Corporate-Level Strategy

CB4303: Lecture Week 8

Chya-Yi Liaw, Emily

Department of Management
City University of Hong Kong
Strategic Management Process

Three ongoing, interrelated processes:

Strategic
Analysis

Business-Level
Strategic Strategic Corporate-Level
Implement Formulation International

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 Topics Overview

Corporate-level strategy
Definition and main concerns
Vertical integration and industry value chain
Transaction costs and boundary of firms
Product / service diversification
Related or unrelated diversification
Geographic diversification

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Two generic business strategies to achieve competitive advantage: increase differentiation (while
containing cost) or lower costs (while maintaining differentiation). If trade-offs can be reconciled by
blue ocean strategy: increasing differentiation and lowering costs.
From Business- to Corporate-Level

Business-level strategy:
Designed for a firm, or a division of a firm, that
competes within a single business to achieve
competitive advantage
A firm can diversify into new businesses
outside its original business
Strategy made by each new business affects
competitive advantage of the entire firm
Need corporate-level strategy
As firms grow, they are frequently expanding their business activities through seeking new markets
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both by offering new products and services and by competing in different geographies.
Aka The decisions that senior management makes and the goal-directed actions it takes to gain
and sustain competitive advantage in several industries and markets simultaneously.

Corporate-Level Strategy

The strategy a firm takes to gain a competitive

advantage through selecting and managing
multiple businesses simultaneously
Addresses where to compete along three
dimensions:
Industry value chain
Products and services
Geography (regional, national, or global markets)

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 Main Concerns

In what stages of the industry value chain

should the firm participate?
Related to the topic of vertical integration
What range of products and services should the
firm offer?
The topic of related vs. unrelated diversification
Where should the firm compete geographically?
International strategy
in terms of regional, national, or international markets
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 Corporate-Level Strategy and
Growth
Economies of scope - savings that come from providing different outputs. services at less cost than producing each
individually, though using the same resources and technology
Increase profits Benefit from economies of scale, thus driving down average costs as
output increases. Firms need to grow to achieve minimum efficient scale
Lower costs: Growth enables efficiency
Consolidate industries through horizontal M&A (buying
Increase market power competitors) to change the industry structure in their favor
Fewer competitors, more bargaining power,
with suppliers and buyers
higher profitability
falling sales and lower performance in one sector (e.g., General Electric’s oil and
Reduce risk gas unit) might be compensated by higher performance in another (e.g., GE’s
health care unit). Conglomerates help achieve economies of scope
Low performance in one business can be
compensated by another
Profitable growth allows private business to provide higher return for shareholders; Public companies’ stock
market valuation is determined by expected future revenue & profit streams. E.g. Amazon’s high stock price =
expectations of future profitability. If firms fail to achieve growth target, stock price falls. -> lower market 7
capitalization -> risk of hostile takeover & difficult to raise capital to fuel future growth by issuing stock.
Vertical integration is the firm’s ownership of its production of needed inputs or of the channels by which it distributes its outputs

Vertical Integration and Industry

Value Chain
. Industry value chains are also called vertical value chains, because they depict:

The transformation of raw materials into finished goods and

services along distinct vertical stages

Benefits of vertical integration:

■ Lowering costs & Improving quality.
■ Facilitating scheduling and planning.
■ Facilitating investments in specialised assets.
■ Securing critical supplies & distribution channels.

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Each stage of the vertical value chain typically represents a distinct industry in which a number of different firms are competing
 Text

Types of Vertical Integration

Backward vertical integration

Moving ownership of activities upstream to the
originating inputs of the value chain
Forward vertical integration
Moving ownership of activities closer to the end
customer
Similarly to HTC, Foxconn is moving backward in the industry value chain into design of consumer electronics and
forward into marketing and sales by using the Sharp brand.

Foxconn, Apple’s largest OEM, vertically integrates along the industry value chain. In 2016, it purchased the struggling
Japanese electronics manufacturer Sharp for some $4 billion. Sharp is known for its high-quality display panels (used in
smartphones) as well as other innovative consumer electronics such as microwave ovens and air purifiers.

