Strategic Development: Scope of the Firm

**DIRECTIONS FOR STRATEGIC DEVELOPMENT** **THE SCOPE OF THE FIRM AND ITS STRATEGIC DEVELOPMENT:** **DEFINING THE SCOPE OF THE FIRM:** **Scope of the firm:** range of products and markets in which a firm wishes to compete (set of businesses in which the firm is to compete and how those businesses...

**DIRECTIONS FOR STRATEGIC DEVELOPMENT** **THE SCOPE OF THE FIRM AND ITS STRATEGIC DEVELOPMENT:** **DEFINING THE SCOPE OF THE FIRM:** **Scope of the firm:** range of products and markets in which a firm wishes to compete (set of businesses in which the firm is to compete and how those businesses will be interrelated). It´s the strategy´s point of [departure] it impacts upon the firm as a whole and its future development. \*It´s included in the mission of a firm as a way of expressing its identity with regard to what is essential in its operations. 3 DIMENSIONS OF ABELLS MODEL - Functions (what) - Customer groups (who) - Technologies (how) DEFINING A FIRM´S FIELD OF OPERATIONS OR RANGE OF BUSINESSES: A. **SCOPE:** number of functions, customer groups or technologies a firm uses. - [Scope of functions:] diversity of customer needs to be met. - [Scope of customers:] target group of customers according to one or more of the usual criteria for the segmentation of demand, depending on the customers´ characteristics. - [Scope of technologies:] the way of competing in different industries with different businesses. The way of manufacturing the product or providing a service (technology used to solve those problems and needs) A firm may go further in the definition of its scope by combining broad scopes and/or narrow ones in each one of the 3 variables used. \*Extreme case firm that chooses a broad scope for both its functions and its customer groups and technologies. B. **DIFFERENTIATION BETWEEN STRATEGIC SEGMENTS:** The degree to which a firm treats the various segments differently according to each one of the basic dimensions (functions, customer groups and technologies). \*It refers to the variety of the dimensions and the manner in which a firm addresses that variety (not that much to the quantity of those dimensions) qualitative aspect. This differentiation is seen as a response to the varying needs of consumers. It can be achieved in 2 ways by modifying the actual product or through some change in the firm´s commercial strategy. \*A firm that caters for several customer groups may decide to homogenize its offer or seek to customize it according to each segment of demand targeted. Regarding functions and technologies customer industries provide multi-products designed to cover various needs by using several technologies that proceed from different industries. The combination of the variables scope and differentiation among strategic segments defines a firm´s field of activity. As the field becomes broader and this differentiation greater scope of the firm becomes more complex and demanding for it. The manner in which each firm defines its scope will depend on its mission and objectives, the environment in which it operates, and the provision of resources and capabilities available to it. **FIRM GROWTH AND DEVELOPMENT:** Once the scope is defined, a firm evolves over time due to its current operations and to any possible strategic decisions adopted. **Firm growth:** increases in the size of variables (volume of assets, output, sales, profits and headcount). Growth is a core ingredient in the definition of strategy: - Growth is interpreted as a sign of health, vitality and strength. Firms that grow record a steady progression, a sense of flow with high expectations for the future - In dynamic and competitive environments, firms have to grow and continuously develop to sustain their competitive positioning regarding other growth companies and to improve it - The growth objective is closely related to the utility function of the firm´s top managers they will seek to boost it **Firm development:** quantitative and qualitative changes in the firm derived of the modification of its scope of activity. \*It includes the firm´s qualitative variations (broader than that of growth). \*It tends to be accompanied by growth in most cases, but it´s not always the case. The logic of the choice of development strategies should be centred on value creation (it helps to avoid identifying growth with business development). Development strategies may create value with or without growth through a restructuring of the business portfolio, or by reducing the size of the firm. \*Diversified growth designed to reduce a firm´s overall risk may be achieved at the expense of not creating value, or by destroying value for the firm as a whole. Strategic decisions on a firm´s development involve some options that depend on the response given to 2 [core issues]: - **Development direction:** decision on whether a firm should focus on or specialize in the activities it has been pursuing, develop other new ones or restructure the sum of its businesses. (A firm should decide whether or not to modify its scope) - **Development method:** select the method, manner or path for achieving the goals set out in that development direction. Basic options: - Internal or organic growth (new investment within the heart of the firm) - External growth (mergers, takeovers and alliances) **DIRECTIONS FOR DEVELOPMENT:** \*The definition of the scope of a firm may vary over time, as the factors with a bearing on its definition can change (the kernel of development strategies). TYPES OF BASIC GROWTH AND DEVELOPMENT STRATEGIES (based on the relationship