3. Corporate Level Strategy PDF

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Strategic Management Lecture Notes...

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The Strategic Management Process

Corporate Level Strategy deals with the overall scope of the company and how value is added to the business unit thanks to the existence of headquarters. Key questions: Which businesses to enter or exit? Which business unit of the portfolio should the company keep? If the company wants to grow its portfolio should it be through vertical integration or diversification? The logic of Corporate Level Strategy and Portfolio Management The role of the headquarters (corporate parent) in portfolio management Value Creation and Portfolio Management Business Level Strategy makes sure that each SBU is performing well individually. Headquarters are responsible for the creation of value that is a result of the R&C Synergies between different SBUs.

The Logic of Corporate Level Strategy Throughout its life, a firm acquires or develops different activities as it grows. A firm is often organized around several SBUsa firm has a portfolio of activities/SBUs. Performance tends to suffer when organizations become very diverse (You can become less efficient, less agile, slower to answer to changes) Corporate parents(headquarters) may seek to add value by adopting different parenting roles: portfolio manager, synergy manager, or parental developer. A company may decide to have one parenting role or play with different types of parenting roles (usually 2 of them) This is done to compensate the performance/value loss that is caused by the diversification of the organization. Portfolio Management (Parenting Roles) Portfolio Manager: Logic of a holding, you basically have the corporate parent(headquarters) which is small and they have diverse business units. The main emphasis is downward (meaning

that the corporate parent will give objectives to the business units. They will also give the resources necessary but let them choose their own strategy and how they decide to create value. Keeps the SBUs autonomous. Synergy Manager: Contrary to Portfolio Manager. Circulation of knowledge and resources & capabilities between different business units is important as the man source of value creation. As a result, the corporate office is usually large and there is still some sort of downward influence (the business units are not fully independent from the parent) but the parent emphasizes coordination between different business units. The corporate parent will identify where are the resources ad capabilities that can be transferred between different business units (moving a successful manager from an SBU to another one) Parental Developer: Corporate office is large. There is still some type of coordination between different business units. But the main emphasis is downward (parent will provide capabilities and resources) E.g. Banking industry: often large corporate offices with a lot of support functions (HR, marketing etc.) and skilled people in the headquarters are sent to the business units for a temporary period to diffuse the knowledge that was gained from the corporate parent. The corporate parent will centralize the R&C and will diffuse them downward when they deem it necessary. Most firms adopt one or two of these parental roles and it depends on the culture, history and the level of diversification of the firm. For example sometimes if you are too diversified, it may not make sense to circulate R&C between SBUs that are too different, so you will adopt portfolio manager role.

Value-adding activities18 There are five main types of activity by which a corporate parent can potentially add value: • Envisioning. The corporate parent can provide a clear overall vision or strategic intent for its business units.19 This should guide and motivate business unit managers to maximise corporation-wide performance through commitment to a common purpose. Envisioning should also provide stakeholders with a clear external image about what the organisation as a whole is about: to reassure shareholders about the rationale for having a diversified strategy in the first place.20 Finally, a clear vision provides a discipline on the corporate parent to stop its wandering into inappropriate activities or taking on unnecessary costs. • Facilitating synergies. The corporate parent can facilitate cooperation and sharing across business units, so improving synergies from being within the same corporate organisation. This can be achieved through incentives, rewards and remuneration schemes. • Coaching. The corporate parent can help business unit managers develop capabilities, by coaching them to improve their skills and confidence. Corporate-wide management 252 courses are one e_ective means of achieving these objectives, as bringing managers across the business to learn strategy skills also allows them to build relationships between each other and perceive opportunities for cooperation. • Providing central services and resources. The centre can provide capital for investment as well as central services such as treasury, tax and human resource advice. If these are centralised

they may have su.cient scale to be e.cient and can build up relevant expertise. Centralised services often have greater leverage: for example, combining many business unit purchases increases bargaining power for shared inputs such as energy. This leverage can be helpful in brokering with external bodies, such as government regulators, or other companies in negotiating alliances. Finally, the centre can have an important role in managing expertise within the corporate whole, for instance by transferring managers across the business units or by creating shared knowledge management systems via corporate intranets. • Intervening. Finally, the corporate parent can also intervene within its business units to ensure appropriate performance. The corporate parent should be able to closely monitor business unit performance and improve performance either by replacing weak managers or by assisting them in turning around their businesses. The parent can also challenge and develop the strategic ambitions of business units, so good businesses are encouraged to perform even better. Value-destroying activities However, there are three ways in which the corporate parent can inadvertently destroy value: • Adding management costs. Most simply, corporate sta_ and facilities are expensive. Corporate sta_ are typically the best-paid managers with the most luxurious o.ces. It is the actual businesses that have to generate the revenues that pay for them and if corporate centre costs are greater than the value they create, then corporate sta_ are net value-destroying. • Adding bureaucratic complexity. As well as these direct financial costs, there is the ‘bureaucratic fog’ created by an additional layer of management and the need to coordinate with sister businesses. These typically slow down managers’ responses to issues and lead to compromises between the interests of individual businesses. • Obscuring financial performance. One danger in a large diversified company is that the under-performance of weak businesses can be obscured. Weak businesses might be cross-subsidised by stronger ones. Internally, the possibility of hiding weak performance diminishes the incentives for business unit managers to strive as hard as they can for their businesses: they have a parental safety net. Externally, shareholders and financial analysts cannot easily judge the performance of individual units within the corporate whole. Diversified companies’ share prices are often marked down, because shareholders prefer the ‘pure plays’ of standalone units, where weak performance cannot be hidden.21 Portfolio Analysis As a company grows, it will acquire diverse business units. SBUs operate on different markets. A single company can not lead the markets in each of its busines units. Role of portfolio analysis tools is to evaluate the current quality of your portfolio Goal: Analyze the quality of a firm’s portfolio of activities:  Its balance: is the portfolio well balanced? (business unit operating on mature markets or an emerging market? Business unit in which you are in a leading or following position? )

