CORPORATE STRATEGY A RESOURCE-BASED APPROACH (2nd edition) COLLIS & MONTGOMERY AN INTRODUCTION TO CORPORATE STRATEGY ANTONIO BERNARDOPractice FIGURE 1.1 Corporate Strategy ‘Triangle A Framework for Corporate Strategy _ Our framework starts from the empirical observation that there is no one right corporate strategy. There is not even a taxonomy of a limited nuimber of generic corporate strategies that can be identified as leading. to success. Instead, an effective corporate strategy is a consistent set of five elements that together as a system lead to a corporate advantage that creates economic value—what we call the Corporate Strategy Triangle igure 1.0. ‘The three sides of the triangle—resources; businesses; and organiza~ tion—are the foundations of corporate strategy. When aligned in pursuit ofa vision, and motivated by appropriate goals and objectives, the sys- tem can produce a corporate advantage, which justifies the firm's existence as a multibusiness entity. Vision Ithas been said that “if you don’t know where you are going, any road can take you there.” To eliminate such disorientation and provide direction, the discussion of corporate strategy necessarily begins with vision. Its po- sitioning in the center of the Triangle reflects its central role in the formu- lation and implementation of corporate strategy. ‘One of the strongest finciings of our research was that successful corpo- rations were those that had a vision and were committed to fulfill it over an extended period of time. Indeed, the ability to articulate a coherent vi- sion is a valuable indication that a firm, in fact, has a corporate strategy. ‘A powerful vision should continually stretch the corporation's capabil- ities. For many companies, therefore, the overarching vision is captured in an ambitious aspiration, the time frame of which may be illdefined and. distant." In the 1920s, Ford wanted to put “a car in every home”; in the 1980s, Apple looked toward the future and saw “a computer in every home.” By the 1990s, Bill Gates had gone further yet: “a computer on every desk, and in every home, running on Microsoft software.” (By the ‘end of that decade, this vision had grown to include the Internet.) Each of these simple expressions offers a compelling statement that challenges and motivates employees by providing meaning and fulfillment to thei work. Each also defines the broad domain in which the firm will operate. 7 C.K. Prahalad and G. Hamel, “Strategic Intent,” Harvard Business Review, May-June 1989, pp. 63-77,12 Chapter 1 An Introduction to Corporate Strategy Importantly, defining the domain is primarily concerned with setting the boundaries of the firm—with describing what businesses the corpora- ‘tion will not go into—more than with identifying exactly which businesses it will compete in.!* Within those broad bounds, managers will have the autonomy to operate without the distraction of looking outside the do- ‘main or the interference of being told precisely where to compete. Thus, @ corporate vision should describe, in fairly loose and qualitative terms, the boundary beyond which it will not operate. Nokia's “portable communi- cations’ vision describes a sense of what businesses the company will op- erate in without, for example, being specific as to whether or not liquid ‘exystal displays are part of that domain. Often, visions also describe the ethical values a corporation will adhere to in the conduct of its business, Called the mission in some companies, this part of a vision usually reflects the code of behavior by which em- ployees are governed.” While important, such statements complement, rather than substitute for, articulations about how the company intends to create economic value, Goals and Objectives If the vision describes what the corporation wishes to become in many years’ time, an effective corporate strategy must also have a set of shorter- term goals and objectives. These will serve as milestones on the path to the fulfillment of the vision. Goals and objectives will more immediately io- tivate employees because they are closer at hand and so can be seen to be achievable, Objectives refer to specific short- and medium-term quantitative tar- gets, such as “sustain a 40 percent debt/equity ratio” or “achieve sigma six quality within four years.” Goals, on the other hand, refer to qualitative intentions in the same time frame, such as “improve new product devel- ‘opment capabilities” or “become a global organization.” By providing an immediate challenge to employees, goals and objec- tives can become powerful incentives that support a formal reward struc- ture. Indeed, many companies use some version of an annual corporate challenge, such as “improve productivity by 7 percent,” to supplement the normal incentive scheme and focus attention on particular activities or targets. While the vision itself may evolve through time, and always appear on the horizon, goals and objectives are important strategic hurdles. Re- peated failures to meet goals and objectives imply a threat both to the fea- sibility of the corporate strategy and to the motivation of employees. On ° R Simons, Levers of Control Boston, Harvard Business School Press, 1995), 17 Andreve Campbell, M. Devine, and D. Young, 4 Sense of Mission (London: The Economist Books Limited, 1990).CChapter 1 Ar Introduction 10 Corporate Strategy 13 the route to “encircling Caterpillar,” Komatsu, among other things, had