between a firm´s current or traditional situation, and new developments regarding products and markets): - **EXPANSION:** maintaining a close relationship with the present situation through traditional products, traditional markets, or both at the same time. - **DIVERSIFICATION:** implies something of a fresh start, with the firm developing in response to new markets and products. This classification poses the problem of identifying development with firm growth. Nevertheless, firms may also consider the option of downsizing or restructuring their business portfolio in search of the greater specialization or consistency of their core activities. Development strategies may be identified according to a specific composition of the business portfolio at the present time, considering different alternatives according to: a. Whether or not the strategy chosen changes the scope of the firm b. Whether or not the strategy chosen implies growth c. Whether or not operations continue with the same products and in the same markets d. Whether or not the new products and markets accessed are related to traditional ones. As well as the type of relationship maintained STRATEGIES OR DIRECTIONS FOR DEVELOPMENT: - **Consolidation:** a firm seeks to uphold its current performance levels (It doesn´t entail growth or modification of the scope of the firm). This arises when the firm operates in mature or declining industries in which the aim is to sustain and protect its current positioning. - **Expansion:** maintaining a close relationship with the present situation on the basis of traditional products, traditional markets, or both at the same time. It provides growth and it may or may not lead to a change in the scope of the firm. - **Diversification:** the firm launches new products and enters new markets simultaneously (break with the present situation). It implies growth and leads to a change in the scope of the firm (under all circumstances) - [Related diversification:] the new business is related to the previous ones - [Unrelated diversification:] the new business is not related to the previous ones - **Vertical integration:** the firm launches new businesses that are related to the full cycle for the exploitation of its core product it becomes its own supplier or customer, undertaking activities that were formerly covered through market operations. - [Backward vertical integration:] the new business is situated upstream of the core product. - [Forward vertical integration:] the new business is situated downstream of the core product. - **Restructuring:** reorganize the business portfolio closing one or more of the current businesses and restructuring one or more of the businesses in the portfolio. It involves upholding the size, or even reducing it if the business abandoned is not replaced by another one (in this case, it involves modifying the scope of the firm) These strategies represent decisions that lead a firm to maintain or modify its scope. Development strategies may be analyzed within a 3-dimensional framework in which a firm decides upon its: - [Horizontal or product scope:] a firm may decide to: - Remain specialized (consolidation, expansion) - Enlarge its business portfolio (related and unrelated diversification) - Reduce that portfolio (restructuring) - [Vertical scope:] a firm may choose to increase or reduce the degree of vertical integration. - [Geographical scope:] a firm may decide to expand or cut back on its operations in other countries. \*CONSOLIDATION doesn´t entail growth or any change to the scope of the firm. **EXPANSION STRATEGY:** The enlargement or exploitation of a firm´s traditional products and markets. The expansion/exploitation of the current business or businesses close relationship assumed with its current operations. Use may normally be made of the same technical, financial and commercial resources employed for the present product line. It has variations depending on the relationship between the products and markets to be developed and currently existing ones. **MARKET PENETRATION:** To increase a firm´s volume of sales by targeting its present customers or looking for new customers for its current products. It´s a form of specialization it doesn´t involve any change to the scope of the firm it maintains its current businesses (traditional products and markets) it entails growth because it at least increases turnover, and probably assets and recruitment. - It may be achieved with **marketing variables** (advertising campaigns, promotions, price reductions). - These marketing actions may target **current customers** by seeking to increase the [frequency] with which they use the product or service (when they are given an incentive to use the product more often or replace it more quickly) or increase the [quantity] used (when the amount consumed in the same consumer act is increased) - Marketing actions may be used to **attract new customers** from other firms or new potential customers that don´t currently consume the product/service. - **Exploiting a firm´s sources of competitive advantage** cost leadership, providing cheaper products than competitors, product differentiation it permits greater long-term growth - **It´s the right choice** when the industry is expanding rapidly, with major expectations for future growth. \*Even though the industry has reached maturity, pockets of demand may be identified that haven´t been catered for and which may provide a significant number of potential customers. \*Even in declining industries, a firm may grow because of the withdrawal of rivals in the sector that