Foundations of Strategy 2nd Edition

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 Grant & Jordan
Foundations of Strategy, second edition
Instructor Manual

Chapter 7: Corporate Strategy

Introduction
The number of sessions the instructor devotes to this topic depends on the time available.
It is worth devoting two sessions to this material if time permits, one on diversification and
one on vertical integration. If this is not possible then the instructor can give a broad
overview of corporate strategy by discussing its major dimensions (vertical scope, product
scope and geographic scope) and key analytical concepts (transactions costs, economics
of scope and the costs of complexity).

The aim is for students to:

• be familiar with the concepts of economies of scope, transaction costs and the
costs of managing complexity and understand how these ideas help to explain firm
boundaries and shifts in firm boundaries over time;
• understand the rationale behind multi-business activity and the potential benefits
and costs of extending the horizontal or vertical scope of a firm;
• be able to evaluate the advantages and disadvantages of changing a firm’s scope
and the different ways of exploiting opportunities for value creation;
• appreciate the trends in diversification and vertical integration over time;
• be familiar with the techniques of portfolio analysis and be able to apply these to
corporate strategic decisions.

Lecture/Instructor-led Session
To capture students’ attention at the start of the class, the instructor could begin by
highlighting a well-known firm’s strategy for growth. For example the strategy of Tesco, the
UK supermarket chain, is outlined in Case Insight 7.1 on page 139. In its 2010 annual
general report Tesco stated that the rationale for its strategy was “to broaden the scope of
the business to enable the [the company] to deliver strong, sustainable, long-term growth
by following customers into expanding markets-such as financial services, non-food and
telecoms- and new markets abroad, initially Central Europe and Asia and more recently
America.” By the start of 2015, following a succession of trading poor results and an
accounting scandal, Tesco had exited the US market and placed much more emphasis on
investing in its core UK food retailing business and pursuing a more disciplined growth
strategy. Students can be invited to comment why Tesco’s strategy has changed. This
discussion provides the opportunity for the instructor to introduce the central themes of
corporate strategy, in particular the notion that by extending its activities a firm has the
potential to add or to destroy value. The concepts of economies of scope, transaction
costs and the costs of corporate complexity are then introduced so that the instructor can
draw on them in his or her subsequent discussion of diversification and vertical integration.
Alternatively, instructors might prefer to show the short video clip at the start, for example,
the video clip that accompanies the opening case to chapter 7.

The session progresses with the instructor:

• Explaining the terminology of corporate strategy;
• Looking at the benefits and costs of extensions in the firm’s scope and ways in
which changes in firm scope can add or destroy value;

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Foundations of Strategy, second edition
Instructor Manual

• Discussing the challenges of managing the multi-business firm and evaluating the
role of portfolio planning models.

If the instructor is devoting two sessions to this there will be time to explore associated
themes in more detail for example, recent trends in diversification and vertical integration,
the empirical evidence on the link between corporate strategy and firm performance,
different means of extending scope (internal vs. external growth) and topical issues such
as outsourcing and off-shoring.

Tutorial/Student-led Session
The short case accompanying this chapter explores diversification by the Disney
organisation. The case deals with Disney’s extension of both its product and its vertical
scope. If instructors prefer to use a longer case then the Virgin Group in 2012 is
recommended. The case and an accompanying teaching note is available on this web-site.
We find that case-based work works well for this topic area but if the instructor wishes to
vary the format then, as an alternative, students can be asked to undertake an internet-
based exercise in which they identify the range of activities undertaken by well-known
(diversified) firms such as Sony, Virgin, Google or Honda. In this case class discussion
centres on the extent to which the different activities in which these firms engage can be
considered to be “related”. Students explore different types of relatedness between
businesses and the advantages and disadvantages of multi-business organisation.

Teaching Notes and Suggested Answers to the Disney Case Questions

Students are asked to prepare answers to the case the questions in advance and, at the
start of class, asked to discuss their answers with other members of a pre-assigned work
group. Each group is asked to start with a different question but then works its way
through the other questions (e.g. group 1 starts with question 1 and works through 2, 3,
4;group 2 starts with question 2 and then considers questions 1, 3 and 4 etc.). Each work
group is then asked to present its answer to its initial question. If there are more than 4
groups, one group presents and the other offers a critique of that group’s answer.

1. How does the concept of ‘economies of scope’ help to explain Disney’s

diversification strategy?

Economies of scope are the reductions in unit costs that result from an increase in
the firm’s output of multiple products so in this context the concept refers to the cost
advantages that Disney achieves by virtue of the broad scope of its activities. The
nature of economies of scope varies between different types of resources and
capabilities (in the text we distinguish between tangible and intangible resources
and organisational capabilities).

