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2/5/2018 Week 5: Feb 5 -11 - BMGT 495 6380 Strategic Management (2182)

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Strategic Management:

Chapter 7:  Competing in International Markets

Chapter 8:  Selecting Corporate Level Strategies

Boston Consulting Group (BCG) Matrix

What is Corporate Strategy, Really?

Strategy, Marketing, and Technology are all Intertwined

Exploring the Structural Effects of Internetworking

IBM Internetworking

How to Build Collaborative Advantage

Globalization in Uncertain Times: 10 Key Takeaways

What a Trump Presidency Will Mean for Globalization

Complete:

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Chapter 7

Competing in International Markets

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What are the main benefits and risks of competing in international markets?

2. What is the “diamond model,” and how does it help explain why some firms compete better in

international markets than others?

3. What are the various global strategies that firms can adopt?

4. What forms of involvement are available to firms that seek to compete in international markets?

Kia Picks Up Speed

Kia is enjoying accelerated growth within the global automobile industry.

On June 2, 2011, South Korean automaker Kia announced plans for a major expansion of its American

production facility. Capacity at Kia Motors Manufacturing Georgia Inc. (KMMG) was slated to expand 20

percent from 300,000 to 360,000 vehicles per year. In addition to the crossover utility vehicle Sorento,

the plant would begin making a sedan named the Optima in September 2011. The expansion of the plant

was estimated to cost $100 million and was expected to create 1,000 new jobs. [1]

This ambitious growth was made possible by Kia’s superb performance in the US market. KMMG had

started building vehicles less than two years earlier after being constructed for a cost of $1 billion. In

2010, yearly sales in the United States climbed above 350,000 vehicles. Kia’s overall share of the US

market increased in 2010 for the sixteenth consecutive year. In May 2011, Kia sold more than 48,000 cars

and trucks in United States, an increase of more than 53 percent from May 2010 sales levels. The Optima

led the way with a whopping 210 percent increase in sales.

Kia was not the only beneficiary of its success. KMMG’s location of West Point, Georgia, had been

economically devastated when its homegrown textile company, WestPoint Home, shut down its local

Chapter 7 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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factories to take advantage of lower labor prices overseas. Following a fierce competition with towns in

Mississippi, Kentucky, and other states, West Point was selected in 2006 as the site of Kia’s first US

manufacturing facility. To win the plant, state and local authorities offered Kia more than $400 million

worth of incentives, including tax breaks, free land, and infrastructure creation.

Georgia’s return on this investment included two thousand new jobs at the plant as well as hundreds of

jobs at suppliers that set up shop to support KMMG. The neighboring state of Alabama benefited from

KMMG’s success too. As of June 2011, nearly sixty companies spread across twenty-three Alabama

counties supplied parts or services to KMMG. [2]

The name “Kia” means to arise or come up out of Asia. [3] This name is very appropriate; Kia rose from

humble beginnings as a maker of bicycle parts in 1944 to become a global player in the automobile

industry. As of 2011, Kia was producing more than 2.1 million vehicles per year in eight countries. Kias

were sold in 172 countries. Kia employed more than 44,000 people and enjoyed annual revenues in excess

of $20 billion. Fellow South Korean automaker Hyundai owned just over 33 percent of Kia, and the two

firms strengthened each other through collaboration. When taking all of these facts into consideration,

Kia’s slogan—The Power to Surprise—had to make its rivals wonder what surprises the Korean upstart

might have in store for them next.

Workers in Georgia build Sorentos for South Korea–based Kia.

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Image courtesy of IFCAR,

http://upload.wikimedia.org/wikipedia/commons/9/98/2011_Kia_Sorento_LX_2_--_02-13-

2010.jpg.

[1] http://www.kmmgusa.com/2011/06/kia-motors-manufacturing-georgia- begins-expansion-projects-to-support-

increased-volume-beginning -in-2012/

[2] Kent, D. 2011, June 19. Kia production in Georgia helping companies across Alabama. al.com. Retrieved from

http://blog.al.com/businessnews/2011/06/kia_production_in_georgia_help.html

[3] Frequently asked questions. Kia website. Retrieved from http://www.kia.com/#/faq/

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7.1 Advantages and Disadvantages of Competing in International Markets

L E A R N I N G O B J E C T I V E S

1. Understand the potential benefits of competing in international markets.

2. Understand the risks faced when competing in international markets.

As Kia’s experience illustrates, international business is a huge segment of the world’s economic

activity. Amazingly, current projections suggest that, within a few years, the total dollar value of

trade across national borders will be greater than the total dollar value of trade within all of the

world’s countries combined. One driver of the rapid growth of internal business over the past two

decades has been the opening up of large economies such as China and Russia that had been mostly

closed off to outside investors.

The United States enjoys the world’s largest economy. As an illustration of the power of the

American economy, consider that, as of early 2011, the economy of just one state—California—would

be the eighth largest in the world if it were a country, ranking between Italy and Brazil. [1] The size of

the US economy has led American commerce to be very much intertwined with international

markets. In fact, it is fair to say that every business is affected by international markets to some

degree. Tiny businesses such as individual convenience stores and clothing boutiques sell products

that are imported from abroad. Meanwhile, corporate goliaths such as General Motors (GM), Coca-

Cola, and Microsoft conduct a great volume of business overseas.

Access to New Customers

Perhaps the most obvious reason to compete in international markets is gaining access to new customers.

Although the United States enjoys the largest economy in the world, it accounts for only about 5 percent

of the world’s population. Selling goods and services to the other 95 percent of people on the planet can be

very appealing, especially for companies whose industry within their home market are saturated ().

Few companies have a stronger “All-American” identity than McDonald’s. Yet McDonald’s is increasingly

reliant on sales outside the United States. In 2006, the United States accounted for 34 percent of

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McDonald’s revenue, while Europe accounted for 32 percent and 14 percent was generated across Asia,

the Middle East, and Africa. By 2011, Europe was McDonald’s biggest source of revenue (40 percent), the

US share had fallen to 32 percent, and the collective contribution of Asia, the Middle East, and Africa had

jumped to 23 percent. With less than one-third of its sales being generated in its home country,

McDonald’s is truly a global powerhouse.

Levi’s jeans are appreciated by customers worldwide, as shown by this balloon featured at the Putrajaya

International Hot Air Balloon Fiesta.

Image courtesy of Kevin Poh, http://www.flickr.com/photos/kevinpoh/4446228896.

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China and India are increasingly attractive markets to US firms. The countries are the two most populous

in the world. Both nations have growing middle classes, which means that more and more people are able

to purchase goods and services that are not merely necessities of life. This trend has created tremendous

opportunities for some firms. In the first half of 2010, for example, GM sold more vehicles in China than it

sold in the United States (1.2 million vs. 1.08 million). This gap seemed likely to expand; in the first half of

2010, GM’s sales in China increased nearly 50 percent relative to 2009 levels, while sales in the United

States rose 15 percent. [2]

Lowering Costs

Many firms that compete in international markets hope to gain cost advantages. If a firm can increase it

sales volume by entering a new country, for example, it may attain economies of scale that lower its

production costs. Going international also has implications for dealing with suppliers. The growth that

overseas expansion creates leads many businesses to purchase supplies in greater numbers. This can

provide a firm with stronger leverage when negotiating prices with its suppliers.

Offshoring has become a popular yet controversial means for trying to reduce costs. Offshoring involves

relocating a business activity to another country. Many American companies have closed down operations

at home in favor of creating new operations in countries such as China and India that offer cheaper labor.

While offshoring can reduce a firm’s costs of doing business, the job losses in the firm’s home country can

devastate local communities. For example, West Point, Georgia, lost approximately 16,000 jobs in the

1990s and 2000s as local textile factories were shut down in favor of offshoring. [3]Fortunately for the

town, Kia’s decision to locate its first US factory in West Point has improved the economy in the past few

years. In another example, Fortune Brands saved $45 million a year by relocating several factories to

Mexico, but the employee count in just one of the affected US plants dropped from 1,160 to 350.

A growing number of US companies are finding that offshoring is not providing the benefits they had

expected. This has led to a new phenomenon known asreshoring, whereby jobs that had been sent

overseas are returning home. In some cases, the quality provided by workers overseas is not good enough.

Carbonite, a seller of computer backup services, found that its call center in Boston was providing much

strong customer satisfaction than its call center in India. The Boston operation’s higher rating was

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attained even though it handled the more challenging customer complaints. As a result, Carbonite plans

to shift 250 call center jobs back to the United States by the end of 2012.

In other cases, the expected cost savings have not materialized. NCR had been making ATMs and self-

service checkout systems in China, Hungary, and Brazil. These machines can weigh more than a ton, and

NCR found that shipping them from overseas plants back to the United States was extremely expensive.

