They may justify the suspension of the better-off test by pointing to the way they manage diversity. By cutting corporate staff to the bone and giving business units nearly complete autonomy, they believe they avoid the pitfalls. Such thinking misses the whole point of diversification, which is to create shareholder value rather than to avoid destroying it.
The three tests for successful diversification set the standards that any corporate strategy must meet; meeting them is so difficult that most diversification fails. Many companies lack a clear concept of corporate strategy to guide their diversification or pursue a concept that does not address the tests. Others fail because they implement a strategy poorly. My study has helped me identify four concepts of corporate strategy that have been put into practice—portfolio management, restructuring, transferring skills, and sharing activities.
While the concepts are not always mutually exclusive, each rests on a different mechanism by which the corporation creates shareholder value and each requires the diversified company to manage and organize itself in a different way. The first two require no connections among business units; the second two depend on them.
See Exhibit 4. While all four concepts of strategy have succeeded under the right circumstances, today some make more sense than others.
Ignoring any of the concepts is perhaps the quickest road to failure. The concept of corporate strategy most in use is portfolio management, which is based primarily on diversification through acquisition. The corporation acquires sound, attractive companies with competent managers who agree to stay on. While acquired units do not have to be in the same industries as existing units, the best portfolio managers generally limit their range of businesses in some way, in part to limit the specific expertise needed by top management.
The acquired units are autonomous, and the teams that run them are compensated according to the unit results. The corporation supplies capital and works with each to infuse it with professional management techniques.
At the same time, top management provides objective and dispassionate review of business unit results. Portfolio managers categorize units by potential and regularly transfer resources from units that generate cash to those with high potential and cash needs.
In a portfolio strategy, the corporation seeks to create shareholder value in a number of ways. It uses its expertise and analytical resources to spot attractive acquisition candidates that the individual shareholder could not. The company provides capital on favorable terms that reflect corporatewide fundraising ability. It introduces professional management skills and discipline. Finally, it provides high-quality review and coaching, unencumbered by conventional wisdom or emotional attachments to the business.
The logic of the portfolio management concept rests on a number of vital assumptions. Acquired companies must be truly undervalued because the parent does little for the new unit once it is acquired. To meet the better-off test, the benefits the corporation provides must yield a significant competitive advantage to acquired units. The style of operating through highly autonomous business units must both develop sound business strategies and motivate managers.
In most countries, the days when portfolio management was a valid concept of corporate strategy are past. Other benefits have also eroded. Large companies no longer corner the market for professional management skills; in fact, more and more observers believe managers cannot necessarily run anything in the absence of industry-specific knowledge and experience.
Another supposed advantage of the portfolio management concept—dispassionate review—rests on similarly shaky ground since the added value of review alone is questionable in a portfolio of sound companies. The benefit of giving business units complete autonomy is also questionable. Setting strategies of units independently may well undermine unit performance. The companies in my sample that have succeeded in diversification have recognized the value of interrelationships and understood that a strong sense of corporate identity is as important as slavish adherence to parochial business unit financial results.
But it is the sheer complexity of the management task that has ultimately defeated even the best portfolio managers. As the size of the company grows, portfolio managers need to find more and more deals just to maintain growth. Supervising dozens or even hundreds of disparate units and under chain-letter pressures to add more, management begins to make mistakes. Eventually, a new management team is installed that initiates wholesale divestments and pares down the company to its core businesses.
Reflecting these realities, the U. In developing countries, where large companies are few, capital markets are undeveloped, and professional management is scarce, portfolio management still works. But it is no longer a valid model for corporate strategy in advanced economies. Nevertheless, the technique is in the limelight today in the United Kingdom, where it is supported so far by a newly energized stock market eager for excitement.
But this enthusiasm will wane—as well it should. Portfolio management is no way to conduct corporate strategy. Unlike its passive role as a portfolio manager, when it serves as banker and reviewer, a company that bases its strategy on restructuring becomes an active restructurer of business units.
The new businesses are not necessarily related to existing units. All that is necessary is unrealized potential. The restructuring strategy seeks out undeveloped, sick, or threatened organizations or industries on the threshold of significant change. The parent intervenes, frequently changing the unit management team, shifting strategy, or infusing the company with new technology. Then it may make follow-up acquisitions to build a critical mass and sell off unneeded or unconnected parts and thereby reduce the effective acquisition cost.
The result is a strengthened company or a transformed industry. As a coda, the parent sells off the stronger unit once results are clear because the parent is no longer adding value and top management decides that its attention should be directed elsewhere. A conglomerate with units in many industries, Hanson might seem on the surface a portfolio manager. In fact, Hanson and one or two other conglomerates have a much more effective corporate strategy. Although a mature company suffering from low growth, the typical Hanson target is not just in any industry; it has an attractive structure.
