Corporate Strategy Lecture 7 PDF

Lecture 7 – Corporate Strategy Prof. Dr. Eva Niesten LECTURE 7 – Corporate Strategy 3 dimensions of corporate strategy: vertical, product and geographic scope 1. Corporate Strategy T...

Lecture 7 – Corporate Strategy Prof. Dr. Eva Niesten LECTURE 7 – Corporate Strategy 3 dimensions of corporate strategy: vertical, product and geographic scope 1. Corporate Strategy Transaction cost economics Reasons for vertical integration 2. Vertical Scope Types of diversification 3. Product Scope Motives for diversification Diversification and value creation 4. Managing Corporate BCG matrix Portfolios 5. Practicing with a Case Kodak’s diversification 7.1 Corporate Strategy Corporate strategy is concerned with where a firm competes. Business strategy is concerned with how a firm competes within a particular area of business. Corporate strategy: Decisions that define the scope of the firm: vertical scope → make, buy or ally product scope → diversification geographic scope → internationalization  7.1 Corporate Strategy Three reasons for growth: To increase profitability To lower costs To increase market power To reduce risk To motivate management and employees Source: Rothaermel, Strategic Management 7.2 Vertical Scope Transaction Cost Economics Invisible Hand: Markets organize production Visible Hand: Firms organize production 7.2 Vertical Scope Transaction Cost Economics Core questions of this theory: Why do we organize transactions in firms when markets are so efficient? What is the comparative efficiency of markets versus firms? Answer: We choose governance structures (markets or firms) that lower transaction costs the most. 7.2 Vertical Scope Transaction Cost Economics Ronald Coase: Nobel Prize 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy”. Oliver Williamson: Nobel Prize 2009 “for his analysis of economic governance, especially the boundaries of the firm”.  7.2 Vertical Scope Transaction Cost Economics Definition of Transaction Costs Mundane Costs of describing, communicating and negotiating about goods to be transaction costs transferred Costs of verifying the quality of transacted goods Costs of valuing and paying for goods Lawful Costs resulting from transacting parties that break an informal transaction costs agreement or a relational contract Blatant Costs resulting from transacting parties that violate a formal contract transaction costs or break the law 7.2 Vertical Scope TCE: Firms vertically integrate when transaction costs are high Raw Materials Vertical Integration Manufacturing is a firm’s ownership Backward and control of Integration multiple vertical Distribution stages in the supply Forward chain of a product. Integration Retail After-Sales Service 7.2 Vertical Scope Reasons for Vertical Integration TCE: Firms vertically integrate when transaction costs are high due to: High asset-specific investments Hold-up behavior: Opportunism The extent to which investments made in a particular transaction have a higher value to that transaction than if they were redeployed for any other purpose Actors who disguise or distort information to act in Physical asset-specificity their self-interest Human asset-specificity Location asset-specificity 7.2 Vertical Scope Reasons for Vertical Integration If you were the CEO of a coal mine and you signed an incomplete contract with an electricity producer that has just built an electricity plant nearby, what would you do? Electricity producer has invested in location-specific assets. This gives the coal mine an opportunity to renegotiate the contract. Opportunistic hold-up behavior is demanding a higher price for the coal 7.2 Vertical Scope Benefits & Risks of Vertical Integration Benefits: - Protect against opportunistic behavior - Better scheduling and planning; securing critical supplies and distribution channels Risks: Reduced flexibility; potential for legal repercussions Decreasing costs: Internal production, no profits shared with suppliers Increasing costs: No exposure to market competition Increasing quality: Specific investments in physical and human assets Decreasing quality: No exposure to market competition  7.2 Vertical Scope Taper Integration A firm is backwardly integrated but also relies on outside-market firms for some of its supplies, and/or a firm is forwardly integrated but also relies on outside-market firms for some of its distribution. → Dual or Concurrent Sourcing: - To solve cost-quality tensions; best of both worlds? - Absorptive capacity Source: Rothaermel, Strategic Management 7.3 Product Scope Corporate strategy: Decisions that define the scope of the firm. Product scope → diversification Some questions on diversification: Is it better to be specialized or diversified? Is there an optimal degree of diversification? Under what conditions does diversification create rather than destroy value? When will diversification lead to competitive advantage? 