Strategic analysis

Business- vs. Corporate-level Strategy

While business-level strategy focused on how an organization generates value by positioning products and services relative to the offerings of other firms in the same industry, corporate-level strategy deals with a portfolio of distinct products and services. When dealing at the business- level, managers ask, “How can we be successful in this business?” When dealing with corporate- level strategy, executives ask, “In what industry or industries should our firm compete?”

The executives in charge of a firm such as The Walt Disney Company must decide whether to remain within their present domains or venture into new ones. In Disney’s case, the firm has expanded from its original business (films) and into television, theme parks, and several others. In contrast, many firms never expand beyond their initial choice of industry.

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Concentration Strategies

For many firms, concentration strategies are very sensible. These strategies involve trying to compete successfully only within a single, broad industry. There are three concentration strategies: (1) market penetration, (2) market development, and (3) product development. A firm can use one, two, or all three as part of their efforts to excel within an industry.1 Ansoff described these strategies in a matrix, see Figure 7.1. Ansoff’s matrix is a tool for understanding at a high- level, the general direction of growth. It helps a firm match products and markets. The firm must decide whether to prioritize increasing profit or growth and how the firm will achieve it. No one strategy is appropriate for all companies at all times! Markets are defined as customer groups, and products are items sold to customers.

Example 7.1 Market Penetration

LVMH has made a deal to acquire Tiffany & Co. This acquisition will boost LVMH’s presence in the United States and help them increase their sales in its jewelry and watch division. It could be a win for Tiffany & Co. as well, as this will help then gain success among millennials.

Source: CNN Business, LVMH scoops up Tiffany for $16.2 billion, Ashley Wenger, 2020Wi

1. Ansoff, H. I. 1957. Strategies for diversification. Harvard Business Review, 35(5), 113–124.

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Market Penetration

Market penetration involves increasing the firm’s share within existing markets using existing products. Often firms will rely on advertising to attract new customers within existing markets using loyalty program, coupons, and sales promotions. Nike, for example, features famous athletes in print and television ads designed to take market share within the athletic shoes business from Adidas and other rivals.

Market Development

Example 7.2 Market Development

This article discusses the importance of stock and how it differentiates a company based on how high or low their stock evaluation is. Companies that defy the social norm, such as Amazon and Netflix have a high stock and are growing at an annual rate of 99 and 93 percent, respectively.

Source: Investor’s Business Daily, Who Joins Canada Goose, Square On This List Of Today’s Fastest-Growing Companies?, Carolyn Hoard, 2018Fa

Market development involves selling existing products within new markets. One way to reach a new market is to enter a new retail channel. Starbucks has stepped beyond selling only coffee beans in its stores and now sells beans in grocery stores. This enables Starbucks to reach consumers that do not visit its coffee houses. Entering new geographic areas and adding new sales or distribution channels are other ways to pursue market development.

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Product Development

Example 7.3 Product Development

Colgate has developed a vegan-certified toothpaste that comes in a recyclable tube, the first of its kind in the industry. It has taken five years for them to develop this product because they needed to make sure all the materials came from natural sources, and that the company would be able to meet the demands of production.

Source: CNN Business, Colgate finally launched its recyclable toothpaste tube. It’s made from the same type of plastic as milk jugs, Ashley Wenger, 2020Wi

Product development involves creating new products to serve existing markets. In the 1940s, for example, Disney expanded its offerings within the film business by going beyond cartoons and creating movies featuring real actors. More recently, McDonald’s has gradually moved more and more of its menu toward healthy items to appeal beyond its existing base and to attract customers who are concerned about nutrition.

In 2009, Starbucks introduced VIA, an instant coffee variety that executives hoped would appeal to their customers when they do not have easy access to a Starbucks store or a coffee pot. The soft drink industry is a frequent location of product development efforts. Coca-Cola and Pepsi regularly introduce new varieties—such as Coke Zero and Pepsi Cherry Vanilla—in an attempt to take market share from each other and from their smaller rivals.

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Horizontal Integration: Mergers and Acquisitions

Rather than rely on their own efforts, some firms try to expand their presence in an industry by acquiring or merging with one of their rivals. This strategic move is known as horizontal integration. An acquisition takes place when one company purchases another company. Generally, the acquired company is smaller than the firm that purchases it. A merger joins two companies into one; mergers typically involve similarly sized companies. Disney was much bigger than Miramax and Pixar when it joined with these firms in 1993 and 2006, respectively. Thus, these two horizontal integration moves are considered to be acquisitions.

