Dr. Harris Turinoharristk@indo.net.id

harristk.blogspot.com

Corporate vs. Business Level Strategy

Business Corporate

Challenge Build competitive advantage Increase parenting advantage

Purpose Beat competitors to:• Grow revenue and profit• Grow market share

Beat competitors by:• Add more value to its businesses

Competitor • Other businesses in industry• Substitutes

• Other parent companies which own similar business

• Investment institutions

1. The Concept of Diversification

2. Diversification and Performance

3. Corporate Parenting

AGENDA

Introduction

In investment field, the purpose of diversification

is risk reduction.

In business field, diversification have several

motives and purposes.

Diversification is the act to form portfolio that comprises of some assets.

Diversified Company

multiple divisions and/or SBUs, or

multiple product lines, or

multiple market segments (by geographic

location or customer type)

A Company can be considered diversified if it has:

Existing Market New Market

Exis

tin

g P

rod

uct

New

P

rod

uct

Igor Ansoff

Ansoff Matrix (1957)

Market Penetration

• Increase sales per customer

• Find new customer in existing segment

Market Development

• Offer product to new market segment (geo-graphic or customer type) – Delta Airline

Product Development

• Develop new product with different charact-eristics to existing market segments - Apple

Diversification

• Develop new product to new market segment

Business Development

Motive for Diversification

Operational economies of scope and scale (Strategic Competitiveness)• shared and transferred activities• leveraging core competencies

Financial economies of scope (Internal Capital Market)• internal capital allocation• risk reduction• tax advantages

Anticompetitive economies of scope (Market Power)• Multimarket competition• exploiting market power

Maintain and Increase Growth (Growth Motive)• avoid declining industries (portfolio renewal)• grasp new growth opportunities

Cross utilization

Cross Utilization

Assets Amortization: SBUs share same strategic assets.

Assets Improvement: strategic assets in one SBU are used to improve strategic assets’ quality in other SBUs.

Assets Creation: strategic assets in one SBU are used to create new strategic assets for other SBUs.

Assets Fission: Knowledge and experience in creating new strategic assets for new SBU provide insight (feedback) to improve strategic assets’ quality in existing SBU.

Example: Honda Motor Co. Ltd

Assets Amortization: All SBU use at least three corporate strategic asset (brand, machine

technology, distribution knowledge).

Assets Improvement: Honda build distribution channel for motorbike based on knowledge and

experience in car (both have much similar characteristics).

Assets Creation: When creating distribution channel for motorbike, Honda got insight and

inspiration to build “parallel network” (achieve more rural areas) for its other SBU, i.e. lawnmower.

Assets Fission: Knowledge and experience from building parallel

network can be used to expand car and motorbike distribution channel (deep penetration).

Direction of Diversification

Upstream

Midstream

Downstream

Industry A Industry B

sub sub

Horizontal Diversification

Vertical Diversification

Lateral Diversification

(Conglomeration)

Level of Diversification

Type SR Note

Single Business

SR > 95% 95% of revenues come from single business unit (focus diversification)

Vertically integrated

SR > 70% More 70% of revenues come from series of SBUs in a value chain

Dominant Business

95% <= SR <= 70%

70% - 95% of revenues come from single business unit

Related SR < 70% • Majority of businesses share linkage, or• Majority of businesses linked to at least one

other businesses

Unrelated SR < 70% Most of SBUs are not linked each others

Low

High

• SR = specialization ratio = share of main SBU in total corporate revenue

Example: Honda Motor Co. Ltd

Net Sales 2010:

Automobile business : 76.4%

Motorcycle business : 13.3%

Financial service business : 7.1%

Other business : 3.2%

(power generator, lawnmower, ski vehicle, aircraft

engine, solar cell, etc.)

• What is the diversification level of Honda?• What if automobile business net sales

drops to 60%?

Way to Diversify

Corporate Venture

Creating division or SBU internally.

Acquisition

Acquire other business and integrate it into corporate management

Strategic Alliance

Creating SBU by joint venturing with other parties

Diversification Development

1960s – 1970s: Broad (related and/or unrelated)

diversification was a fashion.

1970s – now: Related diversifications tend to outperform

the unrelated one.

1980s: Corporations tended to refocus their portfolio

around the core business. Some corporations almost

become single business (e.g. Nokia).

1990s – now: Some researches indicate that moderate

diversification tend to be better than focus.

Overdiversified refocusingUnderdiversified more diversification

Diversification Trend

1949(%)

1954(%)

1959(%)

1964(%)

1969(%)

1974(%)

Single Business 42.0 34.1 22.8 21.5 14.8 14.4

Vertically Integrated 12.8 12.2 12.5 14.0 12.3 12.4

Dominant Business 15.4 17.4 18.4 18.4 12.8 10.2

Related 25.7 31.6 38.6 37.3 44.4 42.3

Unrelated 4.1 4.7 7.3 8.7 18.7 20.7

Source: Rumlet (1982)

Fortune 500 Companies: 1949 - 1974

1950 1960 1970 1980 1990 2000 Now

Broad diversificationRefocus

(related diversification)Moderate

diversification

• Only 1% Fortune 500 did refocusing

• 1960s: diversification was a fashion.