haven´t been able to withstand the competitive pressure. - **Risks:** - Highly dependent on the conditions in the competitive environment and their evolution. Major changes in the environment may lead to the obsolescence of the firm´s business and its competitive advantage, with no possibility of quickly switching to a new activity. - The firm places all its bets on a single business. Any mistake made in a strategic decision may threaten the business project. - The firm forgoes the opportunity to generate synergies and extend the scope of its business to exploit its more valuable capabilities and resources in new products or markets, obtaining an additional return. **PRODUCT DEVELOPMENT:** The aim is to remain in the current market while developing products with new and different characteristics. Products serve the same purpose they play the same role as the previous products while improving the function´s satisfaction in the same customer segment. - It may be achieved by **introducing technological innovations** in traditional products that improve their specifications. These product modifications may be accessory when slightly improving the products (new updated versions of a software program or a mobile device), or substantial ones that entail replacing traditional products as these are rendered obsolete (new smartphones regarding traditional mobile phones). - It may also be achieved by **extending the range of a core product** with different presentations. The function doesn´t change, although the new formats can better cater for customer´s different tastes and needs - Appropriate in **highly dynamic or hypercompetitive industries** in which there´s constant innovation and product life-cycles are very short. Product development is almost mandatory for a firm seeking to compete with any chance of success. - This strategy is extremely demanding for the firm in terms of resources and capabilities as it involves constantly renewing and improving their provision success requires having a major capacity for new product research and development. - This strategy enables the firm: - To provide the market with an image of innovation that reinforces its prestige among customers - To generate synergies, as the different products (or other variants) share the same commercial and distribution structures and, at least in part, those of production - **The process of new product development may be costly** and not necessarily lead to immediate success, where new products should be related to the firm´s core competencies. **MARKET DEVELOPMENT:** Used to introduce its traditional products into new markets. It makes the most of its existing technology and production capabilities to sell its products outside its current scope. The new markets a firm target may be understood in 3 ways: - **New segments** of the industry with critical success factors of a similar nature to the ones in the former operating segments. These new segments may correspond to different criteria: type of customer, income, distribution channel. - **New applications** for current products, adapting them to new functions other than those already fulfilled. - **New geographical areas** in which to market traditional products. REASONS FOR CHOOSING THIS DEVELOPMENT OPTION: - The appearance of new distribution channels that are high quality, reliable and without overly high costs - The firm has attained high rates of efficiency and performance in current markets, and now seeks to enter new ones that are not saturated - The firm´s production facilities are currently underused, so new markets may be found for the better exploitation of its installed capacity The development of new markets sometimes requires some form of product adjustment. As it entails a greater change in the product (the entry into new markets requires new products or variants of the previous ones) closer to a diversification strategy. **FIRM DIVERSIFICATION:** A firm adds new products and new markets to its already existing ones. The firm now operates in new competitive environments, with success factors different to the customary ones. It implies new knowledge, new techniques and new premises, as well as changes to its organizational structure, its management processes and its management systems. Outcome physical and organizational changes that affect the firm´s structure break with its past trajectory. \*More drastic and risky strategy than expansion. REASONS: - **External reasons:** - [Saturation of the traditional market]: the firm can´t achieve its growth targets through expansion due to saturation, a general downturn in demand, the obsolescence of the product line, a generally smaller market, or the influence of new technologies. - [Identification of investment opportunities] in new businesses that provide interesting levels of growth and return. \*These opportunities augur a better performance than the expansion opportunities. - **Internal reasons:** - [It reduces a firm´s overall long-term risk]: even if one activity should fail, it´s hard to believe they will all falter at the same time. - [Existence of resources and capabilities that are surplus to the needs of traditional activities (physical and financial):] intangible resources and capabilities whose nature renders them susceptible to application in other ambits. - [May lead to the generation of synergies] through the common exploitation of resources or through strategic interrelations between activities the overall performance of the businesses is better than the sum of each one separately. - MARKETING: commercial brand, distribution channels, sales