Strategic Audit Report

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Strategic Management Week 10 – Chapter 10

Organizing for Corporate Diversification

Chapter 10 Learning Objectives

• Describe the multidivisional or M-Form and how it differs from a U-Form. • Describe how the M-Form can be used to implement a corporate

diversification strategy. • Describe the role of various stakeholders in the functioning of the M-form. • Understand key elements of implementation of corporate diversification

strategy. • Understand the key role of implementation in strategies in general.

Where Are We in the SM Process?

Mission Objectives

External Analysis

Internal Analysis

Strategic Choice

Strategy Implementation

Competitive Advantage

Business Level Strategy

Corporate Level Strategy

How to Position a Business

in the Market? Which Businesses

to Enter?

•Vertical Integration •Diversification

Strategies used as a means to avoid or be better than competitors

• Module 3: – Vertical Integration (8) – Corporate Diversification (9) – Organizing for diversification (10)

• Module 4: – Collusion (7) – Strategic Alliances (10) – Mergers and Acquisitions (11)

What is Corporate Diversification?

Operation in multiple industries or markets simultaneously

à2 Categories (not mutually exclusive)

Value of Diversification

Two Criteria

1) There must be some economy of scope

2) The focal firm must have a cost advantage over outside equity holders in exploiting any economies of scope

Implementation Issues

• How Information Flows • Where and By Whom are Decisions Made • How to Influence the Behavior of People

The Need for Organizational Structure

Information Processing Requirements

• as organizations become larger and more complex, information processing requirements exceed individual capacity

• bounded rationality

• organizational structure divides information processing into manageable blocks (span of control)

• satisficing

The Agency Relationship - Managing Agency

Individual Shareholders

Institutional Shareholders

Principals Agents

Senior Executives

Corporate Staff

Division General

Managers

Shared Activity

Managers

Monitors

Board Of

Directors

Dual Role

Strategic Planning

Corporate Finance

Corporate R&D

Corporate Marketing

ProductionFinanc e

Engineerin g

Accounting

Human Resource

Division Division Division

Sales & Marketing

Senior Executive

Corporate Human

Resources

Board of Directors

Shared Activity Managers

ProductionFinance

Engineering

Division Division Division

Human Resources

Sales & Marketing

ProductionFinance

Engineering

Shared Activities

Cost Centers

Profit Centers

Firm Presidency - CEO Duality & TMT Structure

Chairman of the Board (monitoring)

Chief Executive

Officer (strategy formulation)

Chief Operating

Officer (strategy implementation)

Chairman

CEO

COO

Chairman

CEO

COO

Chairman

CEO

COO

Chairman

CEO

COO

One Person Two People Three People

Information Filtering

• information about the divisions’ businesses is filtered as it rises to the senior executive

• the senior executive can ‘manage’ the information flow

• information flow should not exceed the bounded rationality of managers at any level in the organization

• information should flow should be matched with decision-making authority

Management Controls

• Evaluating Divisional Performance – Economic value added (EVA) – Allocating costs & revenues

• Allocating Capital – Managerial Motivation – Budgeting

• Transferring Intermediate Products – Negotiated – Market-based – Dual pricing

Evaluating Divisional Performance

• A hurdle rate (common across all BU’s in the firm)

• Budgeted performance level (assigned by division)

• Avg. level of profitability in each division’s industry

• EVA = WACC * Capital employed by divison

Allocating Capital

• GMs have an incentive to overstate prospects and understate potential problems

• Zero-based budgeting vs. incremental • Incremental

– Can lead to bloat • Zero-based

– Ranking a request’s importance is subjective & requires complete understanding of strategic role of proposed projects

Transfer Pricing

• Intermediate Products/Services – those produced by one division and used as inputs in another division

• At the transfer the product/service is “sold” within the company – but how is the price determined without a market?

• Transfer price should = opportunities foregone by “selling” division

Transfer Pricing Systems

• Exchange Autonomy

• Mandated Full Cost

• Mandated Market Based

• Dual Pricing

Freely negotiated b/w divisions Set at price for sales to external customers

Set equal to cost of production Set at standard cost (cost when operating at full capacity)

Transfer price is set equal to the market price in selling division's market

Transfer price for buying division is set equal to the selling division’s actual or std. cost; credit seller w/ normal profit

Compensation Policies Compensation Committee In theory…

• represents interests of owners in setting compensation of top executive team

• sets compensation based on performance or market

In practice…

• sometimes appear to be beholden to executives • compensation decisions often bear little relationship

to performance

Aligning Incentives

Salary

Cash Bonus

Stock Grants

Stock Options

Not Tied to Performance

Tied to Performance

Long Time Horizon

Short Time Horizon

Tax code applicable to publically-traded firms

• §162(m): adopted in 1993, modified in 2013 • Compensation committee typically represents owners in

determining CEO/GM compensation • §162(m): adopted in 1993, modified in 2013 • Limitation on deductibility of compensation above $1M w/

exception for "performance-based compensation” (e.g. stock options, SARs issued at FMV; non-equity incentive compensation for preference “approved by an independent compensation committee”

• Utilizing these exemptions has been described as a “loophole”

Aligning Incentives

Salary

Cash Bonus

Stock Grants

Stock Options

Not Tied to Performance

Tied to Performance

Deductible subject to $1M cap

Likely to be fully deductible

Dependent on implementation

Pension and deferred compensation If deferred to after retirement likely

to be fully deductible

Tax Policy & Compensation

• Should Tax Code be used to discourage exec. comp.? – Is the exception in 162 (m) a loophole? – Is favoring stock options in compensation policies tax avoidance? – Is catering packages to maximize deductibility unethical?

• How does institutional investment affect this? – Own 69% of 1000 largest US firms @ 2005 – Logically may be more interested in maximizing short-term investment – Research in US & Japan suggests not unduly myopic – High institutional investment à sale of strategically unrelated

businesses

Refocusing Corporate level strategy may call for exiting a business

• a conglomerate discount may exist • the corporation may lack necessary skills • expected economies of scope may not exist

• the corporation may need funds for core activities

Divest Assets

Spin-off MBO

IPO or,

Ethics & Strategy

• “Do CEOs get paid too much?” • Possible mechanism for compensation increase: at

new compensation agreement BOD will pay above average same industry, same size compensation; as this repeats compensation inevitable rises

• Corr. [(Avg. experience-based compensation– actual compensation), firm performance] is significant

• Effect on morale? Does it encourage and foster ambition or demoralize?