• It signaled a strong company.

• 47% North America Companies refocused their business (Wall Street Journal, 1985)

• 20% - 50% Fortune 500 did refocusing (Markides, 1993)

• Diversification index dropped from 1.0 to 0.67 (Grant, 1998)

• Moderate diversified companies outperformed focused and broad diversified companies (Harper & Viguerie, 2002).

• It is more related diversification

Diversification In History

Focused, Moderate, and Diversified

Which Diversification Performs Better?

Perf

orm

ance

Single Business

Related Diversification

Unrelated Diversification

Last four decades researches seem to support curvilinear

relationship between level of diversification and performance,

but some researches did not indicated consistent results.

Why Related Diversification Fails?

Increasing the costs of sharing, i.e.:o Cost of coordination: greater complexity.o Cost of compromise: suboptimal of SBU performance

due to the necessity of sharing it with other SBU.o Cost of inflexibility: difficulty to respond or exit due to

greater firm size and bureaucracy.

Information-processing capability (bounded rationality).

Political maneuver and agency problem.

Acquisition premium paid.

Source: Whittington (1999)

Some corporations tend to continue diversifying their

portfolio (become conglomerates), especially in

Europe

Which Diversification Performs Better?

Why Unrelated Diversifications Occur?

Cognitive relatednessManagers believe that they have management logic or process knowledge to run seem-similar business (e.g. chemical vs. drug store).

Conglomerates as cluster managersConglomeration can be viewed as group of unrelated clusters of related businesses. Corporation might control each cluster financially, where each cluster consists of related businesses.

Efficient internal capital market (governance structure)o Slack resources vs. attractive opportunities (excess resources)o Risk-return balancingo Principal-agent consideration

Superior talentCorporations have superior talent, and/or have capability to attract or to develop talent.

Which Diversification Performs Better?

Source: BCG (1996)

There are bad and good conglomerates as well as

bad and good single businesses.

Academic researches can not indicate

consistently which diversification level

perform better yet.

It is too simple to relate performance only

with level of diversification.

Investigation should accommodate other

factors, such as form of organization,

management competence, corporate style,

etc.

Which Diversification Performs Better?

Corporate Strategy Perspective

BUSINESS SELECTIONWhat business should we own or divest, how portfolio mix

should we balance.

VALUE ENHANCINGWhat organizational structure, management process, and

philosophy should we develop to foster superior performance.

Two major tasks of corporate strategy:

The best corporations create more value than any of their rivals if they owned the same business

Existing Value Enchancing Concept

BCG Matrix

The businesses are related if their cash, profit, and growth performance create a balance within portfolio (star, cash cow, and question mark).

Core Competence Concept (Hamel & Prahalad, 1990)

The businesses are related if they shared technical or operating

competencies.

Corporations will create more value if they are able

to build related business portfolio.

BCG Matrix

Deficiencies

Those concepts does not account for the success

of broad diversified corporations (e.g. GE).

Those concepts has not provided practical

guidelines for developing corporate-level strategy.

Campell, Goold, and Alexander (1995) proposed The Parenting Model to fill those deficiencies.

This model was built based on the fitness between parent (corporation) and its businesses (SBUs).

Corporate A

SBU-A1 SBU-A2

Corporate B

SBU-B1 SBU-B2 Firm 2

Investment Company

Investors

Firm Value= 100

Firm Value= 70

Firm Value= 75

Parenting Concept

Parenting Advantage

Fitness

Parenting Advantage

Parent Characteristics

Business (SBU) Characteristics

Decision about the parent

Decision about the portfolio

Parent’s Rivals

Environmental Changes

Corporate Strategy Framework

FIT

FIT

Identify CSF for each businesses

Identify Parenting Opportunity (PO)

Evaluate Parent Characteristics (PC)

Assessing Fitness

FIT = add value =parent knows the

business, and influence

operational positively

FIT = add value =Parent knows where the improvement opportunities is

Understanding the business Identify Improvement Areas

• Portfolio decisions• Characteristics

decisions

Understanding the business

Identify Critical Success Factors

Product branding V V

Selling V V

Product mix mgt V

Capacity utilization V

Biz development skill V

Formula branding V V

Positioning to match locality V V V

Site selection V V V V

Property development cost V V V

Value engineering V V

Detailed operating control V V V

Mgt selection & training V V V

Supply chain logistic V V V V

Low overhead V V V V V

Food Production

Property Resto HotelRetailCritical Success Factors

Identify Parenting Opportunities

By analyzing this areas:

• Size and age• Management• Business definition• Predictable errors• Linkages• Common capabilities• Special expertise• External relations• Major decisions• Major changes

• Major challenges facing a business

• Influence of parent on a business

• Influence of parent rivals on same business

PO might be identified on:

Identify Parenting Opportunities

Major challenges facing a businessExample: restaurant business face two challenges: (1) expand capacity, and (2) lower cost by increasing purchasing.