NCR hired 500 workers to start making the ATMs and checkout systems at a plant in Columbus, Georgia.

NCR’s plans call for 370 more jobs to be added at the plant by 2014. Similarly, General Electric

announced plans to hire approximately 1,300 workers in Louisville, Kentucky, starting in the fall of 2011.

These workers will make water heaters and refrigerators that had been produced overseas. [4]

Diversification of Business Risk

A familiar cliché warns “don’t put all of your eggs in one basket.” Applied to business, this cliché suggests

that it is dangerous for a firm to operate in only one country. Business risk refers to the potential that an

operation might fail. If a firm is completely dependent on one country, negative events in that country

could ruin the firm. Just like spreading one’s eggs into multiple baskets reduces the chances that all eggs

will be broken, business risk is reduced when a firm is involved in multiple countries.

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Firms can reduce business risk by competing in a variety of international markets. For example,

the ampm convenience store chain has locations in the United States, Mexico, Brazil, and Japan.

Image courtesy of MASA, http://upload.wikimedia.org/wikipedia/commons/d/db/Ampm.JPG.

Consider, for example, natural disasters such as the earthquakes and tsunami that hit Japan in 2011. If

Japanese automakers such as Toyota, Nissan, and Honda sold cars only in their home country, the

financial consequences could have been grave. Because these firms operate in many countries, however,

they were protected from being ruined by events in Japan. In other words, these firms diversified their

business risk by not being overly dependent on their Japanese operations.

American cigarette companies such as Philip Morris and R. J. Reynolds are challenged by trends within

the United States and Europe. Tobacco use in these areas is declining as more laws are passed that ban

smoking in public areas and in restaurants. In response, cigarette makers are attempting to increase their

operations within countries where smoking remains popular to remain profitable over time.

In 2006, for example, Philip Morris spent $5.2 billion to purchase a controlling interest in Indonesian

cigarette maker Sampoerna. This was the biggest acquisition ever in Indonesia by a foreign company.

Tapping into Indonesia’s population of approximately 230 million people was attractive to Philip Morris

in part because nearly two-thirds of men are smokers, and smoking among women is on the rise. As of

2007, Indonesia was the fifth-largest tobacco market in the world, trailing only China, the United States,

Russia, and Japan. To appeal to local preferences for cigarettes flavored with cloves, Philip Morris

introduced a variety of its signature Marlboro brand called Marlboro Mix 9 that includes cloves in its

formulation. [5]

Trends in the decline of cigarette use in the United

States and Europe may snuff out profits enjoyed by

brands such as Marlboro.

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Image courtesy of Autodesigner, http://en.wikipedia.org/wiki/File:Marlboroultralights.JPG.

Figure 7.2 Entering New Markets: Worth the Risk?

Image courtesy of The Fayj, http://www.flickr.com/photos/fayjo/333325967/

Political Risk

Although competing in international markets offers important potential benefits, such as access to new

customers, the opportunity to lower costs, and the diversification of business risk, going overseas also

poses daunting challenges. Political risk refers to the potential for government upheaval or interference

with business to harm an operation within a country (). For example, the term “Arab Spring” has been

used to refer to a series of uprisings in 2011 within countries such as Tunisia, Egypt, Libya, Bahrain, Syria,

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and Yemen. Unstable governments associated with such demonstrations and uprisings make it difficult

for firms to plan for the future. Over time, a government could become increasingly hostile to foreign

businesses by imposing new taxes and new regulations. In extreme cases, a firm’s assets in a country are

seized by the national government. This process is callednationalization. In recent years, for example,

Venezuela has nationalized foreign-controlled operations in the oil, cement, steel, and glass industries.

Countries with the highest levels of political risk tend to be those such as Somalia, Sudan, and Afghanistan

whose governments are so unstable that few foreign companies are willing to enter them. High levels of

political risk are also present, however, in several of the world’s important emerging economies, including

India, the Philippines, Russia, and Indonesia. This creates a dilemma for firms in that these risky settings

also offer enormous growth opportunities. Firms can choose to concentrate their efforts in countries such

as Canada, Australia, South Korea, and Japan that have very low levels of political risk, but opportunities

in such settings are often more modest. [6]

Economic Risk

Economic risk refers to the potential for a country’s economic conditions and policies, property rights

protections, and currency exchange rates to harm a firm’s operations within a country. Executives who

lead companies that do business in many different countries have to take stock of these various

dimensions and try to anticipate how the dimensions will affect their companies. Because economies are

unpredictable, economic risk presents executives with tremendous challenges.

Consider, for example, Kia’s operations in Europe. In May 2009, Kia reported increased sales in ten

European countries relative to May 2008. The firm enjoyed a 62 percent year-to-year increase in Slovakia,

58 percent in Austria, 50 percent in Gibraltar, 49 percent in Sweden, 43 percent in Poland, 24 percent in

Germany, 21 percent in the United Kingdom, 13 percent in the Czech Republic, 6 percent in Belgium, and

3 percent in Italy. [7] As Kia’s executives planned for the future, they needed to wonder how economic

conditions would influence Kia’s future performance in Europe. If inflation and interest rates were to

increase in a particular country, this would make it more difficult for consumers to purchase new Kias. If

currency exchange rates were to change such that the euro became weaker relative to the South Korean

won, this would make a Kia more expensive for European buyers.

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Cultural Risk

Cultural risk refers to the potential for a company’s operations in a country to struggle because of

differences in language, customs, norms, and customer preferences (). The history of business is full of

colorful examples of cultural differences undermining companies. For example, a laundry detergent

company was surprised by its poor sales in the Middle East. Executives believed that their product was

being skillfully promoted using print advertisements that showed dirty clothing on the left, a box of

detergent in the middle, and clean clothing on the right.

A simple and effective message, right? Not exactly. Unlike English and other Western languages, the

languages used in the Middle East, such as Hebrew and Arabic, involve reading from right to left. To

consumers, the implication of the detergent ads was that the product could be used to take clean clothes

and make the dirty. Not surprisingly, few boxes of the detergent were sold before this cultural blunder was

discovered.

A refrigerator manufacturer experienced poor sales in the Middle East because of another cultural

difference. The firm used a photo of an open refrigerator in its prints ads to demonstrate the large amount

of storage offered by the appliance. Unfortunately, the photo prominently featured pork, a type of meat

that is not eaten by the Jews and Muslims who make up most of the area’s population. [8] To get a sense of

consumers’ reactions, imagine if you saw a refrigerator ad that showed meat from a horse or a dog. You

would likely be disgusted. In some parts of world, however, horse and dog meat are accepted parts of

diets. Firms must take cultural differences such as these into account when competing in international

markets.

Cultural differences can cause problems even when the cultures involved are very similar and share the

same language. RecycleBank is an American firm that specializes in creating programs that reward people

for recycling, similar to airlines’ frequent-flyer programs. In 2009, RecycleBank expanded its operations

into the United Kingdom. Executives at RecycleBank became offended when the British press referred to

RecycleBank’s rewards program as a “scheme.” Their concern was unwarranted, however. The

word scheme implies sneakiness when used in the United States, but a scheme simply means a service in

the United Kingdom. [9]Differences in the meaning of English words between the United States and the

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United Kingdom are also vexing to American men named Randy, who wonder why Brits giggle at the

mention of their name.

K E Y T A K E A W A Y

Competing in international markets involves important opportunities and daunting threats. The

opportunities include access to new customers, lowering costs, and diversification of business risk. The

threats include political risk, economic risk, and cultural risk.

E X E R C I S E S

1. Is offshoring ethical or unethical? Why?

2. Do you expect reshoring to become more popular in the years ahead? Why or why not?

3. Have you ever seen an advertisement that was culturally offensive? Why do you think that companies are

sometimes slow to realize that their ads will offend people?

[1] Stateside substitutes. 2011, January 2011. The Economist. Retrieved

fromhttp://www.economist.com/blogs/dailychart/2011/01/comparing_us_states_ countries

[2] Isidore, C. 2010. July 2. GM’s Chinese sales top US. CNNMoney. Retrieved from

http://money.cnn.com/2010/07/02/news/companies/gm_china/index.htm

[3] Copeland, L. 2010, March 25. Kia breathes life into old Georgia textile mill town. USA Today. Retrieved

from http://www.usatoday.com/news/nation/2010-03-24-boomtown_N.htm

[4] Isidore, C. 2011, June 17. Made in USA: Overseas jobs come home. CNNMoney. Retrieved from

http://money.cnn.com/2011/06/17/news/economy/made_in_usa/index.htm

[5] T2M. 2007, July 3. Clove-flavored Marlboro now in Indonesia [Web blog post]. Retrieved from http://www.the-

two-malcontents.com/2007/07/clove-flavored-marlboro- now-in-indonesia

[6] Kostigen, T. 2011, February 25. Beware: The world’s riskiest countries. Market Watch.Wall Street Journal.

