AB3601/2

Strategic Management

Week #6
Corporate Strategy
Case: REC Solar Part I

Leow Foon Lee

AY2023-24 Semester 2
Jan-Apr 2024
0
 Corporate Strategy - Lesson Outcomes

 Categorise different types of corporate-level strategy

(product diversification)
 Explain the motives for product diversification
 Demonstrate how to use a portfolio management tool
Corporate Strategy - Learning Objectives

• Define corporate-level strategy (WHAT) and discuss its purpose (WHY).

• Describe different levels of diversification (WHAT) achieved using
different corporate-level strategies.
• Explain three primary reasons firms diversify (WHY).
• Describe how firms can create value by using a related
diversification strategy (HOW).
• Explain the two ways value can be created with an
unrelated diversification strategy (HOW).
• Discuss the incentives and resources that encourage diversification.
• Describe motives that can encourage managers to over diversify a firm.
3
 Corporate Strategy

• Corporate-level strategy specifies actions a firm takes to gain a

competitive advantage by selecting and managing a group of different
businesses competing in different product markets.
• Corporate-level strategy is used as means to grow revenues and profits.
• Focuses on diversification.
• Expected to help firm earn above-average returns by creating value.
• Concerned with two key issues:
1. What product markets and businesses the firm should compete?
2. How corporate headquarters should manage those
businesses?
 Corporate Strategy

• Product diversification concerns:

• Scope of markets and industries in which the firm competes
• How managers buy, create, and sell different businesses to match
skills and strengths with opportunities.
• Diversification:
• Is successful when it reduces variability in firm’s profitability
as earnings are generated from different businesses
• Provides firms with flexibility to shift investments to markets with
greatest returns rather than being dependent on only one or a few
markets.
 Corporate Strategy
(Product Diversification)
1. To categorize different types of corporate strategy
(product diversification)

2. To understand motives for product diversification

3. To understand how to use portfolio management tools (BCG

matrix and GE-McKinsey matrix)
 Efficient Internal Capital Market Allocation
(slide 1 of 2)

• In a market economy, capital markets are believed to efficiently

allocate capital.
• Efficiency results as investors take equity positions with high
expected future cash-flow values.
• Capital is allocated through debt as shareholders and debt
holders try to improve the value of their investments by taking
stakes in businesses with high growth and profitability
prospects.
 Efficient Internal Capital Market Allocation
(slide 2 of 2)

• In large diversified firms, corporate headquarters office distributes

capital to businesses to create value for overall corporation.
• Those in firm’s corporate headquarters generally have access to
detailed and accurate information regarding performance of the
company’s portfolio of businesses; thus, they have the best
information to make capital distribution decisions.
• Because it has less accurate information, external capital market
may fail to allocate resources adequately to high-potential
investments.
 Types of Corporate Strategy

Determined by Distribution of Revenue and Linkages across Business Units

Types of Corporate Strategy- based on
Relatedness
Relatedness Between Business Units
Two Approaches
 Levels of Diversification (WHAT)

 Diversified firms vary according to their level of

diversification and the connections between and among
their businesses.
 There are five categories of businesses according to
increasing levels of diversification:
 Single business
 Dominant business
 Related constrained
 Related linked
 Unrelated
Levels & Types of Diversification
 Low Levels of Diversification

• Two types of strategies a firm with a low level of

diversification can use:
1. Single-business diversification strategy
• Firm generates >95% of sales revenue from core
business area.

2. Dominant-business diversification strategy

• Firm generates 70~95% of total revenue within single
business area.
 Moderate and High
Levels of Diversification
• Firm uses related diversification strategy when:
• Generates > 30% of revenue outside dominant business.
• Businesses are related to each other in some manner.
• Two types of related diversification strategies:
1. Related constrained diversification strategy
• Links between the diversified firm’s businesses use similar
sourcing, throughput, and outbound processes.
• Related constrained firm shares resources and activities across its
businesses.
2. Related linked diversification strategy
• Firm’s portfolio of businesses have only few links between them.
• Related linked firm concentrates on transferring knowledge and
core competencies between businesses.
 Moderate and High
Levels of Diversification

• Highly diversified firm that has no relationships between

businesses follows an unrelated diversification strategy.
• Commonly, firms using this strategy are called conglomerates.
• Unrelated firms make no effort to share activities or transfer
core competencies between or among their businesses.
 Value-Creating Diversification Strategies