force, advertising, knowledge of customers - OPERATING: product and process technology shared across businesses, better use of equipment, spreading indirect costs, sharing the experience effect, concentrated purchases - FINANCIAL AND INVESTMENT: joint use of fixed assets, joint capture of financial resources on the markets, transfer of financial resources from one business to another - MANAGERIAL: exploitation of the competence, capabilities and experience of top managers - **Other reasons:** - [Diversification window:] being present in activities involving major technological changes and which may have a bearing on the technology used in the main activity. - [Image diversification:] firm´s desire to uphold or enhance its image before society \*Although these strategy involves entering new markets with new products, both of them may not be related in some way to the current ones. - [Related diversification:] when there are shared resources across businesses, similar distribution channels, common markets, shared technologies or any tangible attempt to jointly exploit production factors. - [Unrelated/Conglomerate diversification:] greater break with the current situation (new products and markets aren´t related in any way to the firm´s traditional ones) **RELATED DIVERSIFICATION STRATEGY:** Diversification is related when there are similarities among the resources used by the businesses, the distribution channels, the markets, the technologies or any other feature that helps to complement the businesses with one another. - [Related constrained diversification:] most businesses are interrelated through a core competence or asset located in the dominant business - [Related linked diversification:] each activity or business is related to at least one of the other activities, but not necessarily to a core competence or asset. REASONS FOR PURSUING RELATED DIVERSIFICATION: The generation of synergies across the various businesses. Synergies appear when the joint development of 2 businesses provides a better result than the sum of the development of each one of them separately. \*When new businesses are related to prior ones, it should be possible to use the resources and capabilities already available for these activities, which will generate additional earnings. Generation of these synergies may be achieved in 2 ways: - **Sharing the resources and capabilities with the new activities,** both tangible (material assets) and intangible ones (skills) available in the firm generating economies of scope. This may be done because resources and capabilities are underused (facilities, warehouses, human resources, distribution network) or because some of them have unlimited user capacity due to their intangible nature (brand, technology) - **Transferring knowledge and/or capabilities from one business to another** exploiting the interrelations between old and new activities to obtain sustainable competitive advantages that formerly didn´t exist, or transfer competitive advantages to new activities for a lower cost than if they had been created directly. [\*Core competences:] knowledge and capabilities transferred to other businesses to imbue them with a competitive advantage more quickly logical basis for a related diversification strategy (dominant business´s knowledge and capabilities are exported to the firm´s other businesses) Areas where resources are usually shared and knowledge transferred activities involving R&D, procurement, manufacturing, distribution, sales and marketing, managerial and administrative support, and financial. \*The use of synergies arising from shared activities or knowledge may reinforce a firm´s competitive position in each one of its businesses by facilitating strategies in cost leadership (permitting the all-out undertaking of operations, paving the way for economies of scale or driving the experience effect) and in product differentiation (using a brand or technology with a shared base). RISKS OF RELATED DIVERSIFICATION: The greatest problems stem from the difficulties and costs involved in generating synergies. Types of costs: - **Cost of coordination:** due to the greater effort in organizational coordination. Coordination costs grow with the [number] of businesses comprising the portfolio and with the [variety] existing between some businesses and others. \*Synergies are not generated automatically by investing in related businesses, as they have to be created by management through continued effort. - **Cost of compromising:** the generation of synergies calls for commitments and obligations when the different businesses have shared resources, none of them can be managed separately, ignoring the repercussions this may have on the development of the others. - **Cost of inflexibility:** the relationship between the various businesses may give rise to situations of inflexibility due to the difficulties a business may have to respond separately to the movements of competitors without compromising the other businesses or because of the exit barriers created in a business that shares resources with another business. \*Related diversification will be successful when proper use is made of the capabilities and resources for generating synergies without the associated costs totally wiping out the profits obtained accordingly. **UNRELATED DIVERSIFICATION STRATEGY:** There´s no relationship between the firm´s traditional activity and the new businesses in which it invests. It involves a break with the former situation the firm ventures into industries far removed from its traditional business. The different businesses