Foxconn hopes to move upmarket by leveraging Sharp’s strong brand name, and to benefit from the Japanese high-tech
company’s efforts to produce organic light-emitting diode (OLED) displays. This shows that OEMs, over time, tend to
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acquire skills, know-how, and ambition to move beyond mere manufacturing, where profit margins are often razor thin.
 Boundary of Firms

Which value chain activities should be

performed internally, and which should be
negotiated or bought on the market?

Make: Integration pursue in-house (“make”)

obtain externally (“buy”).
Buy: Contractual arrangement

which is then related to firm size

Costs of using the market such as search costs, negotiating and drafting contracts, monitoring work, and enforcing
contracts when necessary may be higher than integrating the activity within a single firm and coordinating it through
an organizational hierarchy. 10
A theoretical framework in strategic management to explain and predict the boundaries of the firm,
which is central to formulating a corporate strategy that is more likely to lead to competitive advantage.

Transaction Cost Economics (TCE)

Proposed by Ronald Coase (1937) to explain the
existence of firms, won Nobel Price later
Early economic theory focuses on industry-level
analysis, i.e., market-price mechanism
All activities directed by market and market price
(e.g., barter, trading, selling/buying)
Firms proliferated after WW1
Why do firms emerge? Why are not all transactions
in the economy mediated over the market?

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Transaction cost: All internal and external costs associated with an economic exchange, whether
within a firm or in markets.

Nontrivial search costs: Rather than owning the various production and distribution activities within
the firm itself, perhaps the biggest disadvantage of transacting in markets

Firms emerge because the market is not perfectly

efficient to organize all activities (imperfect market)
Transactions costs are the costs associated with
acquiring an input that are in excess of the amount
paid to the input supplier These are external transaction costs,
incurred when companies transact in the open market.
Search and information costs: identify goods
available in the market, find lowest price etc.
Bargaining costs: stipulating agreement/contract
Policing and enforcement costs: monitoring,
quality inspection Contracts Enforcement: often is difficult, costly & time-consuming.
Litigation absorb a large amount of managerial resources & attention and easily amount to several million dollars in legal
——
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fees. Legal exposure occurs when using markets rather than integrating an activity within a firm’s hierarchy.
Oliver E. Williamson (1975) further expanded TCE to
explain a number of different behaviours that
involve use of contract, also won a Nobel Price
Specify the source of high transaction costs:
Limited rationality of actors
Opportunistic behavior of actors
Opportunism is behavior characterized by self-interest seeking with guile
Transaction frequency
Transaction uncertainty
Asset specificity
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 If the assets are produced for a specific use, it might not be suitable for alternative use,
and that would incur higher transaction cost

Asset Specificity
Unique assets with high opportunity cost
They have significantly more value in their
intended use than in their next-best use
Examples:
Physical asset specificity: Unique physical and
engineering properties (e.g., Coca-Cola bottle)
Human asset specificity: Investments on human
capital (knowledge/skills for specific process)

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Benefits of firm
1. Make command-and-control decisions by fiat along clear hierarchical lines of authority
2. Coordination of highly complex tasks to allow for specialized division of labor.

When market transactions become too

expensive, the activities should be integrated
within a firm to avoid transaction costs
Benefits of integration:
Long-term contracts to replace short-term ones
Hierarchical control reduces transaction costs
(e.g., better communication, better quality
control, faster decision etc.)
- Allow transaction-specific investments, e.g. specialized robotics equipment that is highly valuable
within the firm, but of little use in the external market.
- Create a community of knowledge —> employees have ongoing relationships, exchanging ideas
and working closely together to solve problems —> facilitates development of a deep knowledge 15
repertoire and ecosystem within firms.
Situation in which an agent performing activities on behalf of a principal pursues his own interests.

Principal-Agent Problem

Same as markets, firms also involve costs to

organize activities
Principal-Agent relationship

delegates activates to the salaried employee

Agent acts on behalf of the principal

Disadvantages of organizing economic activity within firms:
■ Administrative costs because of necessary bureaucracy.
■ Low-powered incentives, e.g. hourly wages, are less attractive motivators than the
entrepreneurial opportunities and rewards that can be obtained in the open market.
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■ The principal–agent problem.
Principal-
Incentives between the principal and the agent are
not always aligned
Manager (principal): Aim for higher business
performance, e.g., more sales, better reputation
Employee (agent): Fixed income, the only way to
earn extra profit is by lowering operating costs
Agent shirking harms principal business
Principal incurs extra costs to monitor and regulate
agent, and align incentives
Agency cost
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Advantages of markets: 1) High-powered incentives. Rather than work as a salaried engineer for
an existing firm, an individual can start a new venture offering specialized software.