Operational relatedness
provides opportunities to
share resources among
operational activities of
the firm.
Corporate relatedness
provides opportunities
for transferring
corporate-level
competencies across
businesses of the firm.
Value-Creating Diversification: Related
Constrained & Related Linked Diversification

• Company using related diversification strategy wants to

develop and exploit economies of scope between businesses.
• Economies of scope are cost savings firm creates by
successfully sharing resources and capabilities or transferring
corporate-level core competencies among businesses.
• Firms seek to create value from economies of scope through
two basic kinds of operational economies:
1. Sharing activities (operational relatedness)
2. Transferring corporate-level core competencies
(corporate relatedness)
Reasons for Diversification (WHY)

Financial Operational Strategic

Reasons for Diversification (WHY)

 Reasons for Diversification (slide 1 of 2)

Value-Creating Diversification
• Economies of scope (related diversification)
• Sharing activities
• Transferring core competencies
• Market power (related diversification)
• Blocking competitors through multipoint competition
• Vertical integration
• Financial economies (unrelated diversification)
• Efficient internal capital allocation
• Business restructuring
 Reasons for Diversification (slide 2 of 2)

Value-Neutral Diversification
• Antitrust regulation
• Tax laws
• Low performance
• Uncertain future cash flows
• Risk reduction for firm
• Tangible resources
• Intangible resources
Value-Reducing Diversification
• Diversifying managerial employment risk
• Increasing managerial compensation
 Restructuring of Assets

• Financial economies can be created when firms learn how to

create value by:
1. Buying assets at a low cost
2. Restructuring the assets
3. Selling the assets at a price that exceeds their cost in the
external market

• Buying, restructuring, and then selling service-based assets for

profit in the external market is difficult.
• This is because technology firms and service-based companies
have relatively few tangible assets that can be restructured to
create value and sell profitably.
Operational Relatedness: Sharing Activities

• Firms can create operational relatedness by sharing either:

• Primary activity, e.g. Inventory delivery systems
• Support activity, e.g. Purchasing practices
• Sharing activities is usually associated with related constrained
diversification corporate-level strategy.
• Activity sharing:
• Costly to implement and coordinate
• May create unequal benefits for divisions involved
• Can lead to fewer managerial risk-taking behaviors
 Corporate Relatedness:
Transferring of Core Competencies

• Corporate-level core competencies are complex sets of resources and

capabilities that link different businesses, through managerial and
technological knowledge, experience and expertise.
• Firms using related linked diversification strategy can create value by
transferring core competencies in at least two ways:
1. Because the expense of developing core competence has
already been incurred in one of the firm’s businesses,
transferring it to second business eliminates need for that
business to allocate resources to develop it.
2. Because intangible resources are difficult for competitors to
imitate, unit receiving transferred corporate-level competence
often gains immediate competitive advantage over rivals.
 Market Power (slide 1 of 3)

• Market power may be gained by firms successfully using

related constrained or related linked strategy.
• Market power exists when firm sells products above existing
competitive level or reduce costs of primary and support
activities below competitive level, or both.
 Market Power (slide 2 of 3)

• Firms can foster market power through multipoint

competition and vertical integration.
• Multipoint competition exists when two or more diversified
firms simultaneously compete in the same product areas or
geographical markets.
• Vertical integration exists when company produces own
inputs (backward integration) or owns its output
distribution (forward integration).
 Market Power (slide 3 of 3)

• Vertical integration allows firm to gain market power by developing

ability to:
• Save on its operations
• Avoid sourcing and market costs
• Improve product quality
• Protect its technology from imitation by rivals
• Potentially exploit underlying capabilities in the marketplace
• Vertical integration has limitations.
• Internal transactions may be expensive and reduce profitability.
• Bureaucratic costs.
• Substantial investments in specific technologies, reducing a
firm’s flexibility.
• Changes in demand create capacity balance and coordination
problems.
Simultaneous Operational Relatedness &
Corporate Relatedness

• Ability to simultaneously create economies of scale by

sharing activities (operational relatedness) and transferring
core competencies (corporate relatedness):
• Difficult for competitors to understand and imitate
• Very expensive to undertake
• If cost of realizing both types of relatedness is not offset by
benefits created, the result is diseconomies.
• Often results in discounted assets by investors
• Can be difficult for investors to identify value that is
created by firm that shares both activities and core
competencies.
 Unrelated Diversification