are components of an investment portfolio in which the aim is to obtain **financial synergies** through the best possible distribution of financial resources those with a surplus may finance those with a shortfall. \*These synergies don't require the business to be interrelated difficult to generate other kinds of synergies. \*The only synergies that might appear are managerial ones, arising from applying management´s general capacity to the new businesses in order to tackle and resolve problems. \*Conglomerate diversification tends to be undertaken through firm takeover and merger processes rather than through internal investments. REASONS FOR UNRELATED DIVERSIFICATION: - **Reduction in the firm´s overall risk:** when businesses are unrelated to each other, the risk of fluctuations in profits tends to decrease. \*Entering new businesses that are completely different to the previous ones also implies assuming an additional risk arising from the lack of knowledge on the new activity and the difficulty in transmitting the experience in existing businesses to the new ones. - **In search of higher earnings:** a firm with a large financial surplus or installed in a mature sector with scant growth perspectives may use unrelated diversification to seek investment opportunities in promising sectors (emerging or growth) to improve its overall performance. - **Better assignment of financial resources:** considering the firm as an investment portfolio, channeling the possible surplus from certain activities into others in which there´s a demand for funds. \*Financial synergies in the management of the business portfolio, avoiding the cost of turning to the financial markets in order to finance loss-making businesses. - **Management targets:** power, status, promotion or higher remuneration are targets for the professional management class. \*The strategic growth objective tends to be closer to the utility function of top managers than that of performance. RISKS OF UNRELATED DIVERSIFICATION: - **Absence of synergies across businesses** (except of financial and managerial ones): the entry into a new business makes no contribution to the firm´s better overall performance difficult to create value. - Although managers´ general competences and capabilities may be transferred to another business, **specific competences are only obtained through time and experience** (these are the ones that generate competitive advantages) - **Dispersion of interests** that may arise within the firm due to the broad diversity of activities compromise a firm´s traditional business - **Difficulties of managing and coordinating** loosely interrelated activities may make a conglomerate firm unmanageable. - **It involves having to overcome the entry barriers in the new industry** as a way of exploiting profitable investment opportunities. These barriers make the investment less attractive. \*Firms undertaking high diversification processes with a view to grow have subsequently realigned their development policy by withdrawing from some of the businesses launched restructuring the strategy. The possible success of unrelated diversification depends on a firm´s ability to discover new capabilities that have hitherto gone unnoticed in the firm´s traditional businesses. This depends on managerial capabilities that may be exported from one business to another, which implies creating management synergies. RELATIONSHIP EXPANSION STRATEGIES -- RELATED AND UNREALTED DIVERSIFICATION -- FIRM PERFORMANCE: - Firms with related diversification record a better performance in terms of returns than firms that are undiversified or with unrelated diversification. Performance improves as a firm switches from a single business to related diversification due to the better exploitation of surplus resources - Performance drops when switching from related to unrelated diversification because of the difficulties in creating synergies in the unrelated. \*If the problems arising from the diversification process grow results compromise conglomerate firms. - Related diversification calls for a greater managerial effort for generating and exploiting synergies high coordination costs. If these costs outweigh the benefits derived from the synergies obtained the expected return from related diversification will be undermined. \*The top management of diversified firms becomes a key element for the success of related diversification **VERTICAL INTEGRATION:** A firm´s entry into activities related to the full production cycle of a product or service it becomes its own suppliers ("backward" or "upstream") or distributor/customer ("forward" or "downstream"). A firm enters new activities, situated at different stages of the product´s full cycle. \*Vertical integration is always present difficult to find firms without any degree of vertical integration. There don´t tend to be neither fully integrated firms that encompass every stages in the full production cycle. The degree of vertical integration is the outcome of a series of decisions that affect the different dimensions: - The level of self-sufficiency in which the necessary factors at any stage in the production cycle are supplied by the firm itself - The number of integrated stages - The volume of activities in each stage assumed by the firm itself - The greater or lesser technological relationship between integrated and traditional activities - The coefficient between value added and turnover - The manner in which such integration is materialized, according to the degree of ownerships and control a firm has over the assets used in the stages of