7.3 Product Scope Types of Diversification Single business: 95% or more of revenue comes from a single business Dominant business: between 70% and 95% of revenue comes from a single business Related diversification: less than 70% of revenue comes from the dominant business, but links between businesses exist Unrelated diversification: less than 70% of revenue comes from the dominant business and no common links exist between the businesses 7.3 Product Scope 7.3 Product Scope Motives for Diversification: GROWTH The desire to escape stagnant or declining industries More stable cash flow for managers RISK But: Shareholders can hold a diversified portfolio at lower cost SPREADING than a diversified firm can Diversification to attractive industries VALUE Synergies: sharing resources & capabilities to obtain economies CREATION of scope 7.3 Product Scope Economies of Scope: When using a resource across multiple activities uses less of that resource than when the activities are carried out independently. Economies of scope due to sharing of: Tangible resources Distribution networks, sales forces, customer databases & service centers, billing systems, IT systems, accounting, legal services, R&D labs. Intangible resources Brands, corporate reputation, technology, expertise of personnel General management Ability to motivate and develop managers, financial management capabilities capabilities (cost control & risk management), international management capabilities, strategic planning capabilities.  7.3 Product Scope Types of Diversification Related constrained: less than 70% of revenue comes from the dominant business, and all businesses share product, technological and distribution linkages Related linked: only limited links between the businesses Source: Rothaermel, Strategic Management  7.3 Product Scope Diversification & Value Creation: Some firms are able to create economies of scope by both sharing activities and transferring core competencies. Very hard for competitors to understand and learn how to imitate Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2011. 7.3 Product Scope BUSINESSES UNITS Characters Mickey Mouse, Avengers, etc. Studio Entertainment Disney, Pixar, Marvel, (Movies) Star Wars, etc. VERTICAL Media Networks and ESPN, ABC, Disney Interactive Media Channels, 21st Century (TV) Fox, etc. Parks & Resorts Disneyland, World, Paris, Tokyo, etc. Consumer Products Disney stores, (Retail) Publications HORIZONTAL & GEOGRAPHICAL  7.3 Product Scope Diversification & Value Creation: Economies of scope by sharing activities (operational relatedness) and transferring core competencies (corporate relatedness). “Effective immediately, several shared- service organizations across the company will support both Disney Entertainment and ESPN, facilitating company-wide efficiencies and creating a more cost-effective, coordinated, and streamlined approach to operations.” Corporate-level core competencies in terms of advertising and marketing (cross-selling of movie characters) https://thewaltdisneycompany.com/the-walt-disney-company-announces-strategic-restructuring-restoring-accountability-to-creative-businesses-2/  7.3 Product Scope Diversification & Value Creation: Unrelated diversification can create value through two types of financial economies: Restructuring of assets: Acquiring of or merging with other corporations, restructuring of their assets, and selling Buying real options for future development Source: Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2011. 7.3 Product Scope Three Tests of Diversification: 1. The attractiveness test Diversification must be directed towards attractive industries (or have the potential to become attractive). 2. The cost of entry test The cost of entry must not capitalize all future profits. 3. The better-off test The new unit must gain competitive advantage from its link with the company, or vice-versa (i.e., synergies must be present). 7.4 Managing Corporate Portfolios Portfolio Planning Matrices are the main strategy tool for facilitating portfolio management in the multi-business firm. They show the positioning of a firm’s different businesses to analyse their value-creating prospects or lack thereof. GE-McKinsey Matrix BCG Growth-Share Matrix 7.4 Managing Corporate Portfolios Industry attractiveness axis combines market size, market growth rate, market profitability (ROS), cyclicality, inflation recovery, international potential. Business unit competitive advantage combines market share, ROS relative to competitors, relative position with regard to quality, technology, manufacturing, distribution, marketing, and cost.  7.4 Managing Corporate Portfolios BCG Matrix Source: Rothaermel, Strategic Management  7.4 Managing Corporate Portfolios Merger: joining of two independent firms to form combined entity Acquisition: purchase (or hostile takeover) of one firm by another Source: Rothaermel, Strategic Management  7.4 Managing Corporate Portfolios Mergers & Acquisitions Extensive literature review shows what consistent predictors of short- and long-run stock returns, and long-run operating performance of M&As are: Related acquisitions outperform unrelated or diversifying acquisitions Performance declines deal by deal as the firm increases its acquisitiveness; CEO overconfidence as a main driver of this underperformance Source: Renneboog and Vansteenkiste, 2019 7.4 Managing Corporate Portfolios Mergers & Acquisitions M&As for product + vertical scope 7.4 Managing Corporate Portfolios ► Divestiture of unprofitable and risky businesses: □ Creates value by refocusing strategic resources into core businesses. □ Helps reducing costs but, if not managed, it diminishes chances for corporate long-term growth. ► Placing certain assets in independent Parent firms’ Announcement businesses outside the company can date EBITDA preserve opportunities for future growth average margin (%) 15.1 and allow the organization to: 13.9 □ Focus on the core business □ Generate cash □ Improve operating performance t-1 t Source: BCG, 2014. A study on 6,642 divestitures from 1990 to 2014. 