Example 7.4 Purchasing Market Share

Google has bought Fitbit, the smartwatch company for 2.1 billion dollars. Previously Google has dabbled in the smartwatch space by providing their Wear OS operating system to smartwatch systems. With this acquisition of Fitbit, they are also purchasing the market shares, considering they were formerly a competitor and capitalizing on the company’s brand value while combining their operating system.

Source: Business Insider, Fitbit surges 17% after Google agrees to buy the company for $2.1 billion (FIT), 2020Wi

Horizontal integration can be attractive for several reasons. In many cases, horizontal integration is aimed at lowering costs by achieving greater economies of scale. This was the reasoning behind several mergers of large oil companies including BP and Amoco in 1998, Exxon and Mobil in 1999, and Chevron and Texaco in 2001. Oil exploration and refining are expensive. Executives in charge of each of these six corporations believed that greater efficiency could be achieved by combining forces with a former rival. Considering horizontal integration alongside Porter’s five forces model highlights that such moves also reduce the intensity of rivalry in an industry and thereby make the industry more profitable.

Some purchased firms are attractive because they own strategic resources such as valuable brand names. Acquiring Tasty Baking was appealing to Flowers Foods, for example, because the name Tastykake is well known for quality in heavily populated areas of the northeastern United States. Some purchased firms have market share that is attractive.

Horizontal integration can also provide access to new distribution channels. Some observers were puzzled when Zuffa, the parent company of the Ultimate Fighting Championship (UFC), purchased rival mixed martial arts (MMA) promotion Strikeforce. UFC had such a dominant position within MMA that Strikeforce seemed to add very little for Zuffa. Unlike UFC, Strikeforce

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had gained exposure on network television through broadcasts on CBS and its partner Showtime. Thus acquiring Strikeforce might help Zuffa gain mainstream exposure for its product.1

Despite the potential benefits of mergers and acquisitions, their financial results often are very disappointing. One study found that more than 60 percent of mergers and acquisitions erodes, while fewer than one in six increases, shareholder wealth.2 Some of these moves struggle because the cultures of the two companies cannot be meshed. This chapter’s opening vignette suggests that Disney and Pixar may be experiencing this problem. Other acquisitions fail because the buyer pays more for a target company than that company is worth and the buyer never earns back the premium it paid.

In the end, between 30 and 45 percent of mergers and acquisitions are undone, often at huge losses.3 For example, Mattel purchased The Learning Company in 1999 for $3.6 billion and sold it a year later for $430 million—12 percent of the original purchase price. Similarly, Daimler- Benz bought Chrysler in 1998 for $37 billion. When the acquisition was undone in 2007, Daimler recouped only $1.5 billion worth of value—a mere 4 percent of what it paid. Thus, executives need to be cautious when considering using horizontal integration.

1. Wagenheim, J. 2011, March 12. UFC buys out Strikeforce in another step toward global domination. SI.com.

2. Henry, D. 2002, October 14. Mergers: Why most big deals don’t pay off. Businessweek, 60–70. 3. Hitt, M. A., Harrison, J. S., & Ireland, R. D. 2001. Mergers and acquisitions: A guide to creating value

for stakeholders. New York, NY: Oxford University Press.

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Vertical Integration Strategies

When pursuing a vertical integration strategy, a firm gets involved in new portions of the value chain. This approach can be very attractive when a firm’s suppliers or buyers have too much power over the firm and are becoming increasingly profitable at the firm’s expense. By entering the domain of a supplier or a buyer, executives can reduce or eliminate the leverage that the supplier or buyer has over the firm. Considering vertical integration alongside Porter’s five forces model highlights that such moves can create greater profit potential. Firms can pursue vertical integration on their own, such as when Apple opened stores bearing its brand, or through a merger or acquisition, such as when eBay purchased PayPal.

Example 7.5 Vertical Integration

Vertical integration is the future of streaming services such as Spotify. While Spotify is primarily a music streaming service, they learn the value of creating and distributing original, organic content to compete effectively in the steaming content market. Their current operating model that puts them in the middle between creators and consumers puts Spotify in a precarious position where music labels extract about 75% of Spotify’s revenue annually. Following Netflix’s model of vertical integration, is widely considered the most effective way to remain relevant in today’s ever changing streaming industry.

