustainable? Why or why not?

Unit 4: Discussion 1

Directions

Using an article from a business publication (Forbes, Wall Street Journal, Businessweek, Fortune, FastCompany), find a company that has expanded by diversification.

Unit 4: Overview – Forming Strategies

Introduction

How and why firms outperform each other goes to the heart of strategic management. There are three generic strategies that help firms attain advantages over competitors and sustain the advantages over time. The three generic strategies are cost leadership, differentiation, and focus. Successful generic strategies invariably enhance a firm’s position; however, there are pitfalls to each of the generic strategies. Thus, the sustainability of a firm’s advantage is always challenged because of imitation or substitution by new or existing rivals. Competitor moves erode a firm’s advantage over time.

Companies may decide to vertically integrate their own value chain (buy their vendors and/ or distributors) or form strategic alliances to expand their reach within their own or other industries. Even the way a company formulates and deploys strategies is changing because of the impact of the Internet, communication capabilities, and digital technologies within many industries.

The concept of the industry life cycle is a critical factor that managers must take into account when striving to create and sustain competitive advantages. The four stages of the industry life cycle — introduction, growth, maturity, and decline —play a role in decisions that managers must make at the business level. These include overall strategies as well as the relative emphasis on functional areas and value creating activities.

Strategic Management

Jeff Dyer

Third Edition

Chapter 6

Corporate Strategy

Professor’s Goals for this Lecture

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:

– the homework assignment involving calculating an experience curve in semiconductors

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry

Corporate vs. Business Unit Strategy

Business Unit Strategy- The search for competitive advantage within a single industry, market, or line of business.

Corporate Strategy- The search for value and competitive advantages through participation in several different industries and markets.

Vertical Integration- Movement into adjacent markets by a firm along its own value chain. Movement in the direction of raw materials is backward integration. Movement in the direction of sales, service, or warranty operations is forward

integration.

Horizontal Diversification- The movement into an adjacent, or unrelated, market that is not along a firm’s own value chain.

Moving along the value chain

Vertical

Backward integration

Forward integration

Horizontal

Diversification

Alliances

2-3 minutes here

We can think of the value chain as moving from raw materials, through manufacturing or production, and on to distribution and post sales work. To move in the direction of raw materials is to backward integrate, in the direction of distribution and the customer is to forward integrate. Chapter 7 deals with vertical integration

To diversify is to move between different value chains between industries. For example, Cisco diversified when they moved from routers into phones.

Alliances are a special case of horizontal (and sometimes vertical) movement and so they get their own chapter, chapter 8.

Two Ways To Diversify

Go at it alone—Greenfield

2. Buy your way in—Acquisition

Organizations can diversify one of three ways (have students try and think of new examples here):

Greenfield entry: Opening your own operations. An example might be Apple building its own presence in music players and phones.

Merger or Acquisition: Buying or getting bought out by another company. This is how Cisco grows. Ask a student to figure out how many acquisitions Cisco has done in the last 20 years.

Levels of Diversification

Single Business- A firm earning more than 95 percent of the revenues from a single line of business.

Dominant Vertical Business- A firm that earns more than 70 percent of its revenue from its main line of business and the rest from businesses located along

the value chain.

Dominant Business- A firm that earns more than 70 percent of revenue from its main line of business and the remainder from other lines across different value

chains.

Related-constrained Diversification- A firm that earns less than 70 percent of its revenue from its main line of business and its other lines of business share product, technological, and distribution linkages with the main business.

Related-linked Diversification- A firm that operates in related markets, but fewer linkages exist between the new and existing markets than the elements create

separately.

Unrelated Diversified Firm- Competes in product categories and markets with few, if any, links between them.

Adding value

The critical question

Deploying and exploiting current resources

Developing and expanding new resources

Exploit v. Expand

I’m probably going to spend about 10 minutes here because it’s important that students understand there is a logic for creating value through corporate strategy.

Why does diversification create value? The data suggest that it doesn’t. Broadly conceived, most diversified companies trade at a 10-15% discount, all else equal, than their focused competitors. Why do investors believe that diversified firms, those competing in multiple lines of business, are worth less than focused companies?

The critical question that executives need to ask is: “why is this business more valuable because we own it than if it operated alone?” The failure to ask, and answer, this question leads to poor choices of corporate strategy.

Companies that win through diversification do so through exploiting their current resources into new market areas. Conversely, diversification creates value when it expands its resources and capabilities through diversification.

You want to draw out the other dimension of front end and back end and get students thinking about why companies that do these win. Have them think of non-amazon examples to use for the rest of these.

Adding Value Through Diversification

Mechanisms to create value

Slack

Synergy

Shared Knowledge

Similar Business Models

Spreading Capital

Stepping stone

I’m going to spend about 20 minutes here: This is the real meat of the chapter.

How do companies exploit or expand their resources and capabilities through diversification?