7.5 Case discussion: Kodak 1895: First pocket Kodak camera ($10 Pocket Kodak) with the tagline “You press the button; we do the rest.” 1970s: Kodak held 90% of US film market. Many remarkable contributions in the field of film, rolls and camera. Source: Here’s Why Kodak Failed: It Didn’t Ask The Right Question! - The Strategy Story 7.5 Case discussion: Kodak ‘RAZOR AND BLADE’ BUSINESS MODEL Clients would take photos with the Kodak camera, sent the film to the Kodak factory where it was developed and photos were printed. Low value capture (but high consumer surplus) on cameras: cameras sold at affordable prices with a small profit margin High value capture on complements: consumable supplies such as films, printing sheets with high-profit margins. (Core business was selling film, not cameras!); retail printing (Kodak labs) Source: Here’s Why Kodak Failed: It Didn’t Ask The Right Question! - The Strategy Story 7.5 Case discussion: Kodak Why do you think the transition to digital photography failed at Kodak? What type of diversification is an investment into digital photography? Can Kodak rely on its core competence? Do you think the transition to pharmaceuticals will be successful for Kodak? Why? What type of diversification is the switch to pharmaceuticals?  7.5 Case discussion: Kodak In 1978, Kodak knew that by 2008 consumer electronic imaging would overtake traditional photography. Moore's law: Number of transistors on a dense integrated circuit doubles about every two years → Rapid change in information processing technologies. 7.5 Case discussion: Kodak 7.5 Case discussion: Kodak 1975: A Kodak engineer, Steve Sasson, invented the 1st ever digital camera Management’s reaction was: ‘that’s cute —but don’t tell anyone about it.’ Was Kodak’s failure due to management’s inability to see digital photography as a disruptive technology? Source: Here’s Why Kodak Failed: It Didn’t Ask The Right Question! - The Strategy Story  7.5 Case discussion: Kodak “Fear of cannibalizing core business”; “fear of killing the golden goose” “Reluctant to disrupt Kodak’s cash cow” “Classic innovator’s dilemma” In 1996, Kodak’s CEO George Fisher aggressively invested more than $2 billion in R&D for digital imaging. https://www.youtube.com/watch?v=u7yo7e3HhKA  7.5 Case discussion: Kodak Advantix Preview film 10,000 Digital Kiosks in Partner Stores & Camera system Fisher and his team were so worried about the threat posed by the new technology that they spent much of that money before they knew how the market would develop. They committed to price points and product specifications that later $500M investment proved difficult to change → no change in business model. Source: Kodak’s Downfall Wasn’t About Technology (hbr.org)  7.5 Case discussion: Kodak 2001 Acquisition of Photo Sharing site Ofoto Before Mark Zuckerberg wrote a line of Facebook’s code, Kodak acquired a photo sharing site called Ofoto in 2001. It could have pioneered a new category called life networking where people could share pictures, personal updates, and links to news and information. …But Kodak used Ofoto to try to get more Source: Kodak’s Downfall Wasn’t About Technology (hbr.org) people to print digital images  7.5 Case discussion: Kodak Source: Here’s Why Kodak Failed: It Didn’t Ask The Right Question! - The Strategy Story 43 7.5 Case discussion: Kodak 7.5 Case discussion: Kodak  7.5 Case discussion: Kodak (millions of USD) Operating Profit 4000 3000 2000 1000 0 -1000 -2000 Net Sales 30000 25000 20000 15000 10000 5000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Chemical imaging Printing labs (Source: WRDS)  7.5 Case discussion: Kodak (millions of USD) Operating Profit 4000 3000 2000 1000 0 -1000 -2000 Net Sales 50000 40000 30000 20000 10000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Chemical imaging Printing labs Medical Digital imaging (Source: WRDS)  Integrated report 2022 https://ir.fujifilm.com/en/invest ors/ir-materials/integrated- report/main/0113/teaserItems1 /011/linkList/01/link/fh_2022_0 01e.pdf 48 7.5 Case discussion: Kodak Kodak had already developed into pharmaceuticals: knowledge of chemicals used in film. In-house school to transform chemical engineers into electrical engineers: “not very successful”. Knowledge of chemicals a core competence – related diversification 7.5 Case discussion: Kodak “Photo industry developed many analytical chemical techniques” → strong application of this expertise in the pharmaceutical industry. Kodak argues to develop production of APIs: Active Pharmaceutical Ingredients. 7.5 Case discussion: Kodak If the market for APIs is growing over the coming years and Kodak has some strength in this business, it may want to invest in this industry. What’s Next? ►Get ready for the next session □ The next session is a lecture in which we will analyze the case of Amazon □ Watch the online tutorial on corporate strategy analysis in Excel □ Anticipate our case study discussion by reading and/or watching the materials on K2 □ Upload your answer to the case study question(s) in advance into the dedicated space on K2