the production cycle REASONS FOR VERTICAL INTEGRATION: Mechanisms through which a vertically integrated firm may achieve a [better financial performance], involving a reduction in costs, may be: - **The synergies or economies of scope** that stem from a better use of resources that may be shared (production facilities, warehouses, transport systems). It allows spreading fixed costs associated with underused assets or without a material limit on their capacity for use (information, knowledge). Use may also be made of existing capabilities and skills that have already been used at other stages of the product cycle. - **Reducing intermediate stock levels** and simplifying the production process through the **removal of intermediate processes** that would otherwise be necessary. - **Eliminating transaction costs**, which arise from contracting with outside suppliers or customers (searching, bargaining and litigating). - **Assuming the margin** associated with the activity of suppliers or customers reducing costs in procurement and distribution improving its performance. A firm may use vertical integration to [improve its competitive position]: - **Facilitating access to the supply of factors or guaranteeing an outlet for products.** It´s an important aspect when the bargaining power of customers or suppliers imposes harsh conditions for the firm or generates uncertainty in procurement or marketing. - **Reinforcing a product differentiation strategy** based on a better control over the quality of the components or factors it requires for its products and take better care of the brand image as regards end consumers by providing an improved after-sales service. - **Protection of an advanced technology:** manufacturing its own components without having to depend on supplier technology. - In industries with high level of concentration (oligopolies), vertical integration may lead to an **increase in market power.** A firm vertically integrated (backward) may be favorably positioned as regards its non-integrated rivals, excluding from the market part of the raw materials available shortage in the intermediate market price increases. This tends to occur through firm mergers or takeovers. It may be repeated through forward integration by securing distribution channels. - **Manipulating prices** through a **"price squeezing"** strategy: reducing the margin of a non-integrated rival to below the acceptable level. As the integrated firm accumulated the different margins of the stages of the process in which it operates, it may reduce the margin in one of them in order to increase its market share in that stage or shut out specialist competitors that can´t cope with that situation. Although this reduction implies a fall in the integrated firm´s overall margin, it strengthens its competitive positioning in the chosen stage. - **Entry barriers** to the industry may be created that are difficult to overcome for non-integrated firms (it´s the case of product differentiation or market power). A new competitor seeking to enter the industry will be forced to do so simultaneously, which multiplies existing entry barriers RISKS OF VERTICAL INTEGRATION: - **A firm´s overall risk increases** due to the commitment of a greater volume of resources to a specific product´s full cycle. If the target market of that product goes into decline, all the other activities will also be affected, as there will be a fall-off in their demand. - **It raises an industry´s exit barriers**, as there are more assets involved in the different stages in which the firm operates compared to specialist firms that operate only in one of those stages. - **Lack of flexibility** when faced with the changes that occur in the market for factors and products. Adapting to changes is easier through the replacement of suppliers or consumer than through internal adjustments that may affect all the stages in the product cycle, which may require major investments. \*The larger and more specialized the investments required by vertical integration are, the greater the resulting rigidity will be. \*An integrated firm may become isolated in the market, reducing its incentives to introduce innovations because of its lack of contact with suppliers or external customer situation of competitive disadvantage. - **The margin of the suppliers or customer replaced is not assumed automatically.** An integrated firm seeking to capture that margin needs to undertake the functions previously performed by suppliers and customer with their same efficiency (it entails developing the necessary capabilities). \*Even when the whole margin can be assumed, one needs to consider the investments a firm would need to make, with a potentially negative impact on the firm´s overall performance. - **Differences in the optimum scale of the various production stages** as a consequence of the amount of products a firm is going to require from a previous stage and the total volume needed for an efficient output at that stage. When the level of self-sufficiency attained in the preceding stage is below the volume of output that would be obtained with a suitably sized facility the firm faces the dilemma of manufacturing on a smaller scale and suffering the ensuing cost disadvantage, or sending the excess output onto the market with the consequent drawback of having to sell it to its own competitors. - **Increase in organizational complexity** of the integrated firm it will require sophisticated planning, coordination and control systems increase in costs There are major risks than advantages worth considering possible alternatives