Source: Quartz, Dan Kopf, Why Spotify wants to be like Netflix now, Aaron N Wager, 2019Wi

Today, oil companies are among the most vertically integrated firms. Firms such as ExxonMobil and ConocoPhillips can be involved in all stages of the value chain including crude oil exploration, drilling for oil, shipping oil to refineries, refining crude oil into products such as gasoline, distributing fuel to gas stations, and operating gas stations.

Vertical integration also creates risks. Venturing into new portions of the value chain can take a firm into very different businesses. A lumberyard that started building houses, for example, would find that the skills it developed in the lumber business have very limited value to home construction. Such a firm would be better off selling just lumber to contractors.

Example 7.6 Safety through Vertical Integration

Seven & i Holdings Co., 7-Eleven’s mother company is considering acquiring Speedway gas stations from Marathon Petroleum Corp. for $2 billion in an effort to protect its convenience store market. Convenience stores and gas stations are strongly linked. Meanwhile, electric vehicles are becoming increasingly popular.

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Creating an electric charging infrastructure is a major problem facing the gas market since the price of electric vehicles has been falling. Vertical integration through combining convenience food and gasoline is now being threatened and Seven & i wants to transform its outlets to compete with more conventional charging in homes and workplaces.

Source: Bloomberg, David Fickling, The Gas Station M&A Frenzy Looks Like a Bubble, Siyuan Wang, 2020Sp

Vertical integration can also create complacency. For example, a situation in which an aluminum company is purchased by a can company. People within the aluminum company may believe that they do not need to worry about doing a good job because the can company is guaranteed to use their products. Some companies try to avoid this problem by forcing their subsidiary to compete with outside suppliers, but this undermines the reason for purchasing the subsidiary in the first place.

A backward vertical integration strategy involves a firm moving back along the value chain and entering a supplier’s business. Some firms use this strategy when executives are concerned that a supplier has too much power over their firm. In the early days of the automobile business, Ford Motor Company created subsidiaries that provided key inputs to vehicles such as rubber, glass, and metal. This approach ensured that Ford would not be hurt by suppliers holding out for higher prices or providing materials of inferior quality.

A forward vertical integration strategy involves a firm moving further down the value chain to enter a buyer’s business. Disney has pursued forward vertical integration by operating more than three hundred retail stores that sell merchandise based on Disney’s characters and movies. This allows Disney to capture profits that would otherwise be enjoyed by another store. Each time a Hannah Montana book bag is sold through a Disney store, the firm makes more profit than it would if the same book bag were sold by a retailer such as Target.

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Diversification Strategies

Firms using diversification strategies enter entirely new industries. While vertical integration involves a firm moving into a new part of a value chain that it is already in, diversification requires moving into new value chains. Many firms accomplish this through a merger or an acquisition, while others expand into new industries without the involvement of another firm.

Three Tests for Diversification

A proposed diversification move should pass these three tests or it should be rejected.1

1. Attractiveness Test – How attractive is the industry that a firm is considering entering? Unless the industry has strong profit potential, entering it may be very risky.

2. Cost-of-Entry Test – How much will it cost to enter the industry? Executives need to be sure that their firm can recoup the expenses that it absorbs in order to diversify.

3. Better Off Test – Will the new unit and the firm be better off? Unless one side or the other gains a competitive advantage, diversification should be avoided.

Related Diversification

Because it leverages strategic fit, companies that engage in related diversification are more likely to achieve gains in shareholder value. Related diversification occurs when a firm moves into a new industry that has important similarities with the firm’s existing industry or industries. Because films and television are both aspects of entertainment, Disney’s purchase of ABC is an example of related diversification. Some firms that engage in related diversification aim to develop and exploit a core competency to become more successful. A core competency is a skill set that is difficult for competitors to imitate, can be leveraged in different businesses, and contributes to the benefits enjoyed by customers within each business.2 For example, Newell Rubbermaid

1. Porter, M. E. 1987. From competitive advantage to corporate strategy. Harvard Business Review, 65(3), 102–121.

2. Prahalad, C. K., & Hamel, G. 1990. The core competencies of the corporation. Harvard Business Review, 86(1), 79–91.

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is skilled at identifying underperforming brands and integrating them into their three business groups: (1) home and family, (2) office products, and (3) tools, hardware, and commercial products.

Example 7.7 Related Diversification

In February 2019, Spotify announced it had acquired two companies, Gimlet Media Inc. and Anchor. The move allows Spotify to add the capability to produce and publish podcasts. This action allows Spotify to strengthen its existing role as a music provider by adding podcasting options. Gimlet Media Inc. was founded in 2014 and has become home to numerous award-winning podcasts including Reply All, StartUp, and Crimetown. Anchor claims that a third of all podcasts are created using its platform.