Make-or-Buy
Liquidity events- entrepreneur’s ability to capture the venture’s profit, to take a new venture through
an IPO/ to be acquired by an existing firm —> make enough $ to provide financial security for life.

P.15

2) Transacting in markets
enables those who wish to
purchase goods to compare
prices and services among
many different providers.

P.16
P.12

Incomplete contracting. Although market transactions are based on contracts, all contracts are incomplete to some extent,
because not all future contingencies can be anticipated at the time of contracting. Difficult to specify expectations (e.g.,
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stipulates “acceptable quality” in a graphic design project?) or to measure performance and outcomes
 Example
Integrated circuit design

Two parties: An IC design house and an IC

fabricator
The decision of fabricator to integrate into
design business

development by acquiring the design house

(backward integration)

from the design house through licensing

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 Licensing Integration

D IC Design
IC Design
IC Fabricator IC Fabricator
House House

A bilateral relationship with A decision made by IC

one-way transaction fabrication to integrate
Presence of complementary design house
assets Access to complementary
assets
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Buying use of the IC design
Some difficulties include: Pricing, verification of
design value, provision of other technical
supports, knowledge protection
Transaction costs
Integrating IC design house
Some difficulties include: Merging organization
culture, employees withholding market and
technical information
Agency costs 21
The decision of make or buy is guided by
comparing transaction costs and agency costs
If transaction costs higher, integration better
If agency costs higher, external purchase better
The decision determines boundary of firms

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SHORT-TERM: a firm sends out requests for proposals (RFPs) to several companies —> initiates
competitive bidding for contracts to be awarded with a short duration, generally less than one year.

Make-or-Buy Continuum
benefit: - allows a longer planning period than individual market transactions
- buying firm can demand lower prices due to the competitive bidding process

drawback: firms responding to the RFP have no incentive to make any transaction-specific investments
(e.g., buy new machinery to improve product quality) due to the short duration
strategic alliances
Voluntary arrangements between firms that involve the sharing of knowledge, resources, and
capabilities with the intent of developing processes, products, or services.

Equity Alliances: a partnership in which at least one partner takes partial ownership in the other partner.

JV: two/ more partners create and jointly own a new organization. Since the partners contribute equity to a
joint venture, they make a long-term commitment, which in turn facilitates transaction-specific investments.
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 Additional Information

Unrelated Diversification
• Financial economies
hierarchies: Analysis and antitrust
■ Restructuring
■ Internal capital markets

• Influence costs
Jensen and Meckling
firm: Managerial behavior, agency costs and
Journal of Financial
 Corporate Diversification

Increase in the variety of products or services

a firm offers:
The variety of products / services a firm offers, or
The markets / geographic regions in which it
competes
Can be targeted towards:
Products and services
Geography
Product and service + Market
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A firm follows a related diversification strategy when it derives less than 70% of its revenues from a single
business activity and obtains revenues from other lines of business linked to the primary business activity.

Related Diversification
Benefit from economies of scale and scope: These multi-business firms can pool and share resources as well
as leverage competencies across different business lines.

Related diversification occurs when a

company expands into a new business similar
or related to its existing business activity
often results in a diversification premium:
Benefits: stock price of related- diversification firms is valued at greater than
the sum of their individual business units.
1. Savings on economies of scope between its
businesses
2. Gain market power relative to competitors
E.g. ExxonMobil move into natural gas in 2009. It bought XTO Energy, a natural gas company, that is known fo
its core competency to extract natural gas from unconventional places such as shale rock. ExxonMobil hopes
to leverage its core competency in the exploration and commercialization of oil into natural gas extraction. The
company is producing nearly equal amounts of crude oil and natural gas, making it the world’s largest producer
of natural gas. It believes that roughly 50% of the world’s energy for the next 50 years will continue to come
from fossil fuels, and that its diversification into natural gas, the cleanest fossil fuels in terms of greenhouse
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gas emissions, will pay off,
E.g. ExxonMobil from last page/
TB P.292 North Carolina National Bank bought smaller banks to supplement its organic growth.

