Formulating Corporate-Level Strategy HCAD 5390 Strategies

Formulating Corporate-Level Strategy HCAD 5390

Strategies

Distinguishing Corporations from Strategic Business Units (SBUs) Multi-SBU Corporations: l l l Sole separate legal entity Authorized to execute contracts Able to borrow money and sell equity Produces no goods or services Quite small staff Primary function is to assemble and manage a portfolio of SBUs

Distinguishing Corporations from Strategic Business Units (SBUs) Strategic Business Units: l l l No separate legal existence No separate ability to contract or raise capital Produce goods and services Compete in one or more markets Relative autonomy to manage operations and strategy

Value-Adding Functions of the Corporate Center l l l l Manage the Portfolio of SBUs Raise Financial Capital for Allocation to SBUs Allocate Resources and Services to SBUs Facilitate Synergies Among SBUs Choose Parenting Style for SBU Interactions Participate in SBU Strategic Planning Process Oversee and Monitor SBU Performance Manage Corporate Relations With Stakeholders

Corporate Management of an SBU Portfolio (I) l l l In pursuit of a corporate vision Acquires, merges with, or develops internally new SBUs Divests existing, unwanted SBUs Set performance goals for SBU management Provide input to SBU strategic decisions Count upon SBUs to perform unique strategic functions

Corporate Management of an SBU Portfolio (II) l l Balance between central corporate direction and individual SBU autonomy Control vs spontaneity Hire good SBU managers, give them general guidelines, and let them loose … or … Give detailed directions, watch closely, and intervene frequently

Model Portfolio Management Process Choose strategic thrust of the corporation 1. – – – 2. 3. Growth Stability Retrenchment Choose geographic areas, markets, and products or services to offer in them Decide how many SBUs in the portfolio and which businesses they will be

Texas Health Resources l Texas Health Resources (THR) is one of the largest faith-based, nonprofit health care delivery systems in the United States and the largest in North Texas in terms of patients served. The system's primary service area consists of 16 counties in north central Texas, home to more than 6. 2 million people. THR was formed in 1997 with the assets of Fort Worth-based Harris Methodist Health System and Dallas-based Presbyterian Healthcare Resources. Later that year, Arlington Memorial Hospital joined the THR system. THR has 12 acute-care hospitals and one long-term care hospital that total 3, 100 licensed hospital beds, employs more than 18, 000 people, and counts more than 3, 600 physicians with active staff privileges at its hospitals. THR is also a corporate member or partner in six additional hospitals and surgery centers.

Adaptive Strategies 10

Corporate-Level Strategic Options: Growth – Expand the Portfolio l l l Most common corporate-level strategy direction Critical to maintaining share in a growing market In pursuit of economies of scale and scope Increase in experience and learning Top executive egos to be satisfied

Adaptive Strategies Expansion Adaptive Strategy: – Orientation toward growth l l l 12 Expand, cut back, status quo? Concentrate within current industry, diversify into other industries? Growth and expansion through internal development or acquisitions, mergers, or strategic alliances?

Growth By Concentration l l l All businesses start here Dedicate all resources and competencies to one or a few products or services Achieved in one of three ways: – – – l Sell more of current products in current markets Sell current products in new markets Sell new products in current markets To sell new products in new markets is diversification

Adaptive Strategies Basic Growth Strategies: Concentration – Current product line in one industry Market Development – Product Development – Penetration – Diversification – 14 Into other product lines in other industries

Concentration on a Single Business S R EA S Southwest Airlines Coca-Col a lds ona Mc. D

Concentration on a Single Business l. Advantages – – – Operational focus on a single familiar industry or market. Current resources and capabilities add value. Growing with the market brings competitive advantage. l. Disadvantages – – – No diversification of market risks. Vertical integration may be required to create value and establish competitive advantage. Opportunities to create value and make a profit may be missed.