Retrieved from http://www.marketwatch.com/story/beware-the -worlds-riskiest-countries-2011-02-25

[7] Kia sales climb strongly in 10 countries in May [Press release]. Kia website. Retrieved from http://www.kia-

press.com/press/corporate/20090605-kia%20sales%20 climb%20strongly%20in%2010%20countries.aspx

[8] Ricks, D. A. 1993. Blunders in international business. Cambridge, MA: Blackwell.

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[9] Maltby, E. 2010, January 19. Expanding abroad? Avoid cultural gaffes. Wall Street Journal. Retrieved from

http://online.wsj.com/article/SB100014240527487036 57604575005511903147960.html

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7.2 Drivers of Success and Failure When Competing in International Markets

L E A R N I N G O B J E C T I V E S

1. Explain the elements of the “diamond model.”

2. Understand how the model helps to explain success and failure in international markets.

The title of a book written by newspaper columnist Thomas Friedman attracted a great deal of attention

when the book was released in 2005. In The World Is Flat: A Brief History of the 21st Century, Friedman

argued that technological advances and increased interconnectedness is leveling the competitive playing

field between developed and emerging countries. This means that companies exist in a “flat world”

because economies across the globe are converging on a single integrated global system. [1] For executives,

a key implication is that a firm’s being based in a particular country is ceasing to be an advantage or

disadvantage.

While Friedman’s notion of business becoming a flat world is flashy and attention grabbing, it does not

match reality. Research studies conducted since 2005 have found that some firms enjoy advantages based

on their country of origin while others suffer disadvantages. A powerful framework for understanding how

likely it is that firms based in a particular country will be successful when competing in international

markets was provided by Professor Michael Porter of the Harvard Business School. [2] The framework is

formally known as “the determinants of national advantage,” but it is often referred to more simply as

“the diamond model” because of its shape.

According to the model, the ability of the firms in an industry whose origin is in a particular country (e.g.,

South Korean automakers or Italian shoemakers) to be successful in the international arena is shaped by

four factors: (1) their home country’s demand conditions, (2) their home country’s factor conditions, (3)

related and supporting industries within their home country, and (4) strategy, structure, and rivalry

among their domestic competitors.

Demand Conditions

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Within the diamond model, demand conditions refer to the nature of domestic customers.

It is tempting to believe that firms benefit when their domestic customers are perfectly willing to purchase

inferior products. This would be a faulty belief! Instead, firms benefit when their domestic customers

have high expectations.

Japanese consumers are known for insisting on very high levels of quality, aesthetics, and reliability.

Japanese automakers such as Honda, Toyota, and Nissan reap rewards from this situation. These firms

have to work hard to satisfy their domestic buyers. Living up to lofty quality standards at home prepares

these firms to offer high-quality products when competing in international markets. In contrast, French

car buyers do not stand out as particularly fussy. It is probably not a coincidence that French automakers

Renault and Peugeot have struggled to gain traction within the global auto industry.

Demand conditions also help to explain why German automakers such as Porsche, Mercedes-Benz, and

BMW create excellent luxury and high-performance vehicles. German consumers value superb

engineering. While a car is simply a means of transportation in some cultures, Germans place value on the

concept of fahrvergnügen, which means “driving pleasure.” Meanwhile, demand for fast cars is high in

Germany because the country has built nearly eight thousand miles of superhighways known as

autobahns. No speed limits for cars are enforced on more than half of the eight thousand miles. Many

Germans enjoy driving at 150 miles per hour or more, and German automakers must build cars capable of

safely reaching and maintaining such speeds. When these companies compete in the international arena,

the engineering and performance of their vehicles stand out.

Factor Conditions

Factor conditions refer to the nature of raw material and other inputs that firms need to create goods and

services. Examples include land, labor, capital markets, and infrastructure. Firms benefit when

they have good access to factor conditions and face challenges when they do not. Companies based in the

United States, for example, are able to draw on plentiful natural resources, a skilled labor force, highly developed

transportation systems, and sophisticated capital markets to be successful. The dramatic growth of Chinese

manufacturers in recent years has been fueled in part by the availability of cheap labor.

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In some cases, overcoming disadvantages in factor conditions leads companies to develop unique skills.

Japan is a relatively small island nation with little room to spare. This situation has led Japanese firms to

be pioneers in the efficient use of warehouse space through systems such as just-in-

time inventory management (JIT). Rather than storing large amounts of parts and material, JIT

management conserves space—and lowers costs—by requiring inputs to a production process to arrive at

the moment they are needed. Their use of JIT management has given Japanese manufacturers an

advantage when they compete in international markets.

Related and Supporting Industries

Could Italian shoemakers create some of the world’s best shoes if Italian leather makers were not among

the world’s best? Possibly, but it would be much more difficult. The concept

of related and supporting industries refers to the extent to which firms’ domestic suppliers and other

complementary industries are developed and helpful.

Italian shoemakers such as Salvatore Ferragamo, Prada, Gucci, and Versace benefit from the availability

of top-quality leather within their home country. If these shoemakers needed to rely on imported leather,

they would lose flexibility and speed.

Fine Italian shoes, such as those found at the famous Via Montenapoleone in Milan, are usually

made of fine Italian leather.

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Image courtesy of Warburg, http://en.wikipedia.org/wiki/File:Milan_Montenapoleone_16.JPG.

The auto industry is a setting where related and supporting industries are very important. Electronics are

key components of modern vehicles. South Korean automakers Kia and Hyundai can leverage the

excellent electronics provided by South Korean firms Samsung and LG. Similarly, Honda, Nissan, and

Toyota are able to draw on the skills of Sony and other Japanese electronics firms. Unfortunately, for

French automakers Renault and Peugeot, no French electronics firms are standouts in the international

arena. This situation makes it difficult for Renault and Peugeot to integrate electronics into their vehicles

as effectively as their South Korean and Japanese rivals.

In extreme cases, the poor condition of related and supporting industries can undermine an operation.

Otabo LLC, a small custom shoe company, was forced to shut down its Florida factory in 2008. Otabo

struggled to find technicians that had the skills needed to fix its shoemaking machines. Meanwhile, there

are very few suppliers of shoelaces, soles, eyelets, and other components in the United States because

about 99 percent of the shoes purchased in the United States are imported, mostly from China. The few

available suppliers were unwilling to create the small batches of customized materials that Otabo wanted.

In the end, the American factory simply could not get access to many of the supplies needed to create

shoes. [3] Production was shifted to China, where all the needed supplies can be found easily and cheaply.

Firm Strategy, Structure, and Rivalry

The concept of firm strategy, structure, and rivalry refers to how challenging it is to survive domestic

competition. The Olympics offer a good analogy for illustrating the positive aspects of very challenging

domestic situations. If the competition to make a national team in gymnastics is fierce, the gymnasts

who make the team will have been pushed to stretch their abilities and performance. In contrast,

gymnasts who faced few contenders in their quest to make a national team will not have been tested

with the same level of intensity. When the two types meet at the Olympics, the gymnasts who overcame

huge hurdles to make their national teams are likely to have an edge over athletes from countries with

few skilled gymnasts.

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Companies that have survived intense rivalry within their home markets are likely to have developed

strategies and structures that will facilitate their success when they compete in international markets.

Hyundai and Kia had to keep pace with each other within the South Korean market before expanding

overseas. The leading Japanese automakers—Honda, Nissan, and Toyota—have had to compete not only

with one another but also with smaller yet still potent domestic firms such as Isuzu, Mazda, Mitsubishi,

Subaru, and Suzuki. In both examples, the need to navigate potent domestic rivals has helped firms later

become fearsome international players.

Succeeding despite difficult domestic competition prepares firms to expand their kingdoms into

international markets.

Image courtesy of Chrisloader,

http://en.wikipedia.org/wiki/File:Leicester_Square_Burger_King.jpg.

If, in contrast, domestic competition is fairly light, a company may enjoy admirable profits within its

home market. However, the lack of being pushed by rivals will likely mean that the firm struggles to reach

its potential in creativity and innovation. This undermines the firm’s ability to compete overseas and

makes it vulnerable to foreign entry into its home market. Because neither Renault nor Peugeot has been

a remarkable innovator historically, these French automakers have enjoyed fairly gentle domestic

competition. Once the auto industry became a global competition, however, these firms found themselves

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trailing their Asian rivals.