• Firms do not seek operational relatedness or corporate

relatedness when using unrelated diversification
corporate-level strategy.
• Financial economies are cost savings realized through improved
allocations of financial resources based on investments inside
or outside the firm.
• Unrelated diversification strategy can create value through two
types of financial economies:
1. Efficient internal capital market allocation
2. Asset restructuring
 Unrelated Diversification

• Firms in emerging economies often use unrelated

diversification strategy.
• Drawback for firms using unrelated diversification strategy in
developed economy is that competitors can imitate financial
economies more easily than they can replicate value gained
from economies of scope developed through operational
relatedness and corporate relatedness.
 Incentives to Diversify

• Incentives to diversify come from both external environment and

firm’s internal environment.
• External incentives include:
- Antitrust regulations
- Tax laws
• Internal incentives include:
- Low performance
- Uncertain future cash flows
- Synergy
- Reduction of risk for the firm
Value-Neutral Diversification: Incentives and
Resources

• Diversification is sometimes pursued for value-neutral reasons.

• Different incentives to diversify sometimes exist.
• Quality of firm’s resources may permit only diversification that
is value neutral rather than value creating.
 Incentives to Diversify (slide 2 of 5)

Antitrust Regulation and Tax Laws

1. 1960s ~ 1970s:
• Antitrust laws prohibiting mergers that created increased
market power (via either vertical or horizontal integration)
were stringently enforced.
• Most mergers were “conglomerate” in character.
2. 1980s ~1990s:
• Merger constraints were relaxed.
• More and larger horizontal mergers (acquisitions of target
firms in the same line of business) occurred.
3. Early 2000s:
• Antitrust concerns emerged again.
• Mergers received more scrutiny.
 Incentives to Diversify (slide 3 of 5)

• 1960s ~ 1970s, dividends were taxed more heavily than capital gains.
Shareholders preferred firms use free cash flows to buy and build
companies in high-performance industries.
• 1986 Tax Reform Act created incentive for shareholders to retain funds
for purposes of diversification by:
• Reducing individual ordinary income tax rate from 50 to 28%
• Changing capital gains tax to treat capital gains as ordinary
income
• Acquisitions were attractive means for securing tax benefits, but
Financial Accounting Standards Board (FASB) reduced some of the
incentives to make acquisitions by eliminating:
• “Pooling of interests” method to account for acquired firm’s assets
• Write-off for research and development in process
 Incentives to Diversify (slide 4 of 5)

Low Performance
• Low returns are related to greater levels of diversification.
• Overall curvilinear relationship may exist between diversification
and performance.

Uncertain Future Cash Flows

• Diversification may be an important defensive strategy:
- As firm’s product line matures or is threatened
- During a financial downturn
- For family firms competing in mature or maturing industries
• Diversifying into other product markets or into other businesses
can reduce uncertainty about firm’s future cash flows.
 Incentives to Diversify (slide 5 of 5)

Synergy and Firm Risk Reduction

• Synergy exists when value created by business units working together
exceeds value that those same units create working independently.
• Synergy produces joint interdependence among businesses that
constrains firm’s flexibility to respond, which may lead the firm to:
• Become risk averse and uninterested in pursuing new product
lines that have potential but are not proven
• Constrain level of activity sharing
• Either decision may lead to further diversification.
• Operating in environments that will likely lead to related
diversification into industries that lack potential.
• Constraining level of activity sharing produce additional,
but unrelated, diversification, where firm lacks expertise.
 Value-Reducing Diversification:
Managerial Motives to Diversify (slide 1 of 2)

• Managerial motives to diversify beyond value-creating and value-

neutral levels include:
- Desire for increased compensation
- Reduced managerial risk
• Diversification and firm size are highly correlated. As firm size
increases, so does:
- Executive compensation
- Social status
 Value-Reducing Diversification:
Managerial Motives to Diversify (slide 2 of 2)
• Managerial motives to diversify can lead to over-diversification
and subsequent reduction in firm’s ability to create value.
• Managerial tendencies to over diversify may be held in check by:
- Governance mechanisms (board of directors)
- Monitoring by owners
- Executive compensation practices
- Market for corporate control
• Top-level executives seek to be good stewards of the firm’s assets
and avoid diversifying the firm in ways that destroy value.
 Curvilinear Relationship between
Diversification & Performance
 Resources and Diversification