Its customer and supplier power is low and rivalry with competitors moderate. The target is a market leader, rich in assets but formerly poor in management.
Hanson pays little of the present value of future cash flow out in an acquisition premium and reduces purchase price even further by aggressively selling off businesses that it cannot improve. In this way, it recoups just over a third of the cost of a typical acquisition during the first six months of ownership. Like the best restructurers, Hanson approaches each unit with a modus operandi that it has perfected through repetition. Hanson emphasizes low costs and tight financial controls.
To reinforce its strategy of keeping costs low, Hanson carves out detailed one-year financial budgets with divisional managers and through generous use of performance-related bonuses and share option schemes gives them incentive to deliver the goods. If it succumbs to the allure of bigness, Hanson may take the course of the failed U.
When well implemented, the restructuring concept is sound, for it passes the three tests of successful diversification. The restructurer meets the cost-of-entry test through the types of company it acquires. It limits acquisition premiums by buying companies with problems and lackluster images or by buying into industries with as yet unforeseen potential. Intervention by the corporation clearly meets the better-off test.
Provided that the target industries are structurally attractive, the restructuring model can create enormous shareholder value. To work, the restructuring strategy requires a corporate management team with the insight to spot undervalued companies or positions in industries ripe for transformation.
The same insight is necessary to actually turn the units around even though they are in new and unfamiliar businesses. These requirements expose the restructurer to considerable risk and usually limit the time in which the company can succeed at the strategy.
The most skillful proponents understand this problem, recognize their mistakes, and move decisively to dispose of them. The best companies realize they are not just acquiring companies but restructuring an industry.
Unless they can integrate the acquisitions to create a whole new strategic position, they are just portfolio managers in disguise. Another important difficulty surfaces if so many other companies join the action that they deplete the pool of suitable candidates and bid their prices up. Perhaps the greatest pitfall, however, is that companies find it very hard to dispose of business units once they are restructured and performing well. Human nature fights economic rationale.
Size supplants shareholder value as the corporate goal. The company does not sell a unit even though the company no longer adds value to the unit. While the transformed units would be better off in another company that had related businesses, the restructuring company instead retains them. Gradually, it becomes a portfolio manager. The perceived need to keep growing intensifies the pace of acquisition; errors result and standards fall.
The restructuring company turns into a conglomerate with returns that only equal the average of all industries at best. The last two concepts exploit the interrelationships between businesses. In articulating them, however, one comes face-to-face with the often ill-defined concept of synergy. If you believe the text of the countless corporate annual reports, just about anything is related to just about anything else!
But imagined synergy is much more common than real synergy. Such corporate relatedness is an ex post facto rationalization of a diversification undertaken for other reasons. Even synergy that is clearly defined often fails to materialize. Instead of cooperating, business units often compete. A company that can define the synergies it is pursuing still faces significant organizational impediments in achieving them. But the need to capture the benefits of relationships between businesses has never been more important.
Technological and competitive developments already link many businesses and are creating new possibilities for competitive advantage. In such sectors as financial services, computing, office equipment, entertainment, and health care, interrelationships among previously distinct businesses are perhaps the central concern of strategy.
To understand the role of relatedness in corporate strategy, we must give new meaning to this ill-defined idea. I have identified a good way to start—the value chain. I call them value activities. It is at this level, not in the company as a whole, that the unit achieves competitive advantage. I group these activities in nine categories. Primary activities create the product or service, deliver and market it, and provide after-sale support. The categories of primary activities include inbound logistics, operations, outbound logistics, marketing and sales, and service.
Support activities provide the inputs and infrastructure that allow the primary activities to take place. The categories are company infrastructure, human resource management, technology development, and procurement. The value chain defines the two types of interrelationships that may create synergy. The second is the ability to share activities. Two business units, for example, can share the same sales force or logistics network. The value chain helps expose the last two and most important concepts of corporate strategy.
The transfer of skills among business units in the diversified company is the basis for one concept. While each business unit has a separate value chain, knowledge about how to perform activities is transferred among the units.
For example, a toiletries business unit, expert in the marketing of convenience products, transmits ideas on new positioning concepts, promotional techniques, and packaging possibilities to a newly acquired unit that sells cough syrup.
Newly entered industries can benefit from the expertise of existing units and vice versa. These opportunities arise when business units have similar buyers or channels, similar value activities like government relations or procurement, similarities in the broad configuration of the value chain for example, managing a multisite service organization , or the same strategic concept for example, low cost.