K E Y T A K E A W A Y

The likelihood that a firm will succeed when it competes in international markets is shaped by four

aspects of its domestic market: (1) demand conditions; (2) factor conditions; (3) related and supporting

industries; and (4) strategy, structure, and rivalry among its domestic competitors.

E X E R C I S E S

1. Which of the four elements of the diamond model do you believe has the strongest influence on a firm’s

fate when it competes in international markets?

2. Automakers in China and India have yet to compete on the world stage. Based on the diamond model,

would these firms be likely to succeed or fail within the global auto industry?

[1] Friedman, T. L. 2005. The world is flat: A brief history of the 21st century. New York, NY: Farrar, Straus and

Giroux.

[2] Porter, M. E. 1990. The competitive advantage of nations, New York, NY: Free Press.

[3] Aeppel, T. 2008, March 3. US shoe factory finds supplies are Achilles’ heel. Wall Street Journal. Retrieved from

http://online.wsj.com/article/SB120450124543206313.html

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7.3 Types of International Strategies

L E A R N I N G O B J E C T I V E S

1. Understand what a multidomestic strategy involves and be able to offer an example.

2. Understand what a global strategy involves and be able to offer an example.

3. Understand what a transnational strategy involves and be able to offer an example.

A firm that has operations in more than one country is known as a multinational corporation (MNC).

The largest MNCs are major players within the international arena. Walmart’s annual worldwide

sales, for example, are larger than the dollar value of the entire economies of Austria, Norway, and

Saudi Arabia. Although Walmart tends to be viewed as an American retailer, the firm earns more

than one-quarter of its revenues outside the United States. Walmart owns significant numbers of

stores in Mexico (1,730 as of mid-2011), Central America (549), Brazil (479), Japan (414), the United

Kingdom (385), Canada (325), Chile (279), and Argentina (63). Walmart also participates in joint

ventures in China (328 stores) and India (5). [1] Even more modestly sized MNCs are still very

powerful. If Kia were a country, its current sales level of approximately $21 billion would place it in

the top 100 among the more than 180 nations in the world.

Multinationals such as Kia and Walmart must choose an international strategy to guide their efforts

in various countries. There are three main international strategies available: (1) multidomestic, (2)

global, and (3) transnational (Figure 7.10 "International Strategy"). Each strategy involves a different

approach to trying to build efficiency across nations and trying to be responsiveness to variation in

customer preferences and market conditions across nations.

Multidomestic Strategy

A firm using a multidomestic strategy sacrifices efficiency in favor of emphasizing responsiveness to local

requirements within each of its markets. Rather than trying to force all of its American-made shows on

viewers around the globe, MTV customizes the programming that is shown on its channels within dozens

of countries, including New Zealand, Portugal, Pakistan, and India. Similarly, food company H. J. Heinz

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adapts its products to match local preferences. Because some Indians will not eat garlic and onion, for

example, Heinz offers them a version of its signature ketchup that does not include these two ingredients.

Figure 7.10 International Strategy

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Images courtesy of kenny-lex,http://www.flickr.com/photos/kenny_lex/3059058350/ (top left);

Pete,http://www.flickr.com/photos/comedynose/3542592243/ (bottom right); Ged

Carroll,http://www.flickr.com/photos/renaissancechambara/4241378353/ (top left); Creative

Tools,http://www.flickr.com/photos/creative_tools/4293407348/ (bottom right); Windell

Oskay, http://www.flickr.com/photos/oskay/4578993380/ (bottom right); Andrew

Maiman,http://www.flickr.com/photos/amaiman/5550834826/ (top right);

Bodo,http://www.flickr.com/photos/64448029@N05/5901416357/ (top right).

Baked beans flavored with curry? This H. J. Heinz

product is very popular in the United Kingdom.

Image courtesy of Gordon Joly,

http://upload.wikimedia.org/wikipedia/commons/f/f4

/Curry_Beanz.jpg.

Global Strategy

A firm using a global strategy sacrifices responsiveness to local requirements within each of its markets in

favor of emphasizing efficiency. This strategy is the complete opposite of a multidomestic strategy. Some

minor modifications to products and services may be made in various markets, but a global strategy

stresses the need to gain economies of scale by offering essentially the same products or services in each

market.

Microsoft, for example, offers the same software programs around the world but adjusts the programs to

match local languages. Similarly, consumer goods maker Procter & Gamble attempts to gain efficiency by

creating global brands whenever possible. Global strategies also can be very effective for firms whose

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product or service is largely hidden from the customer’s view, such as silicon chip maker Intel. For such

firms, variance in local preferences is not very important.

Transnational Strategy

A firm using a transnational strategy seeks a middle ground between a multidomestic strategy and a

global strategy. Such a firm tries to balance the desire for efficiency with the need to adjust to local

preferences within various countries. For example, large fast-food chains such as McDonald’s and

Kentucky Fried Chicken (KFC) rely on the same brand names and the same core menu items around the

world. These firms make some concessions to local tastes too. In France, for example, wine can be

purchased at McDonald’s. This approach makes sense for McDonald’s because wine is a central element of

French diets.

K E Y T A K E A W A Y

Multinational corporations choose from among three basic international strategies: (1) multidomestic, (2)

global, and (3) transnational. These strategies vary in their emphasis on achieving efficiency around the

world and responding to local needs.

E X E R C I S E S

1. Which of the three international strategies is Kia using? Is this the best strategy for Kia to be using?

2. Identify examples of companies using each of the three international strategies other than those

described above. Which company do you think is best positioned to compete in international markets?

[1] Standard & Poor’s stock report on Walmart.

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7.4 Options for Competing in International Markets

L E A R N I N G O B J E C T I V E S

1. Understand the various options for entering an international market.

2. Be able to provide an example of a firm using each option.

When the executives in charge of a firm decide to enter a new country, they must decide how to enter

the country. There are five basic options available: (1) exporting, (2) creating a wholly owned

subsidiary, (3) franchising, (4) licensing, and (5) creating a joint venture or strategic alliance. These

options vary in terms of how much control a firm has over its operation, how much risk is involved,

and what share of the operation’s profits the firm gets to keep.

Exporting

Exporting involves creating goods within a firm’s home country and then shipping them to another

country. Once the goods reach foreign shores, the exporter’s role is over. A local firm then sells the goods

to local customers. Many firms that expand overseas start out as exporters because exporting offers a low-

cost method to find out whether a firm’s products are appealing to customers in other lands. Some Asian

automakers, for example, first entered the US market though exporting. Small firms may rely on

exporting because it is a low-cost option.

Once a firm’s products are found to be viable in a particular country, exporting often becomes

undesirable. A firm that exports its goods loses control of them once they are turned over to a local firm

for sale locally. This local distributor may treat customers poorly and thereby damage the firm’s brand.

Also, an exporter only makes money when it sells its goods to a local firm, not when end users buy the

goods. Executives may want their firm rather than a local distributor to enjoy the profits that are made

when products are sold to individual customers.

Creating a Wholly Owned Subsidiary

A wholly owned subsidiary is a business operation in a foreign country that a firm fully owns. A firm can

develop a wholly owned subsidiary through agreenfield venture, meaning that the firm creates the entire

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operation itself. Another possibility is purchasing an existing operation from a local company or another

foreign operator.

Regardless of whether a firm builds a wholly owned subsidiary “from scratch” or acquires an existing

operation, having a wholly owned subsidiary can be attractive because the firm maintains complete

control over the operation and gets to keep all of the profits that the operation makes. A wholly owned

subsidiary can be quite risky, however, because the firm must pay all of the expenses required to set it up

and operate it. Kia, for example, spent $1 billion to build its US factory. Many firms are reluctant to spend

such sums in more volatile countries because they fear that they may never recoup their investments.

Franchising

Franchising has been used by many firms that compete in service industries to develop a worldwide

presence. Subway, The UPS Store, and Hilton Hotels are just a few of the firms that have done so.

Franchising involves an organization (called a franchisor) granting the right to use its brand name,

products, and processes to other organizations (known as franchisees) in exchange for an up-front

payment (a franchise fee) and a percentage of franchisees’ revenues (a royalty fee).

Franchising is an attractive way to enter foreign markets because it requires little financial investment by

the franchisor. Indeed, local franchisees must pay the vast majority of the expenses associated with

getting their businesses up and running. On the downside, the decision to franchise means that a firm will

get to enjoy only a small portion of the profits made under its brand name. Also, local franchisees may

behave in ways that the franchisor does not approve. For example, Kentucky Fried Chicken (KFC) was

angered by some of its franchisees in Asia when they started selling fish dishes without KFC’s approval. It

is often difficult to fix such problems because laws in many countries are stacked in favor of local

businesses. Last, franchises are only successful if franchisees are provided with a simple and effective

business model. Executives thus need to avoid expanding internationally through franchising until their

formula has been perfected.