Source: WERSM, Spotify Goes ‘All In’ Οn Podcasts With Its Latest Acquisitions, Anak Agung Kompiyang Ratih Maldini, 2019Wi

Sometimes the benefits of related diversification that executives hope to enjoy are never achieved. For example, both soft drinks and cigarettes are products that consumers do not need. Companies must convince consumers to buy these products through marketing activities such as branding and advertising. Thus, on the surface, the acquisition of 7Up by Philip Morris seemed to offer the potential for Philip Morris to take its existing marketing skills and apply them within a new industry. Unfortunately, the possible benefits to 7Up never materialized.

Unrelated Diversification

Why would a soft-drink company buy a movie studio? It’s hard to imagine the logic behind such a move, but Coca-Cola did just this when it purchased Columbia Pictures in 1982 for $750 million. This is a good example of unrelated diversification, which occurs when a firm enters an industry that lacks any important similarities with the firm’s existing industry or industries. Luckily for Coca-Cola, its investment paid off—Columbia was sold to Sony for $3.4 billion just seven years later.

Example 7.8 Unrelated Diversification

General Electronic operates in many different market segments, including oil and gas, healthcare, transportation, aviation, power and water, energy management, appliances and lighting, GE capital. GE is a good example of unrelated diversification. In the story, which follows a months-long series of disappointing

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earnings, markets voiced their approval with the stock’s best trading day since March 2009. The company’s poor performance in its power business (revenues have fallen 25% in the past year) were offset by profits in aviation, health care, and oil and gas. Meanwhile, the company was helped by GE Capital’s divesting of $15B in assets and paying down another $21B in debt. The story is not fully told yet, but these mixed results suggest one reason for unrelated diversification where strong performance in one division can compensate for weak performance in an unrelated market.

Source: CNBC, GE shares surge 11%, the most in 9 years, after a better-than-feared quarter, Zehui Si, 2019Wi

Most unrelated diversification efforts, however, do not have happy endings. Harley-Davidson, for example, once tried to sell Harley-branded bottled water. Starbucks tried to diversify into offering Starbucks-branded furniture. Both efforts were disasters. Although Harley-Davidson and Starbucks both enjoy iconic brands, these strategic resources simply did not transfer effectively to the bottled water and furniture businesses.

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Strategies for Getting Smaller

“In what industry or industries should our firm compete?” is the central question addressed by corporate-level strategy. In some cases, the answer that executives arrive at involves exiting one or more industries.

Retrenchment

In the early twentieth century, many military battles were fought in series of parallel trenches. If an attacking army advanced enough to force a defending army to abandon a trench, the defenders would move back to the next trench and try to refortify their position. This small retreat was preferable to losing the battle entirely. Trench warfare inspired the business term retrenchment. Firms following a retrenchment strategy shrink one or more of their business units. Much like an army under attack, firms using this strategy hope to make just a small retreat rather than losing a battle for survival. Retrenchment is often accomplished through laying off employees.

Example 7.9 Retrenchment

In January 2019, Buzzfeed, announced it would cut 15 percent of its jobs following an evaluation of the “evolving economics of digital platforms.” This was just one of several announced media layoffs in a short period of time. Earlier Verizon Communications announced it would cut 7% of its digital-media operations including operations involving its AOL, Yahoo, and Huffington Post operations. In a separate announcement Gannett, Inc. announced it would reduce staff in several of its newspaper companies. In its announcement, Buzzfeed pointed to the need to “reduce our costs and improve our operating model so we can thrive and control our own destiny.”

Source: Bloomberg, BuzzFeed to Cut 15% of Jobs in Latest Digital-Media Retrenchment, 2019Wi

This is a common rationale for retrenchment—by shrinking the size of a firm, executives hope that the firm can survive as a profitable enterprise.

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Restructuring

Executives sometimes decide that bolder moves than retrenchment are needed for their firms to be successful in the future. Divestment refers to selling off part of a firm’s operations. In some cases, divestment reverses a forward vertical integration strategy, such as when Ford sold Hertz. Divestment can also be used to reverse backward vertical integration. General Motors (GM), for example, turned a parts supplier called Delphi Automotive Systems Corporation from a GM subsidiary into an independent firm. This was done via a spin-off, which involves creating a new company whose stock is owned by investors. GM stockholders received 0.69893 shares of Delphi for every share of stock they owned in GM. A stockholder who owned 100 shares of GM received 69 shares of the new company plus a small cash payment in lieu of a fractional share.