• Firm must have types and levels of resources and

capabilities needed to successfully use corporate-level
diversification strategy.
• Firm’s ability to create value through diversification is
influenced by degree to which resources are (VRIN):
• Valuable
• Rare
• Difficult to imitate
• Nonsubstitutable
• Both tangible and intangible resources facilitate diversification.
• Intangible resources are more flexible in facilitating
diversification.
Diversification & Firm Performance
 Motives For Corporate Strategy
(Product Diversification)
Financial Economies
• Efficient Capital
Allocation
• Business
Restructuring
Regulatory
Requirements
• Antitrust Regulations
Use of Slack
Resources Economies of Scope
• Tangible Resources • Sharing Activities
• Tax Requirements
• Intangible Resources •Transferring
Competencies

Financial / Organizational
Reasons Market Power
Reasons For • Cash Flow Management
• Increase Performance
•Multi-point
Competition
Corporate Strategy • Reduce Risk • Vertical Integration
(Product
Diversification)
Agency Reasons
• Empire Building
•Management
Compensation
• Diversifying managerial
employment risk * Sourced and adapted from Table 6.1 of the Ireland / Hoskission / Hitt Textbook “The Management of Strategy, Concepts, Tenth Edition”, and
Carpenter / Sanders “Strategic Management, A Dynamic Perspective”
 Options to Implement Corporate Strategy
Broad Options Implementation Issues
For Product Diversification For Various Options
Direct Ownership
Product • Do we have the necessary capabilities and competences
Diversification to successfully diversify?

Important questions to be answered

Acquisitions
• Do we have enough resources (financial, managerial) to
take over another firm?
• How can we overcome various post integration issues?
Direct - Cultural issues between firms
Alliances
Ownership - Retention of key personnel
- Integration of functions, people and processes
Internal Development
• How can we develop new capabilities and competencies
required by diversification by ourselves?
• Will we be able to build up capabilities and
competencies in a timely manner?
Internal Alliances
Acquisitions Development/ • Can we find a suitable partner in the endeavor?
Organic Growth • How to structure the alliance to ensure success?
• How to reduce potential agency and coordination
issues?

The Choice of Expansion Will Have to Take into Consideration the Firm’s Unique
Strengths & Weaknesses, and Various External Factors
Internal Portfolio Management
 Guidelines from Portfolio Management

Allocate resources to businesses according to:

 Keep and invest in businesses which are located in

attractive industries and where we have core
competencies (i.e. strong competitive position in an
attractive industry)
 Divest businesses which are located in unattractive
industries and where we do not have core competencies
 Selective investment in moderately attractive industries
where competencies are not strong
 The Product Portfolio: BCG Model

Four situations (Classifications):

 Stars with large cash use and generation patterns
 Cash cows generate more cash than they use
 Question marks need more cash than they can generate
 Dogs (or Deadwood) require more attention to divest
BCG Matrix

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 BCG Matrix & Nestlé

Healthier lifestyle trends & High competition & small

emerging markets market share

Growth potential, slow market

Market share of 80-85 % growth, no impact

Optimize resources, where else to invest to drive future growth

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 The McKinsey Matrix (GE)

Industry Attractiveness: Business Unit Strength :

 Market growth rate  Market share
 Market Size  Growth in market share
 Demand Variability  Brand equity
 Industry profitability
 Industry rivalry  Distribution channel access
 Global opportunities  Production capacity
 General environment  Profit margins relative to
factors competitors
Ansoff Matrix

• Related
• Unrelated

57
Ansoff Matrix & Apple

Enhancing value proposition of

owning other Apple products
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 Summary (Slide 1 of 2)

• Level of diversification with greatest potential positive

effect on performance is based on effects of interaction of
resources, managerial motives, and incentives on adoption
of particular diversification strategies.
• The greater the incentives and more flexible the resources,
the higher the level of expected diversification.
• Financial resources (most flexible) should have stronger
relationship to extent of diversification than either tangible
resources or intangible resources (most inflexible).
 Summary (Slide 2 of 2)

 Firms can improve strategic competitiveness when they pursue

level of diversification that is appropriate for:
• Resources and core competencies (INTERNAL)
• Opportunities and threats in their country’s institutional
and competitive environments (EXTERNAL)