1. Savings on Economies of Scope

further improve its market position. It then turned its core competency to national banks, with the
goal of becoming the first nationwide bank. NationsBank, rebranded as Bank of America since
1998, deployed its core competency of selecting, acquiring, and integrating other commercial
banks to grow in size & geographic scope, emerge as one of the leading banks in the US
Leverage core competency

and capabilities that distinguish a firm

Often intangible resources difficult for
competitors to understand and imitate
Core competence developed in one business and
transferred to other business at no (or little)
additional cost
Immediate competitive advantage achieved
through transfer of core competence 27
1. Savings on Economies of Scope

Share activities
Share tangible and value-creating activities:
Share manufacturing skills and know-how
Share marketing skills and knowledge
Share distribution channel and customers
Access to R&D capabilities
Cost savings through elimination of jobs, facilities
and related expenses, or economies of scale

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 2. Gain Market Power

Market power refers to a firm's ability to

manipulate the price of an item in the market
by controlling level of supply, demand or both

increased scale or size

Two ways to create market power:
Vertical integration
Eliminate the power of suppliers/ distribution channels
Pooled negotiating power
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 Pooled Negotiating Power

The group of similar businesses within a

position relative to suppliers and customers

To suppliers: Reduce supplier bargaining power
by large volume purchases
To customers: Reduce customer bargaining
power by providing a wide variety of products

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 Unrelated Diversification

Unrelated diversification involves adding new

businesses that are significantly different from

Benefits:
1. Create value through corporate parenting
2. Create value through restructuring
Businesses share very few competencies in products, services, technology or distribution,
if there is any. E.g. Samsung

A company that combines two/ more strategic business units under one overarching corporation
and follows an unrelated diversification strategy is called a conglomerate.
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 1. Corporate Parenting

Parenting allows the corporate office to create

value through management expertise and
competent central functions, such as
Improve plans and budgets
Provide support activities functions (e.g., legal,
human resource, procurement, etc.)
Help subsidiaries make expansion decisions

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 2. Restructuring

In restructuring the parent intervenes in,

Asset restructuring: Selling unproductive assets
Capital restructuring: Changing the debt/equity
mix, adding debt or equity
Management restructuring: Changes in the top
management team, organizational structure, and
reporting relationships
Restructuring makes the new business more
profitable for resale, or the corporate office can keep
it to enjoy the benefits
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 Portfolio Management

Portfolio management is to understand the

competitive position of a group of businesses
Main concerns:
How to allocate resources among these
businesses?
What is the strategic alternative for each
business?

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The individual SBUs are evaluated according to relative market share & the speed of market
growth. Each category needs a different investment strategy.

Star BCG Matrix

Earnings: High, stable/ growing | Cash flow: Neutral
Strategy: Hold or invest for growth Question Mark
Earnings: Low, unstable, or growing | Cash flow: Negative
Strategy: Increase market share or harvest/divest
Each circle
represents one

business units
Size of circle
represents the
relative size of
the business
unit in revenue
Dog
Earnings: Low, unstable
Cash Cow Cash flow: Neutral or negative
Earnings: High, stable | Cash flow: High, stable Strategy: Harvest/divest
Strategy: Hold
 Limitations of BCG Matrix

Business units compared on only two dimensions

Are these the only factors that really matter?
Can every unit be accurately compared on that
basis?
Treat each business unit as an independent entity
Oversimplified model, overlook manager experience
Following strict rules for resource allocation can be
-term viability

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E.g. KFC the world’s largest quick-service chicken restaurant chain, operates 20,000 outlets in some 120
countries.Interestingly, ut has more restaurants in China with over 5,000 outlets than in the US, its birthplace,
with some 4,500 outlets. Of course, China has 1.4 billion people and the United States has a mere 320 million.

Geographic Diversification

International strategy
Concern on multinational enterprises (MNEs)
MNEs early definition: Substantial direct
investment in two or more countries
MNEs more recent definition:
Consider varied set of financial, legal, contractual
relationships with different foreign affiliates
Require active, coordinated management of
operations in different countries
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 Three main puzzles:
1. What motives firms to expand overseas?
Firms that expand abroad are likely to operate
at a disadvantage to the host-country
competitors
2. How to choose from different entry modes?
3. How to manage the diversified global
operations?
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 Week 9

Case:
Sony Corporation: Is the Sum Greater than the
Parts? (Harvard case, TB0365)

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