Example 7.10 Divestment

General Electric divested by disposing of a unit of GE Aviation, called MRA Systems LLC, to ST Engineering. By doing this, GE will earn about $630 million in cash by the first quarter of 2019 if all goes as planned. The company made many plans in June of 2018 to restructure their company, and this is just one example of how they’re using divestment to try and increase shareholder value.

Source: Zachs, General Electric’s GE Aviation Unit to Divest MRA Systems, 2018Fa

Divestment also serves as a means to undo diversification strategies. Divestment can be especially appealing to executives in charge of firms that have engaged in unrelated diversification. Investors often struggle to understand the complexity of diversified firms, and this can result in relatively poor performance by the stocks of such firms. This is known as a diversification discount. Executives sometimes attempt to unlock hidden shareholder value by breaking up diversified companies.

Executives are sometimes forced to admit that the operations that they want to abandon have no value. If selling off part of a business is not possible, the best option may be liquidation. This involves simply shutting down portions of a firm’s operations, often at a tremendous financial loss. GM has done this by scrapping its Geo, Saturn, Oldsmobile, and Pontiac brands. Ford recently followed this approach by shutting down its Mercury brand. Such moves are painful because massive investments are written off, but becoming “leaner and meaner” may save a company from total ruin.

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Portfolio Planning and CLS

Executives in charge of firms involved in many different businesses must figure out how to manage such portfolios. General Electric (GE), for example, competes in a very wide variety of industries, including financial services, insurance, television, theme parks, electricity generation, light bulbs, robotics, medical equipment, railroad locomotives, and aircraft jet engines. When leading a company such as GE, executives must decide which units to grow, which ones to shrink, and which ones to abandon.

Portfolio planning can be a useful tool. Portfolio planning is a process that helps executives assess their firms’ prospects for success within each of its industries, offers suggestions about what to do within each industry, and provides ideas for how to allocate resources across industries. Portfolio planning first gained widespread attention in the 1970s, and it remains a popular tool among executives today.

The Boston Consulting Group (BCG) Matrix

The Boston Consulting Group (BCG) matrix is the best-known approach to portfolio planning. Using the matrix requires a firm’s businesses to be categorized as high or low along two dimensions: its share of the market and the growth rate of its industry. High market share units within slow-growing industries are called cash cows. Because their industries have bleak prospects, profits from cash cows should not be invested back into cash cows but rather diverted to more promising businesses. Low market share units within slow-growing industries are called dogs. These units are good candidates for divestment. High market share units within

fast-growing industries are called stars. These units have bright prospects and thus are good candidates for growth. Finally, low-market-share units within fast-growing industries are called question marks. Executives must decide whether to build these units into stars or to divest them.

The BCG matrix is a popular portfolio planning technique. With the help of a leading consulting firm, GE developed the attractiveness-strength matrix to examine its diverse activities. This

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planning approach involves rating each of a firm’s businesses in terms of the attractiveness of the industry and the firm’s strength within the industry. See Figure 7.2.

Limitations to Portfolio Planning

Although portfolio planning is a useful tool, this tool has important limitations. First, portfolio planning oversimplifies the reality of competition by focusing on just two dimensions when analyzing a company’s operations within an industry. Many dimensions are important to consider when making strategic decisions. Second, portfolio planning can create motivational problems among employees. For example, if workers know that their firm’s executives believe in the BCG matrix and that their subsidiary is classified as a dog, then they may give up any hope for the future. Similarly, workers within cash cow units could become dismayed once they realize that the profits that they help create will be diverted to boost other areas of the firm. Third, portfolio planning does not help identify new opportunities. Because this tool only addresses existing businesses, it cannot reveal what new industries a firm should consider entering.

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KEY TAKEAWAY

This chapter explains corporate-level strategy. Executives grappling with corporate-level strategy must decide in what industry or industries their firms will compete. Many of the possible answers to this question involve growth. Concentration strategies involve competing within existing domains to expand within those domains. This can take the form of market penetration, market development, or product development. Integration involves expanding into new stages of the value chain. Backward integration occurs when a firm enters a supplier’s business while forward vertical integration occurs when a firm enters a customer’s business. Diversification involves entering entirely new industries; this can be an industry that is related or unrelated to a firm’s existing activities. Sometimes being smart about corporate-level strategy requires shrinking the firm through retrenchment or restructuring. Finally, portfolio planning can be useful for analyzing firms that participate in a wide variety of industries.

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