to build a presence outside Japan and license state-of-the-art technology. Had it not met these goals, Komatsu not only might have failed to “encircle Caterpillar,” it might not have survived. Thus, goals and objectives should always be in line with the vision, but should be less of a stretch than the vision itself. Resources This book articulates a concept of corporate strategy that rests on the resources—the assets, skills, and capabilities—of the firm. Resources are the critical building blocks of strategy because they de- termine not what a firm wants fo do, but what it am do. They are the durable stocks that determine competitive advantage at the business unit level, and can distinguish one firm from another. If ll firms had identical resources, all could pursue the same strategy, and the basis for competitive advantage would disappear. Itis only when there are important resource differences among firms that each can develop a distinctive strategy. Moreover, resources determine the range of market opportunities that are appropriate for a firm to pursue and so have a major impact on corpo- rate strategy. Many valuable resources enable a firm to compete success- fully in more than one market. For example, in the early years of the PC industry, IBM was able to build on its reputation and customer list in the computer mainframe business to gain dominance in the market for desk- top machines, even though it was a late entrant and did not have the best technology. Similarly, Emerson Electric's efficient production processes and skills in assembling small electric motors supported its success in a number of different markets. Resources are the ultimate source of value creation both within and across businesses. Therefore, identifying, building, and deploying valuable resources are critical aspects of both corporate and competitive strategy. Businesses ‘The “businesses” side of the Triangle refers to the industries in which a firm operates, as well as to the competitive strategy it adopts in each. Industry choice is critical to the long-term success of a corporate strat- egy. It has repeatedly been demonstrated that the best predictor of firm performance is the profitability of the industries in which it competes.” This is true not only for single business firms, but for firms that operate 18 Jay Barney made this point in “Fim Resources and Sustained Competitive Advantage,” Journal of Managernent, 1981, pp. 98-120. 1 Richard P. Rump, "How Much Does Industry Matter?” Strategic Monagement joural, ‘March 1991, pp. 167-85; Cynthia A. Montgomery and Birger Wemerelt, “Diversification, Ricardian Rents, and Tobin’s 4." Rand journal of Economics, Winter 1988, pp. 623-32; and R.Schmalensee, “Do Markets Difer Much?” American Economic Review, 1985, pp. 341-5114 Chapter 1 Ax introduction to Corporate Strategy in multiple businesses. The underlying economics of the industries in Which a firm competes, therefore, will play an instrumental role in its performance, ‘The set of industries in which a firm operates also influences the extent to which it will be able to share resources across its businesses. The notion of portfolio relatedness, for example, which has underpinned corporate strategic thinking for 30 years, has been used to assess a firm's ability to create synergy among its businesses. Thus, it would be expected that ‘an ice-cream manufacturer like Ben & Jerry’s could compete successfully in frozen yogurt. In contrast, a firm that competes in both aerospace and insurance would be expected to have few opportunities to exploit scope ‘economies, (Although that did not deter either General Motors or ITT from trying to do so!) ‘The particular competitive strategy a firm pursues within each incus~ try also affects corporate performance. Only effective strategies that create competitive advantages produce superior returns in the long run. More- over, the range of competitive strategies a firm pursues may be con- strained by their competing requirements. For example, following a low-cost strategy in personal computers and a differentiation strategy in ‘mainframes may well be futile: The key success factors for each strategy are so different that a firm striving to do both is unlikely to succeed. “Thus, an analysis of a firm’s businesses should include the attractive- ness of their industries, the competitive strategy the firm will adopt in each, as well as the constraints on, and opportunities that exist for, cross- fertilization. Structure, Systems, and Processes Ina complex firm, corporate managers rarely can, or should, make all the critical business-tnit decisions. Instead, they influence delegated decision making through the careful design of the context in which business-unit managers operate. Even the most decentralized corporations, therefore, impose some organizational requirements on their businesses, whether it be financial reporting, capital expenditure budgeting, or human resource ‘management. In tum, these policies have important direct and indirect in- fluences on the decisions made in the businesses, as managers follow the rules and respond to the incentives set by the corporate office.” In establishing a firm’s infrastructure, corporate managers have a wide array of organizational mechanisms at their disposal, from the formal ‘boxes in an organization chart to the more subtle elements of corporate culture and style. Itis these structure, systems, and processes