Book 9: Corporate Strategy

_(Originally published on_ _OUBS Blog_ _)_

Corporate strategy signifies an overarching strategy, above and beyond that of one of the businesses of that corporation. The idea is to achieve superior returns through the combination of different businesses.

The book starts with a case on VWs acquisitions of Seat and Skoda and the potential benefits achieved through the integration and combination of those. For one, the company now has different brands in different market segments, but built on a standard platform to achieve economies of scale and scope. The problem that starts to appear is that the differentiation between the different brands is shrinking.

VW is saving some $500 million but this is only an advantage as long as Ford or Toyota cannot cut the costs the same amount.

All this combination stuff has come from portfolio management, which is about combining a portfolio of diversified strategic business units. Important here is also BCG’s growth-share matrix. The idea is to use internal cash flows for financing and manageing the cycle of declining businesses and growing ones. You take the stars, invest in them to make them cash cows which will provide the cash for the next stars.

The problem with portfolio management is that the only idea behind it is the management of cash flows. In the late 1980s, strategy moved back to focussing on core businesses. The thing is that in balancing cash cows and stars, the manager acts as the shareholder. The shareholder can do that himself though and it is sometimes unclear where the manager can add value or if the shareholder should not decide about his exposure to risk himself. Agency theory even suggests that portfolio diversification is bad for shareholders.

Now in the 1990s, strategy moved away from markets and more to capabilities though, which brings us to the notion of synergies.

The thing is that merely putting some companies in a portfolio does not add value, but synergy will need to be created, managed. The idea is to combine activities so that 2+2 = 5 (which can also fail and end up as 3 :)). The thing is that you need to clearly identify what the capabilities will be that will be needed for the synergies to work out.

Complementary benefits can be achieved through combination of physical assets for economies of scale, higher capacity utilisation and an improved product mix. Invisible assets may also be transfered from one business to another.

Itami (1992) suggested that there are combinatorial benefits, like opening a resort for the summer in a sky resort, and synergy which is multiplicative rather than additive, e.g. that by good reputation visitors in any season might come in the other too.

The thing is that some things are limited by some thing like for example capacity. Using a Plant that is used 70% more, can only lead to 100% usage, after that it is finished. This is also unlikely to be of lasting effect as other companies can do the same thing in the end. Invisible, information-based assets will likely remain unique to the company and will not run out or be exhausted.

Adding time to the mix brings you to static combination benefits, which are the integration of two strategies at one point in time and dynamic combination benefits, where they are integrated over time (e.g. reuse of extraction ptis as waste management depositories). Beyond that we come to dynamic synergy.

Prahalad and Hamel identify companies as collections of core competencies and core products. The thing is that core competencies do not diminish with use, as they put it. Rather, they are enhanced by use. In that sense, markets should be moved in that exploit an existing or develop a new competency. To test if these are core, as yourself:

\- do they provide potential access to many markets (is it transferable for combination benefits)

\- do they make a significant contribution to the perceived customer benefit of the end product

\- are they difficult to imitate

If all three fit, the source is likely to be dynamic. Theodore Levitt (1960) argued that many companies focus on their products instead on what the customer wants and one might even argue that they should relate their core competencies to that.

Honda for example did not exploit their products like VW but their core competencies by using the Honda brand across many different products that would not eat away each others profit margins.

Rumelt (1994) established four key components of core competence competition:

\- corporate span

\- temporal dominance (of products)

\- learning-by-doing (to enhance them)

\- competitive locus

The thing is that superior corporate performance based on core competencies allows for dynamics.

Diversification and Divestment

There are two possibilities for superior performance, entering an attractive industry or possessing a competitive advantage. What are the motives for diversification in that light?

\- growth

\- investment risk-spreading

\- profitability (evaluated against Porter’s (1987) three tests for diversification value-creation)

Economies of scope are the main source of corporate superior performance as of Grant. These need to be more cheaply attained through internalising than out-sourcing (cost economics theory). There is a great figure (3.1) on page 9–26 to test for diversification strategies.