Even though the units operate separately, such similarities allow the sharing of knowledge. Of course, some similarities are common; one can imagine them at some level between almost any pair of businesses. Countless companies have fallen into the trap of diversifying too readily because of similarities; mere similarity is not enough. Transferring skills leads to competitive advantage only if the similarities among businesses meet three conditions:.
The activities involved in the businesses are similar enough that sharing expertise is meaningful. Broad similarities marketing intensiveness, for example, or a common core process technology such as bending metal are not a sufficient basis for diversification.
The resulting ability to transfer skills is likely to have little impact on competitive advantage. The transfer of skills involves activities important to competitive advantage. Transferring skills in peripheral activities such as government relations or real estate in consumer goods units may be beneficial but is not a basis for diversification.
The skills transferred represent a significant source of competitive advantage for the receiving unit. The expertise or skills to be transferred are both advanced and proprietary enough to be beyond the capabilities of competitors. The transfer of skills is an active process that significantly changes the strategy or operations of the receiving unit.
The prospect for change must be specific and identifiable. Almost guaranteeing that no shareholder value will be created, too many companies are satisfied with vague prospects or faint hopes that skills will transfer. The transfer of skills does not happen by accident or by osmosis.
The company will have to reassign critical personnel, even on a permanent basis, and the participation and support of high-level management in skills transfer is essential.
Many companies have been defeated at skills transfer because they have not provided their business units with any incentives to participate. Transferring skills meets the tests of diversification if the company truly mobilizes proprietary expertise across units. This makes certain the company can offset the acquisition premium or lower the cost of overcoming entry barriers.
The industries the company chooses for diversification must pass the attractiveness test. Even a close fit that reflects opportunities to transfer skills may not overcome poor industry structure.
Opportunities to transfer skills, however, may help the company transform the structures of newly entered industries and send them in favorable directions. The transfer of skills can be one-time or ongoing. If the company exhausts opportunities to infuse new expertise into a unit after the initial postacquisition period, the unit should ultimately be sold. The corporation is no longer creating shareholder value. Owners also can demonstrate the superiority of their products to sell them at a premium.
The decisions a company makes on its way to creating, maintaining and using its competitive advantages are business-level strategies. A gourmet candy company, for example, might find that it cannot compete on price; larger corporations often enjoy economies of scale that keep costs low.
Instead, the small business would choose a differentiation strategy, emphasizing freshness, quality ingredients or some other attribute consumers will value highly enough to pay extra.
When a business identifies opportunities outside its original industry, it might contemplate diversification. When additional businesses become part of the company, the small business owner must consider corporate-level strategy. To be effective, the umbrella company must contribute to the efficiency, profitability and competitive advantage to each business unit.
The gourmet candy maker may decide to enter the dried-fruit business, for example. A business can only succeed when it carefully considers all the three levels of strategy. In this article, the corporate and business levels of strategy will be discussed as the two are often confused with one another. Corporate strategy is essentially developed to offer directions to the business for accomplishing their long-term objectives.
A corporate strategy is developed in accordance with the objectives and scope of the activities of the organization. It also considers the nature of business by taking into account its operating environment, its position in the market and the degree of competition it encounters. The mission statement of an organization explicitly mentions its corporate strategy.
It plays a very important part in the strategic decision-making across the organization. Corporate-level strategy is typically developed by the highest-level managers in organizations. Most large-scale business organization typically have multiple business units or departments that are spread out across the different businesses and markets that the organization has decided to operate in.
A strategic business unit may include a product division or any other profit center, the objectives of which may be different from the rest of the business units of the organization.
A strategy developed at this level is known as business strategy, the purpose of which is to determine the ways in which an organization plans to accomplish its goals in a particular business unit. At the level of business units, strategy formulation is related to how the business competes with other businesses in the industry.
The strategy developed at this stage may be altered in accordance with the variations in market demand. Business level strategies are a step below the corporate level strategies. These strategies focus on more specific areas of the organization. Three strategies are usually executed in this level, which include differentiation , cost leadership and focus.
The purpose of these business level strategies is to create a competitive edge for the organization. The strategies developed at the business level are used by managers of business units or divisions to determine solutions for problems that they face in their routine activities.
Business strategies are those that are developed at the business unit level to determine the ways in which the objectives of these units can be achieved. Corporate strategies are developed by the top-level managers, including the CEO , Board of Directors and Managing Director, whereas business strategy is developed by the middle-level managers, including the departmental, division or line managers.
Strategic decisions at corporate level are usually analytical and focused on value generation, organizational growth and maximization of profits.
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