Concentration No Longer Sufficient to Maintain Growth l l Unlikely to capture a greater share of current market Current market is stagnating, maturing, shrinking, or otherwise lacking growth potential Excess cash on hand needs to be invested productively Management has greater ambitions for further strategic achievement

Diversification l. Related diversification – Entry into new business activity based on shared commonalities in the components of the value chains of the firms. l. Unrelated diversification – Entry into a new business area that has no obvious relationship with any area of the existing business.

Growth By Related Diversification l l Move beyond existing markets and products Employ existing resources and competencies New businesses are closely connected (“related”) to existing businesses Directions of related diversification – – – Vertical forward integration (toward customers) Vertical backward integration (toward suppliers) Horizontal expansion

Forms of Relatedness l l l Products or services Markets Processes, systems, or other operating features Manufacturing facilities, distribution channels, marketing media, or support services Brand image, corporate reputation, creativity or innovation skills, or general managerial expertise

Vertical Integration l l Forward or backward in the industry value chain Moving “upstream” toward suppliers – l Moving “downstream” toward customers – l Hospital acquiring a physician group practice Hospital acquiring a long-term care facility Examples: physician-hospital organizations (failed), integrated delivery systems (succeeded)

Stages in the Raw-Material-to. Consumer Value Chain Upstream Downstream

Stages in the Raw-Material-to-Consumer Value Chain in the Personal Computer Industry Raw materials Examples: Dow Chemical Union Carbide Kyocera Intermediate manufacturer Examples: Intel Seagate Micron Assembly Examples: Apple Hp Dell Distribution Examples: Best Buy Office Max End user

Vertical Integration

Decision Steps in Vertical Integration l l Adequate resources and competencies to bring the new business operations in-house Choose form of integration – full ownership, partial ownership, joint venture, or long-term contract Consider impact on other stakeholders Pay attention to share of industry value chain being brought in-house

Good Reasons for Vertical Integration l l l Reduce costs by eliminating redundancy throughout the value chain Better coordination at interface between value chain components Profit-taking at several levels in the chain is eliminated Greater overall control of inputs (resources) and outputs (distribution channels) Wider network of sources of competitive intelligence Opportunity to reengineer the value chain

Vertical Integration Problems (I) l l Does the value chain function as well after integration as it did before? Excessive costs may be incurred in managing the new businesses and their interactions Inability to use full capacity of acquired businesses so must … sell to competitors? Must the business deal exclusively with its new integration partners?

Vertical Integration Problems (II) l l l Commitment to entire chain reduces strategic flexibility Commitment may tie business to inefficient processes, poorly managed units, and obsolete technologies Inability to coordinate added units may increase costs and limit opportunities to create value for customers

Horizontal Expansion l l Moving sideways in the value chain, acquiring similar businesses in different geographic areas Acquisition target may be a competitor May create antitrust enforcement concerns Examples: multistate hospital networks, nursing home chains, national health plan systems

Best Circumstances for Horizontal Expansion l l Current market is growing, requiring additional capacity to meet demand Target acquisition doing poorly – lacks resources or competencies possessed by the acquirer Expanded size enables economies of scale leading to competitive advantage Opportunity to create dominant market position by acquiring a competitor

Diversification Basic Diversification Strategies: – – 31 Concentric (Related) Diversification Conglomerate (Unrelated) Diversification

Incentives to Diversify Internal Incentives: l l l Poor performance may lead some firms to diversify an attempt to achieve better returns Firms may diversify to balance uncertain future cash flows Firms may diversify into different businesses in order to reduce risk

Resources and Diversification l l Besides strong incentives, firms are more likely to diversify if they have the resources to do so Value creation is determined more by appropriate use of resources than incentives to diversify

Managerial Motives to Diversify Managers have motives to diversify – – – diversification increases size; size is associated with executive compensation diversification reduces employment risk effective governance mechanisms may restrict such motives

Related Diversification Concentric Diversification – – 35 Growth into related industry Search for synergies