The six S’s:

Utilizing slack managerial capacity (this is companies that diversify into related industries/markets)

Creating synergy between operating units (this is Disney and Cap Cities, ABC. Joining content and distribution makes it all fit)

Exploiting or enhancing shared knowledge or core competences (this is the Honda motor story, also Disney and ESPN in branding)

Employing similar business models (this is the dominant logic, used by Sumitomo and Dover)

Spreading capital between units (This is, in large measure, one way that GE creates value, by allocating capital to new opportunities)

Stepping stones to other markets and industries (this is also the GE story, particularly in oil and gas, their newest entry)

You may also qualify for these benefits

Stopping competitors

Stay ahead of markets

The Six S’s

Slack- Unused resource capacity.

Economy of Scope- Activities where the average cost of producing two different products is less when delivered together than separately.

Management Skill- The individual and collective abilities of a firm’s management team to engage in value-creating activities.

Synergy- Action between different elements of a system that creates more value together than the elements create separately.

Shared Knowledge- Collective knowledge that can be distributed throughout the organization to create value.

The Six S’s continued…

Business Model- A method to enable the creation and exchange of value between companies and their customers.

Dominant Logic A conceptualization of a business, or a set of rules for competition, that applies to seemingly unrelated product markets or industries.

Spreading Capital

Internal Capital Market- The movement of funds, talent, or knowledge from unit to unit directed by the leaders of the firm.

Providing Stepping Stones- Works to enhance capabilities through “long leaps” and “short leaps”, and “short hops”

Destroying Value Through Diversification

Hubris

Sunk-Cost Fallacy

Imitation

Poor Governance and Incentives

Poor Management

BCG Matrix

Cash cows- High share but low growth and can generate large cash flows that can be used to fund growth businesses.

Stars- combine high share with high growth and smart managers should invest heavily in these units to maintain or improve their position over time.

Question marks -represent a conundrum for management because they require significant investment and effective strategic management if they are to become stars.

Dogs- low share and low growth and add little profitability to a company’s overall portfolio businesses

The BCG Matrix

Entry mode

Greenfield

Existing resources move from existing to new business

Brand

Customer knowledge

Technology overlap

Speed not essential

Acquisition

Resources don’t move from existing to new business

No brand equity

New customers

New technology

Speed essential

I’ll spend about 5 minutes here. Once a company has decided that it will diversify, the next question is how.

There are really two central issues here:

How well will the firm’s current resources perform in the new market? If a company as a lot of brand equity (such as Coca Cola) then it may want to enter a new market with a new product or an expansion of its processes (Think Coke Zero). Alternatively, a firm’s current resources may prove of little value in the new market, and so acquisition may be a better way to enter the market. That’s why Coke bought Zico when it wanted to enter the coconut water market.

Timing matters. If speed is not essential, then a firm has time to build out its new business through Greenfield investment, but if timing matters (like entering a high growth market), then acquisition would be the preferred mode of entry.

Acquisition Integration Strategies

Bury—completely absorb target

Build—a new organization, best of breed

Blend—loose coupling, leverage target

Bolt-on—two companies, one owner

This would be the final 5-10 minutes.

You can use this slide as a stand alone description, or you can go back to slide 8/9 as you choose. The 4 B’s overlay quite nicely on the continuum in slide 8. The more tightly integrated the firm wants to combine its operations, the more likely it is to bury a target. Bury usually works for slack.

Build tends to work best for synergies and stepping stones. The goal is not to destroy the target, but to bring important elements of the target into the organization as “whole units.” The firm might want to retain its existing brand, but use the acquired firms sales force and organization. This turns out to be really tough to do in practice. So, very few acquisitions are truly mergers, and managers usually default to either bury or blend.

Blend works for most of the 6 Ss, except for slack and spreading capital. Blending allows the acquiring firm to use whole parts of the target (usually its front end, or customer facing operations) while leveraging its own back-end resources.

Bolt-on is the preferred strategy for spreading capital, where the firm wants to maintain clear lines of accountability for performance. The only real thing being shared in a bolt-on is cash, and so it makes sense to do very little integrating and run the organizations as separate businesses.

General Integration Strategies

Integrating Business Units

Here is the previous slide, with all the rows filled in. I don’t think this is as engaging as using the former slide.

What did you learn today?

Because corporate strategy can be confusing for many students, I’ll call on 2-3 students who seemed particularly engaged and have them summarize their key learning points for the day. This tactic helps students realize that if their peers learned something, they probably did as well.

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Strategic Management

Jeff Dyer

Third Edition

Chapter 7

Vertical Integration and Outsourcing

Professor’s Goals for this Lecture

– the homework assignment involving calculating an experience curve in semiconductors

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry

What is Vertical Integration?

Outsourcing- The process where a firm contracts out a business process or activity to an external supplier.

Vertical Integration (or insourcing)- Bringing business processes or activities previously conducted by outside companies in-house.

Value Chain- The sequence of all activities that are performed by a firm to turn raw materials into the finished product that is sold to a buyer.