 Its evolution: the future of this portfolio, this is needed for strategy When its portfolio is unbalanced, a firm can exit some activities that are not operating efficiently anymore (sell, harvest, divest) or add new activities (organic development, strategic alliances, M&A) to balance its portfolio. The techniques of portfolio analysis rely on two assumptions:  The attractiveness of the SBU (the attractiveness f the market in which this SBU operates): you have this information from the external analysis  The position of the SBU in front of competitors. (from the internal analysis) Boston Consulting Group Matrix (BCG Matrix) Launched in the 80s but used of often because of its simplicity. Two quantitative criteria:  Market growth % (the attractiveness of the market)  The firm relative market share (the position of the SBU in this market)

Limitations: average market growth is defined as 10per cent but in todays business world it was pretty rare to find a market to find a 10 per cent growth. You need to adjust the average market growth for the modern days.

Axis of the BCG Matrix Market Growth: Market growth can be measured in volume or in value. (percentages of tons, increase in euro/dollar etc.) Why did BCG chose the criteria: product life cycle theory (emerging or developing activities are more attractive because they offer long term profitability and potential additional development) Ans SBU that operates in a emerging market will generate more revenue in the long term compared to an SBU that operates in a mature market. This criteria is adapted only to volume industries. (Industries where volume is an important key success factor) Luxury industry: when you sell a luxury item you don’t care about the volume because you already have a high margin in each sale. BCG matrix wouldn’t make sense to apply Relative Market Share Tool: ratio between the local firm’s sales (in volume) and the best competitor’s sales (volume). You include the volume and not the value, because value would include the margin of each competitor but you cant know that. If the ratio >1= the focal firm is better positioned on the learning curve and consequently has less costs and potentially more profits (less cost and more profit than the competitors) If the ratio >1.5= the focal firm is leader in the industry. How to read a BCG matrix?

The market growth will influence the amount of money you need to invest. (The life cycle of the industry: the beginning of the life cycle is the moment you need to invest a lot) I Market share influences the amount of money you receive (profits) P

Stars: PHigh & IHigh Rclose to zero: high profits in a highly growing market, your investments are also high. Which means your results are close to zero. A Star is expensive. Question Mark: The SBU is operating on a highly growing market but you are not well positioned compared to the competitors. Medium profits with very high investment (higher than stars because they need to invest more to catch up) The results are even worse than in the star situation. It is called a “question mark” because you need to question yourself if you will become a start (wll your market share increase) or will you become a dog? Cash Cows: You have a leading position in the market but the market is no longer growing quickly (normal growth) you’re in a mature market so you don’t need to invest much anymore. Your results are very high. It generates a lot of profit. Usually, it used to be star and once the market reached maturity t became a cash cow. Dogs: Low profit because you are not in a leading position and low investment. Results are slightly positive because you don’t need to invest a lot because you are in a mature market.

SBU Priorities Maintain “cash cow” position Invest in “stars” thanks to the profits made by “cash cows”

Choose the “good questions marks” and invest thanks to the profits made by “cash cows” Exit “dogs” Advantages of the BCG Matrix Good way of visualizing the different needs and the potential of the diverse SBU in a portfolio. It warns corporate parents of the financial demands of each SBU. It provides a useful discipline to SBU managers as the corporate parent ultimately owns the surplus resources they generate and can allocate them according to what is best for the whole company. Limits of the BCG matrix  The growth rate is not the only indicator of the attractiveness of an activity (but innovation potential, synergies, margin potential are other indicators of the attractiveness of the industry.) Just because an industry is growing it doesn’t mean that you should enter/remain in this industry.  Depending on the period/market/countries it can be difficult to define the relevant threshold of growth. And if you don’t properly define what is the average growth you can end up with a BCG matrix that is unbalanced.  The relative market share (the way to assess the leadership position) is not the only variable that influence a firm’s profitability. Just because you are the industry leader and sell the most out of all your competitors, it doesn’t mean that you make the most profit. You might control your cost better than your competitors and make the most profit, even though your relative market share is low.  Analyzing market share is looking at the past and not the future. When you calculate market share/growth you always have to wat a full year or at least six months to gather data to calculate these relative markets shares. BCG matrix looks at the past and relies on the past information.  Capital market assumption: the BCG matrix assumes that corporate parents needs a balanced portfolio with cash cows to finance its development.  BCG matrix makes more sense in markets/countries/situation where external sources of capital are limited so you need your own financial resources a.k.a a cash cow to invest in your other business units (but there are other sources of capital such as issuing shares, loans or even business angels and crowdfunding etc.). A start-up will never have a cash cow thus it does not make sense to run a BCG matrix on them.  Potential motivation problems for SBU managers and employees in cash cows and dogs. When you operate in an SBU labeled as a dog, this may not be contributing to your self esteem because you know the dog will be kicked out. Ask a question  The matric ignores linkages between SBUs (an SBU in a portfolio may depend upon keeping a dog alive) The linkage between SBUs re important and can generate value. So