Related Diversification 3 M Marriott ard ack ett P ewl H

Related Diversification

Advantages of Related Diversification (I) l l l Synergies among existing and acquired businesses Lower overall corporate risk – balancing high and low-risk SBUs Greater bargaining power vis-à-vis competitors, suppliers and customers

Advantages of Related Diversification (II) l l Cross-subsidization among businesses at different life cycle stages General increase in revenues and profits from acquired businesses Opportunity to acquire new knowledge, competencies, and technologies Enhance status, power, and compensation of top executives

Forms of Inter-SBU Synergy (I) l l Share solutions to problems and ideas for improving operational efficiency Use slack capacity to achieve economies of scale Earn volume discounts and greater bargaining power with suppliers Integration of computer systems and capabilities

Forms of Inter-SBU Synergy (II) l l By sharing R&D facilities, reduce innovation costs and spread research risks Share distribution channels Leverage the use of influential brand names and images Wide opportunities for knowledge transfer

Adaptive Strategies Unrelated (Conglomerate) Diversification – – 42 Growth into unrelated industry Concern with financial considerations

Growth By Unrelated Diversification l l Few similarities or commonalities among businesses in the portfolio Operate in different industries/markets, serve different customers, face different competitors Corporation composed of unrelated businesses may be called a “conglomerate” What value is added by bringing unrelated businesses together into one corporation?

Unrelated Diversification co Ty Amer Gro up ITT

Adaptive Strategies

Performance Relationship Between Diversification and Performance Dominant Business Related Constrained Level of Diversification Unrelated Business

Bureaucratic Costs and the Limits of Diversification l. Number of businesses – Information overload can lead to poor resource allocation decisions and create inefficiencies. l. Coordination among businesses – – As the scope of diversification widens, control and bureaucratic costs increase. Resource sharing and pooling arrangements that create value also cause coordination problems. l. Limits of diversification – The extent of diversification must be balanced with its bureaucratic costs.

Tools for Implementing Growth Strategies l l l Internal development Internal new venture creation Investments in new ventures Acquisition Merger Joint venture, strategic alliance or partnership

Reasons for Making Acquisitions Increase market power Overcome entry barriers Cost of new product development Learn and develop new capabilities Acquisitions Increase speed to market Reshape firm’s competitive scope Increase diversification Lower risk compared to developing new products

Diversification and Corporate Performance: A Disappointing History l A study conducted by Business Week and Mercer Management Sources: Lipin, S. & Deogun, N. 2000. Big merges of the 90’s prove disappointing to shareholders. Wall Street Journal, October 30: C 1; A study by Dr. G. William Schwert, University of Rochester, cited in Pare, T. P. 1994. The new merger boom. Fortune, November 28: 96; and Porter, M. E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3): 43. Consulting, Inc. , analyzed 150 acquisitions that took place between July 2000 and July 2005. Based on total stock returns from three months before, and up to three years after, the announcement: l 30 percent substantially eroded shareholder returns. l 20 percent eroded some returns. l 33 percent created only marginal returns. l 17 percent created substantial returns. l A study by Salomon Smith Barney of U. S. companies acquired since 1997 in deals for $15 billion or more, the stocks of the acquiring firms have, on average, under-performed the S&P stock index by 14 percentage points and under-performed their peer group by four percentage points after the deals were announced.

Problems With Acquisitions Integration difficulties Inadequate evaluation of target Resulting firm is too large Acquisitions Large or extraordinary debt Managers overly focused on acquisitions Too much diversification Inability to achieve synergy

Corporate-Level Strategic Options: Stability – Maintain the Portfolio l l l Rapid growth outstripped financial and managerial resources Difficulties in assimilating recent portfolio additions Some current SBUs may have serious financial or operational problems No attractive acquisition opportunities available Waiting for environmental changes to develop

Restructuring: Contraction of Scope l. Why restructure? – – – Pull-back from overdiversification. Attacks by competitors on core businesses. Diminished strategic advantages of vertical integration and diversification. l. Contraction (Exit) strategies – – Retrenchment Divestment– spinoffs of profitable SBUs to investors; management buy outs (MBOs). Harvest– halting investment, maximizing cash flow. Liquidation– Cease operations, write off assets.