Influence of parent on businessRetail, restaurant, and hotel business need training facilities to improve their leaders’ management skill.

Identifying improvement areas in business, through analyzing:

Influence of rivals on same businessIt can be obtained by public documents, individuals in rival companies, consultant, or benchmarking.

Parent Characteristics

Mental map: value, aspiration, rule of thumb, success formula that guide parent managers as they deal with the business

Structure, System, Process: mechanism through with the parent

creates value, e.g. HR system, budgeting, decision making structure, capital approval system, information flow, etc.

Central functions and Resources: function and resources that are managed by parent, e.g. patent, brand, government relation.

Managers’ capabilities: people with unique skill and experience, or

key individuals in parent organization.

Decentralization: delegation of responsibilities and authority from parent to its business.

Fitness Judgement

Judge the fitness by answering these questions

honestly:

Does the parent have PC that fit the PO?

Can the parent exploit the upside potential of those

relationship?

Is there a misfit between PC with business’s CSF?

What is the potential downside of the relationship?

HighPO – PC Fit

Low

High

CSF

–P

C M

isfi

t

Parenting-Fix Matrix

HeartlandBallast

Value TrapAlien Territory

Edge of Heartland

Low

HighPO – PC Fit

Low

High

CSF

–P

C M

isfi

t

HeartlandBallast

Value TrapAlien Territory

Edge of Heartland

Resto

Food Product

Hotel

Property

Retail

Example

Low

Heartland Business

None of PCs conflict with business’s CSF.

Parent is able to identify which area can be improved to add more value to its business.

Heartland business = core business.

Priority to improve.

PCs that fit its heartland business = core competence.

Edge of Heartland Business

For some business, making clear judgment is difficult.

Some PCs fit, but others do not.

Net value added almost zero.

Parent should learn more enough about CSF to avoid destroying business’s value.

Case: Unilever acquired Calvin Klein (CK)o Unilever did not impose its famous talent on CKo Unilever did not use market research to launch CK’ upmarket perfumeso Unilever treated CK as a global business (not regional)

Ballast Business

Most portfolios contain a number of ballast business

Majority of PCs fit CSF comfortably, but parent can not find potential for further improvement (POs).

Ballast business is a source of stability.

Most managers instinctively choose to hold on.

When environment change, it can turn into alien territory.

Parent should find POs, or divest them to other parent as they can get good price (even that business contribute big revenue)

Parent with too many ballast business can easily become target for a takeover

Alien-Territory Business

Most PCs misfit both either CSF or POs.

These business is more likely to destroy than to create value normally, parent should divest them.

Nevertheless, parent managers often have many reason to hold on, e.g.:

business is currently profitable, in the process of a turnaround, has growth potential, parent is learning how to improve fitness, there are few ready buyer, there is commitment from business manager, POWER bias, so forth.

Food product industry has become international, thus national business is less competitive. Parent has little international experience,

Value-Trap Business

They are business with a fit in POs, but misfit in CSF.

The POs often blinds parent to the misfit.

Example: Hotel business in food company

The parent believe its restaurant and retail skill would bring success in the hotel business

Parent initially saw it as edge of heartland experiment, with POs in food purchasing, property development cost, and performance benchmarking.

But value was destroyed in other vital areas: selling skill, referral from other business, and specialized site selection, where parent has not enough skill on them.

Make Decision

From Parenting-Fit Matrix, parent might:o Acquire or divest businesso Change PC (skill, resources, mental map, etc)

Researches suggest that PC are built on deeply held values and beliefs, so they are hard to change fundamentally, even parent parents constantly modify and fine-tune their PCs.

Parents are coming to understand that it is often easier to change the portfolio to fit the PC, than to change PC to fit the businesses.

This realization accounts for the rise in demerges and corporate-level breakup.

Summary

Business Recommended Action for Parent

Heartland Hold on and Improve

Edge of Heartland

• Learn more about business’s CSF• Improve some parent’s skill (if possible)• Move business into Heartland

Ballast • Evaluate the business environment changes• Find POs as soon as possible, or• Divest to other parent

Alien Territory

• Evaluate objectively the judgment for these business• Divest quickly

Value Trap • Evaluate objectively vital CSFs that do not fit PC • Improve some parent’s skill (if possible), or• Divest to other parent