when you kick a dog out you can lose resources and capabilities that were helping your other SBUs. McKinsey Matrix  Created to cope with the limitation of the BCG matrix  A refined tool for portfolio analysis  Multi-criteria analysis (instead of plotting SBUs based on only two criteria -market share and market growth)  Adapted to each industrial context (and not just volume based ones)  More dynamic than BCG Matrix (BCG uses past data while the McKinsey matrix uses current data and addresses the future development of the portfolio better.

Three Main Steps Step 1: Evaluate the attractiveness of the SBU Understand the objectives of top managers and translate these objectives into attractiveness criteria  evaluate the attractiveness of the industry Step 2: Evaluate the competitive position Rank critical success factors. Evaluate the focal firm’s capacity to answer to critical success factors. Evaluate the focal firm’s competitive position (capacity to answer to CFS crossing ranked CSF) Step 3: Draw circles depending on the relative turnover of each activity  Analysis of the portfolio will help you decide the priorities for the future. 1st Step: Evaluate the attractiveness of the SBU  Uses the information collected in the external analysis (PESTEL and 5 Forces Model)  Choose the relevant criteria for the company.  Compare the attractiveness of each SBU to strategic goals of the company (these goals are usually defined by the top managers or shareholders in the early steps of the strategic management process-mission, vision objectives you deal with the objectives here) i. Determine attractiveness indicators and their relative importance (rank 1 to 3) ii. Grade (from 1 to 6) each SBU for each attractiveness indicator iii. Get a balanced grade (to plot on the matrix) -these rankings are given by the McKinsey scale

Example:

Balanced grade: multiply the attractiveness indicator rank with the grade for each SBU

2nd Step: Evaluate the competitive position Goal: Evaluate the position of each SBU according to the critical success factor of the market/industry in which each SBU operates in. 1. What are the most important critical success factors in each SBU? 2. Evaluate the relative importance of the CSF in each SBU 3. Evaluate the degree of control of each CSF compared with the competitor (from -2 to +2) do you control the key success factor better or worse than your competitors? Example: Competitive Position

Portfolio

*in terms of sales: how much the SBU contribute to the overall value creation and sales of the company. SBU 7 and 6 are operating in a market with high attractiveness and they have a high competitive position.

Interpretation 1. Draw a diagonal of the matrix 2. Place the gravity center of the matrix and evaluate its position 3. Analyze the portfolio distribution and the future of the portfolio Portfolio Balance

The “star” is the gravity center Everything on the top left corner is located well.  good signal for the future of the portfolio

Strategy Guideline

If you are on the diagonal you are a “question mark” in the logic of the BCG  select the business units you will keep and the ones you will exit. Divest: get rid of the assets as soon as possible -sell off your activities for probably below the market price Harvest: get rid of the assets but somehow make some profit when you sell them (maybe have some brand reputation, machines that can operate for several years, customers etc.) A portfolio oriented to the future

An analysis on how the portfolio will evolve  the arrows who the direction the SBU will go in the upcoming years. (you can determine the years) Limits of the McKinsey Method  Complex and quite subjective (lots of data, both external and internal analysis, subjective grading so you need an expertise in the industry in which the SBU operates in)  No links to financial aspects (contrary to BGC which is very explicit with what you need to do with the money)  Main strength=multicriteria and adapted to any context (you also have the capacity to draw a portfolio for the future, which is the basis of strategy) The Strategic Direction Thanks to its portfolio analysis, a firm is able to make decision at a corporate level Corporate level decision are decision that create synergies between SBUs and increase the whole corporate value. Three main strategic directions:  Exit (Harvest/Divest)  Consolidation: you observe that the current portfolio of the company works very well and it is perfectly balanced and the company doesn’t have reason to move to other industries. The idea is to protect and reinforce the company position on the current markets with the current products. It is important to not confuse consolidation with immobilism. Consolidation doesn’t mean you get to sit back and relax because you have

to maintain your competitive advantage (by investments, innovation, marketing, services) It is a set of strategic decision to keep the balance of the portfolio.  Development (by vertical integration or diversification)  Diversification: involves increasing the range of products or market served by an organization. (entering new markets either with new products or new geographical markets)  Vertical integration can go in 2 directions i. Backward integration: is movement into input activities concerned with the company’s current business (i.e. further back in the value system) For example acquiring a component supplier would be backward in...