Why Contraction of Scope? l. The causes of corporate decline – – – – Poor management– incompetence, neglect Overexpansion– empire-building CEO’s Inadequate financial controls– no profit responsibility High costs– low labor productivity New competition– powerful emerging competitors Unforeseen demand shifts– major market changes Organizational inertia– slow to respond to new competitive conditions

Corporate-Level Strategic Options: Retrenchment – Cut Back the Portfolio l Need to do more than pause and rethink – – – l Regain control of inefficient operations Rebuild resources and competencies Reconsider strategic direction Result may be a radical restructure and redirection of the organization

Retrenchment Options l l l l Getting back down to fighting weight Returning to core businesses and competencies Seeking a “white knight” to take over Selling the entire organization Divesting pieces of the corporate portfolio Voluntary filing for bankruptcy/reorganization Voluntary/involuntary filing for bankruptcy/liquidation

The Main Steps of Turnaround l. Changing the leadership – Replace entrenched management with new managers. l. Redefining strategic focus – Evaluate and reconstitute the organization’s strategy. l. Asset sales and closures – Divest unwanted assets for investment resources. l. Improving profitability – Reduce costs, tighten finance and performance controls. l. Acquisitions – Make acquisitions of skills and competencies to strengthen core businesses.

Tools for Portfolio Analysis and Management Graphical matrix diagrams showing variable factors key to strategic portfolios decisions 1. 2. Boston Consulting Group Growth-Share Matrix General Electric Business Screen

Reviewing the Corporate Portfolio l Portfolio Planning under the Boston Consulting Group (BCG) matrix: – – – Identifying the Strategic Business Units (SBUs) by business area or product market Assessing each SBU’s prospects (using relative market share and industry growth rate) relative to other SBUs in the portfolio. Developing strategic objectives for each SBU.

The BCG Matrix Source: Perspectives, No. 66, “The Product Portfolio. ” Adapted by permission from The Boston Consulting Group, Inc. , 1970.

The BCG Matrix l Stars – l Question marks – l Low relative market shares in fast growing industries. Cash cows – l High relative market shares in fast growing industries. High relative market shares in low-growth industries. Dogs – Low relative market shares in low-growth industries.

The Strategic Implications of the BCG Matrix l Stars – l Question marks – l Selective investments; divestiture for weak firms or those with uncertain prospects and lack of strategic fit. Cash cows – l Aggressive investments to support continued growth and consolidate competitive position of firms. Investments sufficient to maintain competitive position. Cash surpluses used in developing and nurturing stars and selected question mark firms. Dogs – Divestiture, harvesting, or liquidation and industry exit.

Limitations on Portfolio Planning l Flaws in portfolio planning: – – The BCG model is simplistic; considers only two competitive environment factors– relative market share and industry growth rate. High relative market share is no guarantee of a cost savings or competitive advantage. Low relative market share is not always an indicator of competitive failure or lack of profitability. Multifactor models (e. g. , the Mc. Kinsey matrix) are better though imperfect.

The Mc. Kinsey Matrix

Raise Financial Capital l l SBUs may lack the separate legal existence to do this on their own Corporate center performs this function by issuing stock and borrowing Then, allocates the capital to SBUs in some rational, objective manner that maximizes total return to the corporation This is the practice of corporate strategic financial management

Allocate Resources and Services l In addition to financial capital, corporate center may possess other resources useful to SBUs – – – l Human resource management services Research and development capability Technology assessment competence Information technology support Corporate legal department These too must be allocated to the SBUs

Facilitate Synergies Among SBUs l l Inter-SBU synergies are one of the main reasons for assembling corporate portfolios Synergies do not often occur naturally; the corporate center must foster them – – – Watch each SBU’s operations and strategies Notice lacks of resources and competencies Inventory resources or competencies owned by the SBUs Match lacking and owning SBUs Facilitate actual sharing among them