Reasons for Vertical Integration 3C’s

CAPABILITIES

COORDINATION

Conduct the activity internally when effective coordination and tight integration of the activity with other firm activities provides product performance (differentiation) advantages.

CONTROL

Conduct the activity internally to control scarce inputs (e.g., Alcoa integrates back into bauxite to secure scarce and critical raw material for aluminum) or to control co-specialized asset investments (e.g., oil refinery controlling the pipeline).

Conduct the activity internally when the firm has or can develop better capabilities to perform it than other firms.

The reasons for vertical integration. The chapter talks about three C’s. One is capabilities, the second is coordination and the third is control. If you feel like that you need to build a capability in a particular area to help you be distinctive for one reason or another, than this is an area you want to invest. We often think about those capabilities as competencies or capabilities but things that you think you need to do well in order to differentiate your product or service or to create barriers to imitation. Now those are things that you want to do internally. This assumes that you can do it better than everybody else. You’ve got to figure out whether or not you can perform a certain activity better than anybody else out there in the world but you really want to be world class. Today with a global economy you’ve got to be very good if you’re going to be in a particular activity or in a particular business.

Second reason that you would want to vertically integrate is to coordinate. This would be coordinating two activities where there’s a high degree of interdependence or we would think about it as reciprocal interdependence as you read about in a chapter on vertical integration. The greater the interdependence, the more likely you are to want to have both activities conducted inside your firm and have control over them.

The third reason that you would want to vertically integrate is for control. By conducting internally, you now control the prior steps or the next steps which gives you access to either critical raw materials like Alcoa was able to get when it backward integrated and it started to buy up large areas of land that were known to be rich in boxite, a key raw material that is needed to make aluminum and so, by backward integrating and by buying it, they knew that they were going to have access to that and have control over that key raw material.

Or it could be forward integrating like Apple did with their Apple stores. Which now puts you in direct contact with the customer. You don’t have to rely on Best Buy or Walmart or another retailer to make sure your customer gets good service. You now can control the customer experience in a way that you couldn’t if you’re using other retailers to sell your product or service.

Dangers of Vertical Integration

2F’s

Loss of Flexibility to move the activity to a company or supplier that offers lower costs or better technology.

Loss of Focus associated with managing too many activities may result in poor performance because the firm can’t do them all well.

Advantages of Outsourcing

Flexibility to move to new suppliers that offer lower costs or better technology.

Focus: Keeps the firm focused on a narrower set of core competencies

Lower costs or better performance from a company that specializes in that activity and benefits from economies of scale.

Minimizes capital investment

Vertical Integration

Who Let

Intel Inside?

Outsourcing isn’t always the answer

Dangers of Outsourcing

Loss of Control/Power. May give an outside supplier undue power or control if the outsourced activity is critical to success.

Loss of Capabilities. May set in motion the loss of capabilities that may be important for the future—and create a future competitor.

Outsourcing can set in motion the loss of capabilities—and creation of a competitor

Dell v. AsusTek

How to Prevent a Subcontractor from Becoming a Competitor

Build barriers to imitation

Brand, annual design changes, processes to develop relationships w/ athlete endorsers, distribution

Don’t allow subcontractor to know everything about making a product

Produce a key component or separate production of components or subsystems of the product to multiple suppliers

Do a joint venture or take a minority equity stake

Like IBM could have done with Intel

Use multiple subcontractors; don’t let any one get too big.

(Choose the best answer given the information above and explain your choice)

a) Make the part and capture the profits

b) Buy the part on the market

c) Make some parts and buy some parts to keep leverage over your suppliers

d) None of the above

Mini-Case: Should you Make or Buy?

You have to decide whether to make or buy a component (part) that is an input for a product that you sell for $49.95. Your analysis shows that based upon the estimated volume of parts you will require, your variable costs per unit will be $.50 and given estimated volumes, your fixed (plant and equipment) cost per unit is $.48 per unit. A quick bid in the market suggests that you can currently buy the same part from two suppliers for $1.00 (another supplier bid $1.01). You should:

There was a sidebar in the chapter that looked at this classic mistake. This mistake happens all the time. People will look at it and say, but we can make it for less than we can buy it. That doesn’t mean you have a cost advantage. If you can make it for less, you better be able to make it for significantly less. You should ask, “Are we good enough to sell this product on the market?” Are you good enough at an activity that you should actually be thinking that, we’re so good at this we could actually sell this product on the market ourselves.

Strategic Management

Jeff Dyer

Third Edition

Chapter 8

Strategic Alliances

Professor’s Goals for this Lecture

– the homework assignment involving calculating an experience curve in semiconductors

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry

What is a Strategic Alliance?

Strategic Alliance- A cooperative arrangement in which two or more firms combine their resources and capabilities to create new value, sometimes referred to as a

partnership.

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Directions Using an article from a business publication (Forbes, Wall Street Journal, Businessweek, Fortune, FastCompany), find a company that has expanded by diversificati

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