Disney categorises its activities under five main headings:

• Media Networks
• Parks and Resorts
• Studio Entertainment
• Consumer Products
• Interactive Media

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Foundations of Strategy, second edition
Instructor Manual

and it is possible to see opportunities for sharing resources and economising across
many of these businesses. In particular the case highlights:
• the economies Disney gains by utilising its characters for merchandising
purposes
• the way in which films promote the theme parks and the theme parks
promote the films
• the way in which Disney’s capabilities in tourism, designing and operating
leisure facilities and land management have been leveraged across
businesses
• the extension of the Disney characters and brand to online games
• the development of shared technologies, strategic planning and
administrative systems
Students may also mention Disney’s financial, land and human resources.

The willingness and ability to exploit economies of scope provides a motive for
Disney to diversify its operations and also helps to explain the direction that
Disney’s diversification has taken.

2. What are the pros and cons for Disney of operating television and cable networks?

Disney’s extension of its activities into television and cable networks can be viewed
as vertical integration or diversification, depending on ones starting position. We
might classify this move as vertical integration if we see Disney’s core business as
the production of animated films and the acquisition of television and cable
networks as a forward move into distribution channels. Alternatively if we take
Disney’s theme parks and tourism interests as the point of departure then the
company’s move into television and cable networks as diversification into another
segment of the “family entertainment” market.

From a “vertical integration” perspective, the pros and cons of Disney’s acquisition
of television and cable networks can be debated in terms of the relative advantages
of internal versus market transactions. The advantages of “internalisation” include
achieving cost savings through the physical integration of processes, lower
transaction costs and avoiding problems of “hold up”. In the Disney case, on the
surface at least, there do not appear to be any strong technical economies
associated with the integration of film production and film distribution (although
historically film producers tended to own cinema chains) but the case emphasises
the threat of “hold up”. Disney relies on the television and cable networks to show
its films so the distribution of Disney content relies on assets owned by other parties
and makes Disney dependant of these parties co-operation in the future. By owning
its own channels it ensures that the output of its studios has a clear route to
audiences and it also reduces the need for costly negotiations with media
companies.

In terms of the “cons”, Disney does not produce sufficient content to fill all the
scheduled slots on its TV channels so it needs to acquire the rights to other content
and needs to balance its own and others output. Specialist capabilities are needed
to run television or cable networks and adding this business to Disney’s portfolio

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Instructor Manual

creates additional complexity. There may be a weaker incentive to produce firms of

high quality films when there is a guaranteed route to audiences and there is always
the risk that a failure in one part of the organisation might adversely affect other
parts.

If we view Disney’s move into television and cable networks from a diversification
then we might also consider growth opportunities created by this move (see, for
example, the ROE for the US entertainment industry 2000-2010 outlined in table
2.1), risk reduction, the benefits of internal capital and labour markets and so on.
On the down side the move into this field of activity has undoubtedly increased the
complexity of Disney’s business portfolio and made it more challenging to manage,
particularly as success may require very different resources and capabilities from
those found in other parts of the organisation.

3. In 2009 Disney announced that it had acquired Marvel Entertainment, a comic book
and action hero company for US$4 billion. How would you evaluate the value-
creating potential of this decision?

If we assume that the aim of the acquisition is to create value for Disney’s
shareholders, then Porter’s three essential tests can be applied (See page 329)

The attractiveness test suggests that the industry chosen for diversification must be
structurally attractive or capable of being made attractive. The case does not
provide any data on the attractiveness of the comic book market but it seems
reasonable to assume that Disney’s main motive for acquiring the firm is to leverage
the potential of its intellectual property i.e. comic book characters and action heroes
such as Spider-Man and Hulk

The cost-of-entry-test states that the cost of entry must not capitalise all the future
profits. Disney paid US$4 billion for Marvel. Students could look at pronouncements
of financial commentators at the time to whether this was seen as a “reasonable”
price. For example the article in the Economist, 3rd September 2009 entitled ‘Walt
Disney buys Marvel Entertainment’ which can be accessed from
http://www.economist.com/node/14376422 suggests that the price was “generous”.

The better-off test requires that the acquired business must gain a competitive
advantage from its link with Disney or that Disney must gain an advantage from its
link with Marvel Entertainment. It is easy to argue. Marvel was able to benefit from
Disney’s capabilities in exploiting animated content through multiple channels
(theme parks, films, television etc) and to quote from the Economist article cited
above “the edgier, darker marvel characters should fill a hole in Disney’s much
cuddlier portfolio”. On the down side many of Marvel’s best known characters were
already contractually tied to other media companies so not available to exploited
immediately by Disney.

4. What are the key challenges Disney’s senior management face in running such a
diverse set of businesses?

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Instructor Manual

Running such a diverse set of businesses inevitably adds to complexity and forces
the organisation to incur some additional administrative costs. Portfolio planning
models can help senior managers to:
• determine how to allocate resources between businesses;
• formulate business unit strategy
• analyse portfolio balance
• set performance targets
Students could also discuss in more general terms problems of designing an
appropriate organisational structure, developing a cohesive culture, facilitating open
communication, managerial overload and so forth. These issues are dealt with in
more depth in Chapter 9 but this question can serve as a way of heightening
students’ awareness of issues to be dealt with later in the course.