to vertical integration strategies for [cooperating with customers and suppliers]. \*There´s no precise relationship between the degree of vertical integration and levels of risk and economic performance. **RESTRUCTURING THE BUSINESS PORTFOLIO:** The modification or redefinition of the scope of the firm with the possible withdrawal (divestment) from at least one of its businesses. It may be related to an overhaul of the business (with or without portfolio restructuring). REASONS: - Management prioritizes **value creation for shareholders** over growth - **Turbulent markets** that make it more difficult to manage highly diversified firms - Tendencies in management thinking about the **need to focus on the core businesses** in order to exploit better key capabilities and resources Restructuring seeks to create value when the firm´s management detects that the corporate strategy is not creating as much value as it could. This tends to be due to: - One or more businesses in the portfolio **record losses** reducing the overall performance. Then, the firm needs to consider what to do with a business that is posting unsatisfactory results. - One or more businesses in the portfolio (though they may have recorded a profit) **don´t generate synergies** they don´t create value for the whole they may be discarded [over-diversification of the business portfolio] - The overall structure of the portfolio **doesn´t have a dominant logic** difficult to generate synergies and create value The last 2 situations have a direct impact on the structure of the business portfolio and on the definition of the scope of the firm. This leads to 2 problems: - The poor performance of a business for reasons linked to the business itself (business restructuring) - The withdrawal from one or more businesses (portfolio restructuring) **BUSINESS RESTRUCTURING:** A firms withdraws from a business due to a poor performance that fails to live up to expectations. Then the firm has to decide whether to withdraw from the business or try to re-float or restructure it. CAUSES OF POOR RESULTS: - Inefficient management - Overly fast growth - Inappropriate competitive strategy - High internal costs - Appearance of new competitors - Unexpected changes in demand - Organizational inertia Business´s poor performance is accompanied by heavy borrowing through outside financing in response to the inability to generate profits, aiming to cover basic financial requirements. In these cases, there are 2 basic options: - **[Restructuring:]** keeping it in the portfolio. The option of restructuring the business is appropriate when there are real possibilities of turning a firm´s finances around because: - The poor results are due to circumstantial reasons - The business is in an attractive industry - It´s an important part of the portfolio - Management is in a position to redress the reasons for the poor performance When a firm decides to restructure the business, it may adopt measures: - Changing the management team responsible for the business - Redefining its competitive strategy (strategic change) - The sale of certain assets - Refinancing the debt - Introducing specific measures for returning to profit (redundancy of workers downsizing) - Renewal of machinery - Implementation of strict cost controls The initial aim will be to halt the drop in earnings, and begin the recovery process. \*Firms don´t always analyze the real reasons for poor results they adopt decisions that resolve short-term problems of imbalance that don´t lead to the generation of a competitive advantage over the medium and long terms. - [**Withdrawal from the business**:] restructuring the portfolio. **PORTFOLIO RESTRUCTURING:** The firm may post poor results due to the composition of its business portfolio, which requires a redefinition of that selfsame portfolio. Restructuring doesn´t necessarily involve divestment operations, as it design may include withdrawal and entry operations involving new businesses usually associated with a firm´s core business. REASONS LEADING TO THIS DECISION: - Too much prior diversification - The appearance of major competitors in the core businesses - Top manager favoring their own objectives over those of value creation \*In other cases, the proliferation of ways of cooperating renders it more expedient to enter into an alliance rather than go it alone, or divestment is used in a business as a way of taking over another. TYPES OF STRATEGIES FOR WITHDRAWING A BUSINESS FROM THE PORTFOLIO: - **Sale or divestment strategy:** recouping part of the investment made in the business. The sale may be made to a group of independent investors, to another firm or to the managers/employees of the business. \*It´s attractive when a firm is found for the business for sale and it fits well into its portfolio and reinforces it the firm will normally be willing to pay a good price. - **Harvest strategy:** seeks to maximize short-term financial flows by stopping investments in that business and exploiting any remaining opportunities there might be for gaining a return. After a period of time, the business will normally be abandoned and wound up. The problem is that it may speed up the business´s decline if the workforce or market becomes aware of the firm´s stance toward it. - **Winding-up strategy:** it involves an end to all operations and the sale of any remaining assets that may have some value on the market providing some residual revenue. The problems is that it may be a reluctance to admit to the failure of the business and initiate the winding-up process in a planned and orderly manner.