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Licensing

While franchising is an option within service industries, licensing is most frequently used in

manufacturing industries. Licensing involves granting a foreign company the right to create a company’s

product within a foreign country in exchange for a fee. These relationships often center on patented

technology. A firm that grants a license avoids absorbing a lot of costs, but its profits are limited to the

fees that it collects from the local firm. The firm also loses some control over how its technology is used.

A historical example involving licensing illustrates how rapidly events can change within the international

arena. By the time Japan surrendered to the United States and its Allies in 1945, World War II had

crippled the country’s industrial infrastructure. In response to this problem, Japanese firms imported a

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great deal of technology, especially from American firms. When the Korean War broke out in the early

1950s, the American military relied on Jeeps made in Japan using licensed technology. In just a few years,

a mortal enemy had become a valuable ally.

Strategy at the Movies

Gung Ho

Can American workers survive under Japanese management? Although this sounds like the premise for a

bad reality TV show, the question was a legitimate consideration for General Motors (GM) and Toyota in

the early 1980s. GM was struggling at the time to compete with the inexpensive, reliable, and fuel-efficient

cars produced by Japanese firms. Meanwhile, Toyota was worried that the US government would limit the

number of foreign cars that could be imported. To address these issues, these companies worked together

to reopen a defunct GM plant in Fremont, California, in 1984 that would manufacture both companies’

automobiles in one facility. The plant had been the worst performer in the GM system; however, under

Toyota’s management, the New United Motor Manufacturing Incorporated (NUMMI) plant became the

best factory associated with GM—using the same workers as before! Despite NUMMI’s eventual success,

the joint production plant experienced significant growing pains stemming from the cultural differences

between Japanese managers and American workers.

The NUMMI story inspired the 1986 movie Gung Ho in which a closed automobile manufacturing plant

in Hadleyville, Pennsylvania, was reopened by Japanese car company Assan Motors. While Assan Motors

and the workers of Hadleyville were both excited about the venture, neither was prepared for the

differences between the two cultures. For example, Japanese workers feel personally ashamed when they

make a mistake. When manager Oishi Kazihiro failed to meet production targets, he was punished with

“ribbons of shame” and forced to apologize to his employees for letting them down. In contrast, American

workers were presented in the film as likely to reject management authority, prone to fighting at work,

and not opposed to taking shortcuts.

When Assan Motors’ executives attempted to institute morning calisthenics and insisted that employees

work late without overtime pay, the American workers challenged these policies and eventually walked off

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the production line. Assan Motors’ near failure was the result of differences in cultural norms and

values. Gung Ho illustrates the value of understanding and bridging cultural differences to facilitate

successful cross-cultural collaboration, value that was realized in real life by NUMMI.

Joint Ventures and Strategic Alliances

Within each market entry option described earlier, a firm either maintains strong control of operations

(wholly owned subsidiary) or it turns most control over to a local firm (exporting, franchising, and

licensing). In some cases, however, executives find it beneficial to work closely with one or more local

partners in a joint venture or a strategic alliance. In a joint venture, two or more organizations each

contribute to the creation of a new entity. In a strategic alliance, firms work together cooperatively, but no

new organization is formed. In both cases, the firm and its local partner or partners share decision-

making authority, control of the operation, and any profits that the relationship creates.

Joint ventures and strategic alliances are especially attractive when a firm believes that working closely

with locals will provide it important knowledge about local conditions, facilitate acceptance of their

involvement by government officials, or both. In the late 1980s, China was a difficult market for American

businesses to enter. Executives at KFC saw China as an attractive country because chicken is a key

element of Chinese diets. After considering the various options for entering China with its first restaurant,

KFC decided to create a joint venture with three local organizations. KFC owned 51 percent of the venture;

having more than half of the operation was advantageous in case disagreements arose. A Chinese bank

owned 25 percent, the local tourist bureau owned 14 percent, and the final 10 percent was owned by a

local chicken producer that would supply the restaurant with its signature food item.

Having these three local partners helped KFC navigate the cumbersome regulatory process that was in

place and allowed the American firm to withstand the scrutiny of wary Chinese officials. Despite these

advantages, it still took more than a year for the store to be built and approved. Once open in 1987,

however, KFC was an instant success in China. As China’s economy gradually became more and more

open, KFC was a major beneficiary. By the end of 1997, KFC operated 191 restaurants in 50 Chinese cities.

By the start of 2011, there were approximately 3,200 KFCs spread across 850 Chinese cites. Roughly 90

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percent of these restaurants are wholly owned subsidiaries of KFC—a stark indication of how much doing

business in China has changed over the past twenty-five years.

As of early 2011, KFC was opening a new store in China every eighteen hours on average.

Image courtesy of Wikimedia,

http://upload.wikimedia.org/wikipedia/commons/f/fb/Kfc_of_china.jpg.

K E Y T A K E A W A Y

When entering a new country, executives can choose exporting, creating a wholly owned subsidiary,

franchising, licensing, and creating a joint venture or strategic alliance. The key issues of how much

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control a firm has over its operation, how much risk is involved, and what share of the operation’s profits

the firm gets to keep all vary across these options.

E X E R C I S E S

1. Do you believe that KFC would have been so successful in China today if executives had tried to make

their first store a wholly owned subsidiary? Why or why not?

2. The typical joint venture only lasts a few years. Why might joint ventures dissolve so quickly?

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7.5 Conclusion

This chapter explains competition in international markets. Executives must consider the benefits

and risks of competing internationally when making decisions about whether to expand overseas.

Executives also need to determine the likelihood that their firms will succeed when they compete in

international markets by examining demand conditions, factor conditions, related and supporting

industries, and strategy, structure, and rivalry among its domestic competitors. When a firm does

venture overseas, a decision must be made about whether its international strategy will be

multidomestic, global, or transnational. Finally, when leading a firm to enter a new market,

executives can choose to manage the operation via exporting, creating a wholly owned subsidiary,

franchising, licensing, and creating a joint venture or strategic alliance.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should select a

different industry. Find examples of each international strategy for your industry. Discuss which strategy

seems to be the most successful in your selected industry.

2. This chapter discussed Kia and other automakers. If you were assigned to turn around a struggling

automaker such as General Motors or Chrysler, what actions would you take to revive the company’s

prospects within the global auto industry?

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Chapter 8

Selecting Corporate-Level Strategies

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. Why might a firm concentrate on a single industry?

2. What is vertical integration and what benefits can it provide?

3. What are the two types of diversification and when should they be used?

4. Why and how might a firm retrench or restructure?

5. What is portfolio planning and why is it useful?

What’s the Big Picture at Disney?

Walt Disney remains a worldwide icon five decades after his death.

Image courtesy of Wikipedia,

http://en.wikipedia.org/wiki/File:Walt_Disney_Snow_white_1937_trailer_screenshot_(13).jpg.

Chapter 8 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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The animated film Cars 2 was released by Pixar Animation Studios in late June 2011. This sequel to the

smash hit Cars made $66 million at the box office on its opening weekend and appeared likely to be yet

another commercial success for Pixar’s parent corporation, The Walt Disney Company. By the second

weekend after its release, Cars 2 had raked in $109 million.

Although Walt Disney was a visionary, even he would have struggled to imagine such enormous numbers

when his company was created. In 1923, Disney Brothers Cartoon Studio was started by Walt and his

brother Roy in their uncle’s garage. The fledgling company gained momentum in 1928 when a character

was invented that still plays a central role for Disney today—Mickey Mouse. Disney expanded beyond

short cartoons to make its first feature film, Snow White and the Seven Dwarves, in 1937.

Following a string of legendary films such as Pinocchio (1940), Fantasia(1940), Bambi (1942),

and Cinderella (1950), Walt Disney began to diversify his empire. His company developed a television

series for the American Broadcasting Company (ABC) in 1954 and opened the Disneyland theme park in

1955. Shortly before its opening, the theme park was featured on the television show to expose the

American public to Walt’s innovative ideas. One of the hosts of that episode was Ronald Reagan, who

twenty-five years later became president of the United States. A larger theme park, Walt Disney World,

was opened in Orlando in 1971. Roy Disney died just two months after Disney World opened; his brother

Walt had passed in 1966 while planning the creation of the Orlando facility.

The Walt Disney Company began a series of acquisitions in 1993 with the purchase of movie studio

Miramax Pictures. ABC was acquired in 1996, along with its very successful sports broadcasting company,

ESPN. Two other important acquisitions were made during the following decade. Pixar Studios was

purchased in 2006 for $7.4 billion. This strategic move brought a very creative and successful animation

company under Disney’s control. Three years later, Marvel Entertainment was acquired for $4.24 billion.