What if an activity does not work well, should it be divested or a recovery started? Kathy Harrigan (1988) sees declining industies as opportunities for end game strategies. In this game, you can either go for a quick sale, harvest it for cash, find a niche or go for leadership in which you believe that after the others leave, profitabilty will return.

Harrigan believes that companies either need to flee or fight. Grinyer et al. (1988) studied strategies with companies in delicne followed by dramatic and sustained improvement and found something they found sharpbenders. These will often have major management change, improved marketing, reduced production costs, improved quality and service.

Another usefulness of core competencies is that they allow you to see if you should divest and risk loosing that competency. Otherwise it might be wise to outsource.

Strategies for corporate structure

In Book 7 Alfred Chandler’s (1962) thesis was that ‘structure follow strategy’. Rumelt (1974) argued that for some ‘structure follows fashion’. Divisionalised structure was very in fashion until the 1970s, when the advantage of adopting it was removed as everybody was doing that. Corporate strategy as a management activity originated from the structure though.

The thing is that co-ordination and decentralisation are not easy to reconcile. Especially when leveraging invisible assets or core competencies, or at least trying too. You should also not forget the national interest and government policy when thinking about corporate strategy and the potential structure it entails or brings with it.

Chandler’s work (1962) was born out of the thesis that the devisionalised corporation evolved out of diversification and growth strategies of large enterprises. The thing is though that in different social and economic conditions things work very differently, which is examplified in a case about russias emerging conglomerate corporations. Here the setting that things were taking place in, needed some specific strategies which resulted in some specific structures.

This leads us to the idea that corporations need to understand values and norms behind competitors’ strategies. In the UK and USA there is a market oriented relationship between shareholders and corporations. In the Rhenish model banks play a more important role for long-term loan and equity, bringing more friendly capital and stability. In Japan, companies often have their origins in diversified, family-controlled zaibatsu merchant houses of the seventeenth century. Here the subsidiaries raise 49% of the cash needed for the company letting the family maintain control. These zaibatsu have evolved into keiretsu, involving interconnected members with support from keiretsu banks with interlocking minority shareholding.

You therefor need to understand regulation, government, socio-economics and cultural context to really see the structures in their full bloom.

Multidivisional structure removed the responsibility for the entire enterprise from routine operational tasks. Responsibility was often pushed down with minimal interconnections between different parts of the same corporation, with profit centers being decentralized resulting in less gains from scale and scope and less coherence of the corporation as a whole.

The thing is that if superior performance is about synergy and compination, then decentralisation might be a bad move. Management can managed the corporate portfolio, invididual business or internal linkages. This is not an easy dilemma and managers will always have to choose between centralisation or decentralisation and integration or independence and control or collaboration.

Networks and Corporations

One thing you can do is to accept this tension and get away from it (Sloan, 1963). In Japan instead of a formal hierarchy there are informal networks based on trust and relationships. A simple choice of make or buy is not enough here, even though the structures can be critized for less than free flow of information and capital in the general market.

Kay (1993) identified co-operative relational contracting as an alternative to classical or spot contracts. In Europe these might be:

\- network of italian suppliers for benetton

\- professional service firms who link complementary skills or locations

Four main drivers might encourage the formation of networks:

\- rising global competition

\- deepening industry convergence

\- battels over technical standards

\- positioning

In the end, we need to extend ‘make or buy’ to ‘make, buy or co-operate’. The corporate management needs to include network co-ordination then, co-ordinating joint decision-making. For alliances to fulfil their obligations Gomes-Cassares identified two main methods:

\- establishing group norms and standards

\- leadership in group decision-making (network leader or agreed compromise or consensus method)

The tighter the collaboration, the blurrier the boundary, the more the joined the firms are and the more will they put their economic weight into the battle as one unit.

Potential sources of advantage for networks come from:

\- flexible capabilities

\- specialisation and division of labour

\- learning

\- increased options

Remember though that networks are very complex, in itself and to be managed.