Suggested Answers to Self -Study Questions

1. It has been argued that the developments in information and communication
technology (e.g. telephone and computer) during most of the 20th century tended to
lower the costs of administration within the firm relative to the costs of market
transactions, thereby increasing the size and scope of firms. What about the
Internet? How has this influenced the efficiency of large integrated firms relative to
small, specialised firms coordinated by markets?

The internet is an open network that permits the linking of computers through the
public telephone system. Hence, its principal impact has been to lower
communication and collaboration costs between individuals and organizations. The
internet has greatly reducing information and negotiating costs. The result has been
a huge increase in the efficiency of markets and the creation of new online markets.
This has greatly facilitated the outsourcing of activities by firms. Moreover, the costs
of accessing the web, setting up internet based transactions, and creating web sites
to interact with customers and suppliers is very small (especially compared to the
costs of traditional, proprietary corporate IT systems). The result has been to
increase the efficiency of small firms relative to large firms and to lower the cost of
market transactions relative to internal administration. The implication of the internet
and World Wide Web go even further--in some cases networks of individuals
substitute for firms, e.g. open-source software communities.

2. Minor International plc (MINT) is a large Thai conglomerate that owns and operates
over 70 hotel and resorts, runs a range of fast food outlets and is one of Thailand’s
largest distributors of fashion and cosmetics brands. What are the main advantages
and disadvantages for MINT of engaging in such a wide portfolio of activities?

The diversified nature of Minor International’s activities has the advantage of:
• Providing the organisation with opportunities for growth. The hospitality
industry, which forms the basis of MINT’s core activities, is intensely
competitive so MINT’s moves into fast food, distribution of cosmetic brands
etc are likely to provide easier opportunities for growth.
• Reducing risk. If the cash flows from MINT’s different businesses are
imperfectly correlated then MINT might experience greater stability in its

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Instructor Manual

returns than non-diversified counterparts. However, it possible to overstate

this advantage. Its activities may be more highly correlated than they appear
(for example, the company may focus on the distribution of upmarket brands
and its hotel and distribution activities may both be impacted by recession).
• Creating value by exploiting linkages between businesses. For example its
quick service restaurants and hotels may be linked to its shopping plaza
developments as might its distribution of fashion apparel and cosmetics.
Again it is possible to overstate the linkages. For example MINT also
manufactures cheese and ice cream and while we might speculate on the
links between this and MINT’s restaurant business these business are only
tenuously related.
• Allowing MINT to exploit economies of scope. The conglomerate will also be
able to share central administrative services such as financial and property
management and IT services.
• Internal capital and labour markets. One of the big advantages the firm has is
its ability to avoid the costs of using external capital markets and to have
access to information on the financial prospects of their different businesses.
It also will be able to attract talented recruits because of the broad sets of
opportunities available in the firm and will be able to deploy trusted staff
within different divisions of the organisation.
The disadvantage of such a wide array of activities is managing complexity.
Managing strategically diverse business involves the firm in building and sustaining
a wide range of different capabilities and developing sophisticated communications
and strategic planning and control systems.

3. Tata Group is one of India’s largest companies, employing 424,000 people in many
industries, including steel, motor vehicles, watches and jewellery,
telecommunications, financial services, management consulting, food products, tea,
chemicals and fertilizers, satellite TV, hotels, motor vehicles, energy, IT and
construction. Such diversity far exceeds that of any North American and Western
European company. What are the conditions in India that make such broad-based
diversification both feasible and profitable?

The central concepts of economies of scope, transaction costs and the costs of
complexity (outlined on pages 239-241) can be used to answer this question.
Students should be encouraged to debate Tata’s core capabilities and the concept
of relatedness. While Tata’s current business portfolio appears, at first glance, to be
very diverse and idiosyncratic, patterns emerge when consideration is given to
higher-order capabilities and path dependencies. For example students might
consider that Tata’s strength lies in its ability to manage cultural complexity (India is
a diverse and complex country that is home to many different languages, religions,
cultures), its ability to spot opportunities (for example those created when the Indian
economy was liberalised), acquire and turnaround underperforming companies or
its project management capability. Diversity can encourage creativity when different
parts of an organization share ideas and best practice and learn from each other.
From a transaction cost perspective one could argue that capital, labour and
product markets are less developed in ‘emerging’ markets than ‘developed’ ones
and that Tata’s diversity can again be explained in terms of the company’s heritage

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and the pursuit of least cost ways of “organising” in a context where institutions are
underdeveloped. The work by Khanna (see, for example, Khanna, T. & Palepu, K.
(1997) Why Focused Strategies May Be Wrong for Emerging Markets. Harvard
Business Review 75(4) p.41-51) is relevant here.
However, the company, inevitably, faces the challenge of dealing with corporate
complexity and students might argue that Tata is to some extent protected in Indian
markets but as it becomes more global it will face stiffer challenges from more
focussed global competitors.