Marvel was attractive because of its vast roster of popular characters, including Iron Man, the X-Men, the

Incredible Hulk, the Fantastic Four, and Captain America. In addition to featuring these characters in

movies, Disney could build attractions around them within its theme parks.

With annual revenues in excess of $38 billion, The Walt Disney Company was the largest media

conglomerate in the world by 2010. It was active in four key industries. Disney’s theme parks included not

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only its American locations but also joint ventures in France and Hong Kong. A park in Shanghai, China,

is slated to open by 2016. The theme park business accounted for 28 percent of Disney’s revenues.

Disney’s presence in the television industry, including ABC, ESPN, Disney Channel, and ten television

stations, accounted for 45 percent of revenues. Disney’s original business, filmed entertainment,

accounted for 18 percent of revenue. Merchandise licensing was responsible for 7 percent of revenue. This

segment of the business included children’s books, video games, and 350 stores spread across North

American, Europe, and Japan. The remaining 2 percent of revenues were derived from interactive online

technologies. Much of this revenue was derived from Playdom, an online gaming company that Disney

acquired in 2010. [1]

By mid-2011, questions arose about how Disney was managing one of its most visible subsidiaries. Pixar’s

enormous success had been built on creativity and risk taking. Pixar executives were justifiably proud that

they made successful movies that most studios would view as quirky and too off-the-wall. A good example

is 2009’s Up!, which made $730 million despite having unusual main characters: a grouchy widower, a

misfit “Wilderness Explorer” in search of a merit badge for helping the elderly, and a talking dog. Disney

executives, however, seemed to be adopting a much different approach to moviemaking. In a February

2011 speech, Disney’s chief financial officer noted that Disney intended to emphasize movie franchises

such as Toy Story and Cars that can support sequels and sell merchandise.

When the reviews of Pixar’s Cars 2 came out in June, it seemed that Disney’s preferences were the driving

force behind the movie. The film was making money, but it lacked Pixar’s trademark artistry. One movie

critic noted, “With Cars 2, Pixar goes somewhere new: the ditch.” Another suggested that “this frenzied

sequel seldom gets beyond mediocrity.” A stock analyst that follows Disney perhaps summed up the

situation best when he suggested that Cars 2 was “the worst-case scenario.…A movie created solely to

drive merchandise. It feels cynical. Parents may feel they’re watching a two-hour commercial.” [2] Looking

to the future, Pixar executives had to wonder whether their studio could excel as part of a huge firm.

Would Disney’s financial emphasis destroy the creativity that made Pixar worth more than $7 billion in

the first place? The big picture was definitely unclear.

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Will John Lassiter, Pixar’s chief creative officer, be prevented from making more quirky films

like Up! by parent company Disney?

Image courtesy of Nicolas Genin,

http://upload.wikimedia.org/wikipedia/commons/b/bc/John_Lasseter-Up-66th_Mostra.jpg.

When dealing with corporate-level strategy, executives seek answers to a key question: 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.

[1] Standard & Poor’s stock report on The Walt Disney Company.

[2] Stewart, J. B. 2011, June 1. A collision of creativity and cash. New York Times. Retrieved

from http://www.nytimes.com/2011/07/02/business/02stewart.html

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8.1 Concentration Strategies

L E A R N I N G O B J E C T I V E S

1. Name and understand the three concentration strategies.

2. Be able to explain horizontal integration and two reasons why it often fails.

For many firms, concentration strategies are very sensible. These strategies involve trying to compete

successfully only within a single industry. McDonald’s, Starbucks, and Subway are three firms that

have relied heavily on concentration strategies to become dominant players.

Market Penetration

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 its efforts to excel within an industry.[1]

Market penetration involves trying to gain additional share of a firm’s existing markets using existing products.

Often firms will rely on advertising to attract new customers with existing markets.

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. McDonald’s has pursued market

penetration in recent years by using Latino themes within some of its advertising. The firm also maintains

a Spanish-language website at http://www.meencanta.com; the website’s name is the Spanish translation

of McDonald’s slogan “I’m lovin’ it.” McDonald’s hopes to gain more Latino customers through initiatives

such as this website.

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Nike relies in part on a market penetration strategy within the athletic shoe business.

Image courtesy of Jean-Louis Zimmermann,

http://www.flickr.com/photos/jeanlouis_zimmermann/5175647157/sizes/o/in/photostream.

Market Development

Market development involves taking existing products and trying to sell them within new markets. One

way to reach a new market is to enter a new retail channel. Starbucks, for example, has stepped beyond

selling coffee beans only in its stores and now sells beans in grocery stores. This enables Starbucks to

reach consumers that do not visit its coffeehouses.

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Starbucks’ market development strategy has allowed fans to buy its beans in grocery stores.

Image courtesy of Claire Gribbin,http://en.wikipedia.org/wiki/File:Starbucks_coffee_beans.jpg.

Entering new geographic areas is another way to pursue market development. Philadelphia-based Tasty

Baking Company has sold its Tastykake snack cakes since 1914 within Pennsylvania and adjoining states.

The firm’s products have become something of a cult hit among customers, who view the products as

much tastier than the snack cakes offered by rivals such as Hostess and Little Debbie. In April 2011,

Tastykake was purchased by Flowers Foods, a bakery firm based in Georgia. When it made this

acquisition, Flower Foods announced its intention to begin extensively distributing Tastykake’s products

within the southeastern United States. Displaced Pennsylvanians in the south rejoiced.

Product Development

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

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featuring real actors. More recently, McDonald’s has gradually moved more and more of its menu toward

healthy items to appeal to 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 coffeepot. 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.

Product development is a popular strategy in the soft-drink industry, but not all developments pay

off. Coca-Cola Black (a blending of cola and coffee flavors) was launched in 2006 but discontinued

in 2008.

Image courtesy of Barry,

http://www.flickr.com/photos/buglugs/1536568227/sizes/o/in/photostream.

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Seattle-based Jones Soda Co. takes a novel approach to product development. Each winter, the firm

introduces a holiday-themed set of unusual flavors. Jones Soda’s 2006 set focus on the flavors of

Thanksgiving. It contained Green Pea, Sweet Potato, Dinner Roll, Turkey and Gravy, and Antacid sodas.

The flavors of Christmas were the focus of 2007’s set, which included Sugar Plum, Christmas Tree, Egg

Nog, and Christmas Ham. In early 2011, Jones Soda let it customers choose the winter 2011 flavors via a

poll on its website. The winners were Candy Cane, Gingerbread, Pear Tree, and Egg Nog. None of these

holiday flavors are expected to be big hits, of course. The hope is that the buzz that surrounds the unusual

flavors each year will grab customers’ attention and get them to try—and become hooked on—Jones

Soda’s more traditional flavors.

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.

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 is 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

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have market share that is attractive. Part of the motivation behind Southwest Airlines’ purchase of

AirTran was that AirTran had a significant share of the airline business in cities—especially Atlanta, home

of the world’s busiest airport—that Southwest had not yet entered. Rather than build a presence from

nothing in Atlanta, Southwest executives believed that buying a position was prudent.

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 had gained exposure on network

television through broadcasts on CBS and its partner Showtime. Thus acquiring Strikeforce might help

Zuffa gain mainstream exposure of its product. [2]

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The combination of UFC and Strikeforce into one company may accelerate the growing popularity

of mixed martial arts.

Image courtesy of hydropeek,

http://www.flickr.com/photos/hydropeek/4533084943/sizes/o/in/photostream.

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 erode shareholder

wealth while fewer than one in six increases shareholder wealth. [3] 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 percent and 45 percent of mergers and acquisitions are undone, often at huge

losses. [4] 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.

K E Y T A K E A W A Y S

A concentration strategy involves trying to compete successfully within a single industry.

Market penetration, market development, and product development are three methods to grow within

an industry. Mergers and acquisitions are popular moves for executing a concentration strategy, but

executives need to be cautious about horizontal integration because the results are often poor.

E X E R C I S E S

1. Suppose the president of your college or university decided to merge with or acquire another school.

What schools would be good candidates for this horizontal integration move? Would the move be a

success?

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2. Given that so many mergers and acquisitions fail, why do you think that executives keep making

horizontal integration moves?

3. Can you identify a struggling company that could benefit from market penetration, market development,

or product development? What might you advise this company’s executives to do differently?

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

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

Retrieved from http://sportsillustrated.cnn.com/2011/writers/jeff_wagenheim/03/12/strikeforce-

purchased/index.html

[3] Henry, D. 2002, October 14. Mergers: Why most big deals don’t pay off. Business Week, 60–70.