that deter- mine how the company controls and coordinates the activities of its various business units and corporate staff functions. Structure refers to 2 Joseph H. Bower, Managing the Rezcurce Mlocation Process (Cambridge, MA: Harvard University Press, 1970).Chapter 1 An bnoduction to Corporate Strategy 15 the way the corporation is divided into discrete units. It describes the for- ‘mal organization chart that delineates the allocation of authority inside the corporate hierarchy. Systems are the set of formal policies and routines that govern organizational behavior. They are the set of rules that define how tasks, from strategic planning to personnel evaluations, are to be ful- filled. Processes describe the informal elements of an organization's activ- ities. The network of personal relationships that accompany the flow of work inside a company, for example, can be just as influential on behavior as any formal procedures. Because every corporate strategy is different, there is not one optimal set of structures, systems, and processes for all firms. Rather, as Alfred Chandler long ago noted, structure follows strategy?" In other words, a firm’s internal design should flow from its strategy and be customized to fit the resources and businesses of the particular firm. In fact, an inap- propriate design often causes the failure of otherwise well-constructed corporate strategies. Corporate Advantage An effective corporate strategy results from a harmonious combination of the previously discussed five elements. The elements work together as a system to create value through multimarket activity; that is, to yield a corporate advantage. Although some value may be created at the corpo- rate level itself—through a lower cost of capital, for example—most cor- porate advantages are realized at the business-unit level, where individual businesses use the benefits of corporate affiliation to outperform their rivals in a particular industry. Michael Goold and colleagues suggested three questions a firm should ask to test whether or not it possesses a corporate advantage” A modified version of those questions is presented here, in order of increasing diffi- culty, and can be applied to every business a company owns or is consid- ering acquiring: © Does ownership of the business create benefit somewhere in the corporation? © Are those benefits greater than the cost of corporate overhead? * Does the corporation create more value with the business than any other possible corporate parent or alternative governance structure? ‘The first of these questions simply asks whether benefits are created anywhere in the corporation through the firm’s ownership of the business. Generally, these would occur within the business itself, through the transfer: ® Alfred D. Chandler, Strategy and Stexture (Cambridge, MA: MIT Press, 1962). 2M. C. Goold, A. Campbell, and M, Alexander, Corporate evel Strategy (New York: John Wiley & Sons, 1994).16 Chapter 1 An Introduction to Corporate Strategy ‘of resources from other business units or from the corporate level. In some circumstances, the benefits appear elsewhere in the corporation. The owner- ship of Medco, a leading drug distributor, by the pharmaceutical giant Merck may have been such an example. Even if Merck did not improve the distributor's performance (in fact, Merck's ownership may even have harmed the distributor because other pharmaceutical companies preferred to supply competitors), it may, nevertheless, have benefited from the guar- anteed market for its drugs and improved information about customers’ pharmaceutical usage. ‘The second question recognizes that enhancing the competitiveness of a business unit is not sufficient justification for corporate ownership. ‘Whatever they are, the benefits of corporate ownership do not come cost- lessly. No matter how smal the corporate office, or how little intervention there is in the daily affairs of the divisions, the extra layer of management incurs costs and delays and dampens incentives. To justify ownership these costs must be less than the benefits generated. The third question is a very strenuous test to pass. It implies that the corporation must be the optimum owner for a business. Many firms add value to their businesses and so appear to justify their corporate owner- ship. However, if other companies could add more value to the busi- nesses, and would be willing to pay a correspondingly high price to do so, keeping those businesses in the corporate portfolio would be inconsistent with value maximization. Moreover, the firm might be able to realize much of the value of its resources through market contracts with indepen- dent entities. Justifying ownership of a business, therefore, requires that the value created be greater than that which could be achieved if the busi- ness were operated outside the corporate hierarchy. The retailer JC Penney must have understood this when it decided to outsource the running of its catalog business. Although there was value created by JC Penney offering, a catalog, managing it within the corporate infrastructure created less, value than operating it as a separate unit ‘Managers often find this third test hard to accept. In particular, they of- ten resist selling profitable businesses to which they demonstrably add some value. Nonetheless, a strict interpretation of corporate advantage and the maximization of firm value implies that they should do so.