4. A large proportion of major corporations outsource their IT function to specialist

suppliers of IT services such as IBM, EDS (now owned by Hewlett Packard),
Accenture and Cap Gemini. What transaction costs are incurred by these
outsourcing arrangements and why do they arise? What are the offsetting benefits
from IT outsourcing?

The key benefits of IT outsourcing relate to:

• Developing distinctive IT capabilities—IBM can offer far superior IT
capabilities to my university than my university can provide internally.
• Managing strategically different businesses. For many organizations,
designing, installing and maintaining systems of information and
communication requires very different approaches to management to those
of their main businesses.
• Incentives. The high-powered incentives for contract providers may result in
superior service from that offered by internal providers.
• Flexibility. If the external provider is a large company it may have greater
capacity and technological capabilities that can respond to the changing
needs of the client company.

However, there are also some problems associated with outsourcing and
corresponding benefits from internal provision:
• Transaction costs resulting from transaction-specific investments. IT
outsourcing requires transaction-specific investment: the IT systems must be
located within the client company and need to be adapted to the specific
requirements of the client. This creates scope for “hold-up” and “strategic
misrepresentation”. IT outsourcing contracts must be multiyear and are
always incomplete (future circumstances cannot be accurately predicted)—
hence there is tremendous scope for dispute.
• Coordination issues. IT systems need to be closely integrated with a firm’s
control systems and decision making systems. The greater the need for
integration and the more customized are a firm’s IT requirements, the greater
are the challenges of outsourcing.

5. Electro, a multinational electronics company, operates in four broad product

markets. It produces personal computers, printers and scanners, server computers
(basic infrastructure for corporate IT) and also provides IT services. Its position in
each of these markets is as follows:
• The company is currently the leading manufacturer of personal computers

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with a market share of 20% of the global market. It is, however, facing strong
competition from rival manufacturers whose cost bases appear to be lower
than Electro’s.
• The company’s printer and scanning business has been long been regarded
by the company as its crown jewel. The profits made by this unit are regularly
used to subsidise other parts of the business.
• The company is the third largest supplier of server computers but in recent
years it as lost ground to other established competitors.
• IT services represents a new venture for the company and it has met with
some initial success in this market. Its current capabilities in this area are,
however, limited and it will need to invest heavily and recruit more specialist
staff if it wishes to build this part of the business.

Use a portfolio planning model of your choice to analyse Electro’s position. What
challenges do you face in trying to apply your selected model? What additional
information would you need to make a proper evaluation? What advise might you
be able to offer Electro on managing its portfolio? What are the limitations of the
portfolio approach you have selected?

In chapter 7 we introduce three portfolio planning matrices:

• The GE/McKinsey matrix
• The BCG growth-share matrix
• The Ashridge portfolio display
Any of these matrices can be used for this exercise. Taking the BCG matrix as an
illustrative example, it might be argued that:

In the personal computer market Electro has a relatively high market share but we
know very little about the rate of growth of this market. We could assume that the
annual rate of market growth is low (a mature product) and that that the PCs are a
cash cow for Electro.

We are told that the printing and scanning business is a “crown jewel” and the fact
that profits from this part of the business are used to subsidise others suggests it is
another “cash cow” but there is an absence of any hard evidence.

In the sever business Electro is losing ground although it is the “third largest
supplier”. Again the absence of data on market growth means it is difficult to judge
this product’s position within the matrix. Perhaps a “cash cow” moving towards a
“dog” if servers are a low growth market.

The same absence of information makes it difficult to evaluate IT services. If we

assume this is a high growth market then maybe this is a question mark.

The purpose of the question is not for students to position Electro’s product portfolio
correctly in terms of any given matrix, in fact they will be unable to do so because
only scant information is provided. Rather the main aim of the exercise is for
students to recognise the information requirements of the different models and that
these models involve making subjective judgements about boundaries. For

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Instructor Manual

example, how might we determine whether a business unit’s competitive advantage

is high, medium or low or whether relative market share is high or low? Each of the
frameworks provides prescriptions for strategy e.g. milk cows, invest in stars etc but
the applicability of the advice depends on how much faith is placed on the analysis
that determines the positioning of products or business units within the framework in
the first place. The apparent simplicity of portfolio planning models belies the fact
creating value from the configuration and reconfiguration of a portfolio of
businesses requires detailed and sophisticated analysis of the fundamental
strategic characteristics of these businesses and there are no simple panaceas.

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