[4] 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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8.2 Vertical Integration Strategies

L E A R N I N G O B J E C T I V E S

1. Understand what backward vertical integration is.

2. Understand what forward vertical integration is.

3. Be able to provide examples of backward and forward vertical integration.

When pursuing a vertical integration strategy, a firm gets involved in new portions of the value chain

(Figure 8.3 "Vertical Integration at American Apparel"). 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.

In the late 1800s, Carnegie Steel Company was a pioneer in the use of vertical integration. The firm

controlled the iron mines that provided the key ingredient in steel, the coal mines that provided the

fuel for steelmaking, the railroads that transported raw material to steel mills, and the steel mills

themselves. Having control over all elements of the production process ensured the stability and

quality of key inputs. By using vertical integration, Carnegie Steel achieved levels of efficiency never

before seen in the steel industry.

Figure 8.3 Vertical Integration at American Apparel

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Images courtesy of alossix, http://www.flickr.com/photos/alossix/2588175535/ (top

middle),http://www.flickr.com/photos/alossix/2588242383/ (top

left),http://www.flickr.com/photos/alossix/2589149772/ (bottom left); Dov

Charney, http://www.flickr.com/photos/dovcharney/2885342063/ (top right); Nicolas

Nova, http://www.flickr.com/photos/nnova/3399896671/(background);

vmiramontes,http://www.flickr.com/photos/vmiramontes/4376957889/ (bottom right).

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.

The risk of not being vertically integrated is illustrated by the 2010 Deepwater Horizon oil spill in the

Gulf of Mexico. Although the US government held BP responsible for the disaster, BP cast at least

some of the blame on drilling rig owner Transocean and two other suppliers: Halliburton Energy

Services (which created the cement casing for the rig on the ocean floor) and Cameron International

Corporation (which had sold Transocean blowout prevention equipment that failed to prevent the

disaster). In April 2011, BP sued these three firms for what it viewed as their roles in the oil spill.

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The 2010 explosion of the Deepwater Horizon oil rig cost eleven lives and released nearly five

million barrels of crude oil into the Gulf of Mexico.

Image courtesy of US Coast Guard,

http://en.wikipedia.org/wiki/File:Deepwater_Horizon_offshore_drilling_unit_on_fire_2010.jpg.

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 lumber to contractors.

Vertical integration can also create complacency. Consider, 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.

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Backward Vertical Integration

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 firms. 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.

To ensure high quality, Ford relied heavily on backward vertical integration in the early days of

the automobile industry.

Image courtesy of Ford Corporation, http://en.wikipedia.org/wiki/File:Ford_1939.jpg.

Although backward vertical integration is usually discussed within the context of manufacturing

businesses, such as steelmaking and the auto industry, this strategy is also available to firms such as

Disney that compete within the entertainment sector. ESPN is a key element of Disney’s operations within

the television business. Rather than depend on outside production companies to provide talk shows and

movies centered on sports, ESPN created its own production company. ESPN Films is a subsidiary of

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ESPN that was created in 2001. ESPN Films has created many of ESPN’s best-known programs, including

Around the Horn and Pardon the Interruption. By owning its own production company, ESPN can ensure

that it has a steady flow of programs that meet its needs.

Forward Vertical Integration

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 a little more profit than it would if the same book bag were sold by

a retailer such as Target.

Forward vertical integration also can be useful for neutralizing the effect of powerful buyers. Rental car

agencies are able to insist on low prices for the vehicles they buy from automakers because they purchase

thousands of cars. If one automaker stubbornly tries to charge high prices, a rental car agency can simply

buy cars from a more accommodating automaker. It is perhaps not surprising that Ford purchased Hertz

Corporation, the world’s biggest rental car agency, in 1994. This ensured that Hertz would not drive too

hard of a bargain when buying Ford vehicles. By 2005, selling vehicles to rental car companies had

become less important to Ford and Ford was struggling financially. The firm then reversed its forward

vertical integration strategy by selling Hertz.

eBay’s purchase of PayPal and Apple’s creation of Apple Stores are two recent examples of forward

vertical integration. Despite its enormous success, one concern for eBay is that many individuals avoid

eBay because they are nervous about buying and selling goods online with strangers. PayPal addressed

this problem by serving, in exchange for a fee, as an intermediary between online buyers and sellers.

eBay’s acquisition of PayPal signaled to potential customers that their online transactions were completely

safe—eBay was now not only the place where business took place but eBay also protected buyers and

sellers from being ripped off.

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Apple’s ownership of its own branded stores set the firm apart from computer makers such as Hewlett-

Packard, Acer, and Gateway that only distribute their products through retailers like Best Buy and Office

Depot. Employees at Best Buy and Office Depot are likely to know just a little bit about each of the various

brands their store carries.

In contrast, Apple’s stores are popular in part because store employees are experts about Apple products.

They can therefore provide customers with accurate and insightful advice about purchases and repairs.

This is an important advantage that has been created through forward vertical integration.

K E Y T A K E A W A Y

Vertical integration occurs when a firm gets involved in new portions of the value chain. By entering the

domain of a supplier (backward vertical integration) or a buyer (forward vertical integration), executives

can reduce or eliminate the leverage that the supplier or buyer has over the firm.

E X E R C I S E S

1. Identify a well-known company that does not use backward or forward vertical integration. Why do you

believe that the firm’s executives have avoided these strategies?

2. Some universities have used vertical integration by creating their own publishing companies. The Harvard

Business Press is perhaps the best-known example. Are there other ways that a university might vertical

integrate? If so, what benefits might this create?

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8.3 Diversification Strategies

L E A R N I N G O B J E C T I V E S

1. Explain the concept of diversification.

2. Be able to apply the three tests for diversification.

3. Distinguish related and unrelated diversification.

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 is within, 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 three tests or it should be rejected. [1]

1. 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. 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. When Philip Morris bought 7Up in the late 1970s, it paid

four times what 7Up was actually worth. Making up these costs proved to be impossible and 7Up was

sold in 1986.

3. Will the new unit and the firm be better off? Unless one side or the other gains a competitive

advantage, diversification should be avoided. In the case of Philip Morris and 7Up, for example,

neither side benefited significantly from joining together.

Related Diversification

Related diversification occurs when a firm moves into a new industry that has important similarities with

the firm’s existing industry or industries (Figure 8.4 "The Sweet Fragrance of Success: The Brands That

“Make Up” the Lauder Empire"). 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

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aim to develop and exploit acore 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 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.

Figure 8.4 The Sweet Fragrance of Success: The Brands That “Make Up” the Lauder Empire

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Images courtesy of Betsy Weber, http://www.flickr.com/photos/betsyweber/5915582379/ (fourth

row left); ookikioo, http://www.flickr.com/photos/ookikioo/856924791/ (third row middle);

Shotcuts Software,http://www.flickr.com/photos/57283318@N07/5303842500/ (second row

right); Joanne Saige Lee,

http://www.flickr.com/photos/crystalliferous/3024189623/sizes/m/in/photostream/,

http://www.flickr.com/photos/crystalliferous/3025018504/sizes/m/in/photostream/ (third row

left); Jessica Sheridan,http://www.flickr.com/photos/16353290@N00/4043846042/ (first row

middle); daveynin, http://www.flickr.com/photos/daveynin/2726423708/(second row left);

Handmade Image, http://www.flickr.com/photos/33707373@N03/4643563760/ (fourth row

right); Church Street Marketplace,

http://www.flickr.com/photos/churchstreetmarketplace/4180164459/(third row right); ookikioo,

http://www.flickr.com/photos/ookikioo/314692747/sizes/m/in/photostream/ (first row left);

Liane Chan, http://www.flickr.com/photos/porcupiny/1926961411/sizes/o/in/photostream/ (first

row right).

Honda Motor Company provides a good example of leveraging a core competency through related

diversification. Although Honda is best known for its cars and trucks, the company actually started out in

the motorcycle business. Through competing in this business, Honda developed a unique ability to build

small and reliable engines. When executives decided to diversify into the automobile industry, Honda was

successful in part because it leveraged this ability within its new business. Honda also applied its engine-

building skills in the all-terrain vehicle, lawn mower, and boat motor industries.

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Honda’s related diversification strategy has taken the firm into several businesses, including boat

motors.

Image courtesy of

Wikimedia,http://upload.wikimedia.org/wikipedia/en/5/53/Hondaoutboard.jpg.

Sometimes the benefits of related diversification that executives hope to enjoy are never achieved. 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 ofunrelated diversification, which occurs when a firm enters an industry that lacks any important

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similarities with the firm’s existing industry or industries (Figure 8.5 "Unrelated Diversification at

Berkshire Hathaway"). Luckily for Coca-Cola, its investment paid off—Columbia was sold to Sony for $3.4

billion just seven years later.