Forms of Synergy Facilitation (I) l l l Disseminate knowledge and best practices Facilitate transfer of knowledge assets and services Encourage collaboration and coordination Arrange transfer of skills and capabilities Build central database of resources and competencies available to all SBUs

Forms of Synergy Facilitation (II) l l Temporarily assign a specialist from one SBU to another Sponsor all-SBU meetings to share information and problem solutions Coordinate activities of common SBU functions to gain economies of scale Provide synergy-supporting education, training, and coaching to SBU personnel

Choose a Corporate Parenting Style l l l Conscious choice on how the corporate center will interact with SBUs in its portfolio Range along a continuum from complete detachment to intrusive micromanagement Choice will affect behavior and performance of SBU top management Too loose parenting can lead to rogue SBUs Too tight parenting can stifle creative spontaneity

Participate in SBU Strategy-Making l l Corporate degree of involvement in SBU strategic management is a parenting choice Difference between a true SBU and a division or department of a business: – – l SBU – great autonomy and freedom of action Division – close central direction and control Essence of SBU success is in entrepreneurial impulses of their top executives

Oversee and Monitor SBU Performance l Every corporate center must monitor the performance of SBUs in its portfolio: – – Are they meeting the strategic objectives of the SBU and the overall corporation? Are they financially healthy? Are there any looming problems? Are top executives meeting personal performance standards?

Managing Relationships With External Stakeholders l l l Every organization has numerous stakeholders who must be tended to Meaning of term “stakeholder” Examples of health care stakeholders: – – – Suppliers (employees, unions, contractors) Customers (patients, payers) Competitors Regulators Capital sources (donors, grantors, shareholders, lenders) Media

Corporate Value Negation l l Systems and approvals that add costs, delay decisions, and slow market responsiveness Insulate SBU executives from realities and pressures of financial markets Portfolio so large and diverse that no common theme is apparent Overly large corporate HQ that incur expense without providing added value to SBUs

Strategic Alliance l A strategic alliance is a cooperative strategy in which – – firms combine some of their resources and capabilities to create a competitive advantage l A strategic alliance involves – – exchange and sharing of resources and capabilities co-development or distribution of goods or services

Strategic Alliance Firm A Resources Capabilities Core Competencies Firm B Resources Capabilities Core Competencies Combined Resources Capabilities Core Competencies Mutual interests in designing, manufacturing, or distributing goods or services

Types of Cooperative Strategies l l l Joint venture: two or more firms create an independent company by combining parts of their assets Equity strategic alliance: partners who own different percentages of equity in a new venture Nonequity strategic alliances: contractual agreements given to a company to supply, produce, or distribute a firm’s goods or services without equity sharing

Strategic Alliances M in ar g ar Service Marketing & Sales Procurement Technological Development Human Resource Mgmt. Firm Infrastructure Support Activities gin Outbound Logistics Operations Inbound Logistics Primary Activities Supplier ar gin Service Marketing & Sales Procurement Technological Development Human Resource Mgmt. Firm Infrastructure M M n gi ar Support Activities Vertical Alliance M Outbound Logistics Operations Inbound Logistics Primary Activities • vertical complementary strategic alliance is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms • outsourcing is one example of this type of alliance

Strategic Alliances Buyer Inbound Logistics Primary Activities ar gin Service Marketing & Sales Procurement Operations Human Resource Mgmt. Outbound Logistics M Firm Infrastructure Marketing & Sales M in g ar Technological Development gin Service Procurement Human Resource Mgmt. Firm Infrastructure Support Activities Technological Development a M Potential Competitors ar Support Activities M in rg Outbound Logistics Operations Inbound Logistics Primary Activities • horizontal complementary strategic alliance is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chain • focus on long-term product development and distribution opportunities • the partners may become competitors • requires a great deal of trust between the partners