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.

Lighter firm Zippo is currently trying to avoid this scenario. According to CEO Geoffrey Booth, the Zippo

is viewed by consumers as a “rugged, durable, made in America, iconic” brand. [3] This brand has fueled

eighty years of success for the firm. But the future of the lighter business is bleak. Zippo executives expect

to sell about 12 million lighters this year, which is a 50 percent decline from Zippo’s sales levels in the

1990s. This downward trend is likely to continue as smoking becomes less and less attractive in many

countries. To save their company, Zippo executives want to diversify.

The durability of Zippo’s products is illustrated by this lighter, which still works despite being made in 1968.

Image courtesy of David J. Fred, http://upload.wikimedia.org/wikipedia/commons/9/97/Zippo-Slim-1968-Lit.jpg.

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In particular, Zippo wants to follow a path blazed by Eddie Bauer and Victorinox Swiss Army Brands Inc.

The rugged outdoors image of Eddie Bauer’s clothing brand has been used effectively to sell sport utility

vehicles made by Ford. The high-quality image of Swiss Army knives has been used to sell Swiss Army–

branded luggage and watches. As of March 2011, Zippo was examining a wide variety of markets where

their brand could be leveraged, including watches, clothing, wallets, pens, liquor flasks, outdoor hand

warmers, playing cards, gas grills, and cologne. Trying to figure out which of these diversification options

would be winners, such as the Eddie Bauer-edition Ford Explorer, and which would be losers, such as

Harley-branded bottled water, was a key challenge facing Zippo executives.

Strategy at the Movies

In Good Company

What do Techline cell phones, Sports America magazine, and Crispity Crunch cereals have in common?

Not much, but that did not stop Globodyne from buying each of these companies in its quest for synergy

in the 2004 movie In Good Company. Executive Carter Duryea was excited when his employer Globodyne

purchased Waterman Publishing, the owner of Sports America magazine. The acquisition landed him a

big promotion and increased his salary to “Porsche-leasing” size.

Synergy is created when two or more businesses produce benefits together that could not be produced

separately. While Duryea was confident that a cross-promotional strategy between his advertising division

and the other units within the Globodyne universe was a slam-dunk, Waterman employee Dan Foreman

saw little congruence between advertisements in Sports America on the one hand and cell phones and

breakfast cereals on the other. Despite his considerable efforts, Duryea was unable to increase ad pages

in Sports America because the unrelated nature of Globodyne’s other business units inhibited his strategy

of creating synergy. Seeing little value in owning a failing publishing company, Globodyne promptly sold

the division to another conglomerate. After the sale, the executives that had been rewarded for the initial

purchase of Waterman Publishing, including Duryea, were fired.

Globodyne’s inability to successfully manage Waterman Publishing illustrates the difficulties associated

with unrelated diversification. While buying companies outside a parent company’s core competencies

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can increase the size of the company and in turn its executives’ bank accounts, managing firms unfamiliar

to management is generally a risky and losing proposition. Decades of research on strategic management

suggest that when firms diversify, it is best to “stick to the knitting.” That is, stay with businesses

executives are familiar with and avoid moving into ventures where little expertise exists.

In Good Company starred Topher Grace as ill-fated junior executive Carter Duryea.

Image courtesy of David Shankbone,http://en.wikipedia.org/wiki/File:Topher_Grace_by_David_Shankbone.jpg.

K E Y T A K E A W A Y

Diversification strategies involve firmly stepping beyond its existing industries and entering a new value

chain. Generally, related diversification (entering a new industry that has important similarities with a

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firm’s existing industries) is wiser than unrelated diversification (entering a new industry that lacks such

similarities).

E X E R C I S E S

1. Studies have shown that executives’ pay increases when their firms gets larger. What role, if any, do you

think executive pay plays in diversification decisions?

2. Identify a firm that has recently engaged in diversification. Search the firm’s website to identify

executives’ rationale for diversifying. Do you find the reasoning to be convincing? Why or why not?

[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.

[3] http://th2010.townhall.com/news/us/2011/03/20/zippos_burning_ambition_lies_in_ retail_expansion.

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8.4 Strategies for Getting Smaller

L E A R N I N G O B J E C T I V E S

1. Understand why a firm would want to shrink or exit from a business.

2. Be able to distinguish retrenchment and restructuring.

“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. In July 2011, for example, South

African grocery store chain Pick n Pay announced plans to release more than 3,000 of its estimated

36,000 workers. Just over a month earlier, South African officials had approved Walmart’s acquisition of

a leading local retailer called Massmart. Rivalry in the South African grocery business seemed likely to

become fiercer, and Pick n Pay executives needed to cut costs for their firm to remain competitive.

A Pick n Pay executive explained the layoffs by noting that “the decision was not taken lightly but was

required to ensure the viability of the retail business and its employees into the future.” [1] 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. Without becoming smaller and more cost effective, Pick n Pay and other

firms that use retrenchment can risk total failure.

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The term retrenchment has its origins in trench warfare, which is shown in this World War I photo

taken in France.

Image courtesy of Lt. J. W. Brooke,

http://en.wikipedia.org/wiki/File:Cheshire_Regiment_trench_Somme_1916.jpg.

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.

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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.

Fortune Brands provides a good example. Surprisingly, this company does not own Fortune magazine,

but it has been involved in a diverse set of industries. As of 2010, the firm consisted of three businesses:

spirits (including Jim Beam and Maker’s Mark), household goods (including Masterlock and Moen

Faucets), and golf equipment (including Titleist clubs and balls as well as FootJoy shoes). In December

2010, Fortune Brand’s CEO announced a plan to separate the three businesses to “maximize long-term

value for our shareholders and to create exciting opportunities within our businesses.” [2] Fortune Brands

took the first step toward overcoming the diversification discount in May 2011 when it reached an

agreement to sell its gold business to Fila. In June 2011, plans to spin off the home products business were

announced.

Fortune Brands hopes to unlock hidden shareholder value by divesting unrelated brands such as

Masterlock.

Image courtesy of Thegreenj,

http://upload.wikimedia.org/wikipedia/commons/a/a1/Masterpadlock.jpg.

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

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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.

K E Y T A K E A W A Y

Executives sometimes need to reduce the size of their firms to maximize the chances of success. This can

involve fairly modest steps such as retrenchment or more profound restructuring strategies.

E X E R C I S E S

1. Should Disney consider using retrenchment or restructuring? Why or why not?

2. Given how much information is readily available about companies, why do you think investors still

struggle to analyze diversified companies?

[1] Chilwane, L. 2011, July 7. Pick n Pay to retrench. The New Age. Retrieved

fromhttp://www.thenewage.co.za/22462-1025-53-Pick_n_Pay_to_retrench

[2] Sauerhaft, R. 2011, May 20. Fortune Brands to sell Titleist and FootJoy to Fila Korea. Golf.com. Retrieved

fromhttp://www.golf.com/golf/tours_news/article/0,28136,2073173,00.html#ixzz1MvXStp2b

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8.5 Portfolio Planning and Corporate-Level Strategy

L E A R N I N G O B J E C T I V E S

1. Understand why a firm would want to use portfolio planning.

2. Be able to explain the limitations of portfolio planning.

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, lightbulbs,

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 calledstars. 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.

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Owning a puppy is fun, but companies may want to avoid owning units that are considered to be dogs.

Photo courtesy of D. Ketchen.

The BCG matrix is just one portfolio planning technique. With the help of a leading consulting firm, GE

developed the attractiveness-strength matrix to examine its diverse activities. This 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. Each dimension is divided into three categories, resulting in nine boxes.

Each of these boxes has a set of recommendations associated with it.

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, not just two. 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 deals with existing businesses, it cannot reveal what new industries a

firm should consider entering.

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K E Y T A K E A W A Y

Portfolio planning is a useful tool for analyzing a firm’s operations, but this tool has limitations. The BCG

matrix is one of the most widely used approaches to portfolio planning.

E X E R C I S E S

1. Is market share a good dimension to use when analyzing the prospects of a business? Why or why not?

2. What might executives do to keep employees within dog units motivated and focused on their jobs?

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8.6 Conclusion

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.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should create a

new portfolio planning technique by selecting two dimensions along which companies can be analyzed.

Allow each group three to five minutes to present its approach to the class. Discuss which portfolio

planning technique seems to offer the best insights.

2. This chapter discussed Disney. Imagine that you were hired as a consultant by General Electric (GE), a firm

that competes with Disney in the movie, television, and theme park industries. What actions would you

recommend that GE take in these three industries to gain advantages over Disney?