Foundations of
Strategy Chapter 7:
Corporate Strategy
Sienna Rucker, Jordan Myers, Nick
Thomas, Jayson Davidson, Phoenix
Delcueto
Corporate strategy
The scope of the firm
Key concepts for analysing firm scope
Diversification
Vertical integration
Managing the corporate portfolio
Where a firm competes
Product scope
Vertical scope
Geographical scope
Fluor scope
Product scope
Construction for industrial
Mining and metal
project / plant management
Government projects
energy
Vertical scope
Extensive supply chain and logistics
The Scope of the firm
Narrow or broad
Vertical integration
Supply chain activities
Changes over time
Key Concepts for Analyzing Firm Scope
•Key concepts for analyzing a firm’s decisions and scope overtime:
•Economies of Scope
•Transaction Costs
•Costs of Corporate Complexity
Economies of Scale vs. Scope
•Economies of Scale:
•Refer to the reduction in average costs that result from an increase in
the output of a single product.
•Economies of Scope:
•Are cost economies from increasing the output of multiple products.
Economies of Scope
•Tangible Resources
•Distribution networks
•Information Technology Systems
•Sales Forces
•Research Laboratories
•Intangible Resources
•Brands
•Corporate Reputation
•Technology
•Organizational Capabilities
Transaction Costs
•Market Mechanism
‘Invisible Hand’
•Administrative Mechanism
‘Visible Hand’
Vertical Scope
•Which is more efficient?
•3 independent companies, or
•3 stages of production within a single company
•Answer:
•Internalizing business transactions imposes its own
costs or…
The Costs of Corporate Complexity
•Engaging in more arenas of business involves greater organizational
complexity.
•Can you manage the balancing act?
Diversification is Fun!
“The expansion of an existing firm into another product line or field of
operation.”
Related/Concentric
Expands into a similar field
Unrelated/Conglomerate
Additional product line very different from core business
Horizontal Diversification
Benefits and Costs of Diversification
Growth
“Prisoners of their industry”
Stagnant or declining industries
Risk Reduction
“Don’t put all your eggs in one basket.”
Stable profit earnings, job security
Value Creation
Benefits and Costs of Diversification Cont.
Exploiting Economies of Scope
Using brand name or trade mark to link the business
Internal Capital Markets
Avoid costs of using the external capital market
Better access to info
Internal Labour Markets
Transfer employees throughout corporation
When does diversification create value?
Attractiveness test
Structurally attractive or capable of being made attractive
Insufficient on its own
The Cost-of-Entry test
Must not capitalise all future profits
Barriers to entry
Corporate venture vs. acquire an established company
Diversification Continued
Diversification in Performance
No systematic relationships between diversification and performance
“Strategic sweet spot between focus and broader diversification”
Association or causation
Related and Unrelated Diversification
Management complexity
Recent Trends in Diversification
Vertical Integration
• Vertical Integration refers to a firm’s ownership of vertically related
activities
• The greater the extent to which a firm’s ownership extends over successive
stages of the value chain for its product the greater its degree of vertical
integration
• Extent of vertical integration is indicated by the ratio of a firm’s value added
to its sales revenue
Types of Vertical Integration
• Backward Vertical Integration- when a firm acquires ownership and
control over the production of its own inputs
• Forward Vertical Integration- when a firm acquires ownership and
control of activities previously undertaken by customers
• Full Vertical Integration- When a firm has control and ownership over
all inputs
• Partial Vertical Integration- When a firm has control and ownership
over some but not all input processes
Benefits and Costs of Vertical Integration
• Over last 25 years outsourcing has become more popular
• Enhances flexibility
• Allows firms to focus on their “core competencies”
• Vertical Integration can produce cost savings
• Due to physical integration transaction costs can be cut
• Vertical Integration may restrict a firm’s ability to benefit from scale
economies
• Reduce flexibility
• Increase risk
Transaction Costs in Vertical Exchanges
• Benefits of vertical integration traditionally emphasized the cost
savings that arise from physical integration
• Along a value curve it will make sense to vertically integrate in some
areas but not in others
• Bilateral Monopoly
• Sometimes vertically integrating would be too technical
The Incentive Problem
• Vertical Integration changes incentive between vertically related
businesses
• Market interfaces between buyers and sellers create profit incentives
• High powered incentives
• Vertical Integration creates internal suppliers
• low powered incentives
• Opening internal divisions to external competition creates incentives
in vertically integrated firms
Flexibility
• Where the required flexibility is rapid responsiveness to uncertain
demand there are advantages in market transactions
• Where system wide flexibility is required vertical integration may
allow for speed and coordination in achieving simultaneous
adjustments throughout the vertical chain
Designing Vertical Relationships
• Vertical relationships not limited to simple choice of make or buy
• The extent to which the buyer and seller commit resources to a
relationship determine which relationship is appropriate
• Types of Vertical Relationships:
• Contracts
• Spot Contracts
• Long-Term Contracts
• Vendor Partnerships
• Franchises
Spot Contracts
• Spot Contracts are transactions where there is no need for
transactions specific investments by either party.
•
•
•
•
One time transactions
Many buyers and sellers in market
Standard products
Opportunism
Long Term Contracts
• Long Term Contracts are agreements between firms that specify the
terms and responsibilities of the firms for a series of transactions
over a period of time
• Help avoid opportunism
• Provides security needed to make longer term investments
• Face problem of anticipating future circumstances
Vendor Partnerships
• Vendor partnerships are close collaborative relationships companies
have with their suppliers
• Based on trust and mutual understanding
• Helps avoid opportunism
• Provide security needed for transaction specific investments
Franchise
• A franchise is a contractual agreement between the owner of a
business system and a trademark that permits the franchisee to
produce and market the franchiser’s product or service in a specified
area
• Brings together the brand, marketing capabilities, and business systems of
large corporations with entrepreneurship and local knowledge of small firms
Recent Trends in Vertical Integration
Growth in diversity of hybrid vertical
relationships
Recent phenomenon from high-tech sectors
Competitive tendering and multiple sourcing
have been replaced by single-supplier
arrangements.
“There has been a shift in
supplier relationships from
arm’s length with many
suppliers to long-term
collaboration with fewer
suppliers.”
Managing the Corporate Portfolio
GE/McKinsey Matrix
Allocating resources
Formulating business unit strategy
Analyze Portfolio Balance
Set Performance Targets
Managing the Corporate Portfolio (cont.)
BCG Growth-Share Matrix
Matrix uses industry attractiveness and
competitive position to compare the
strategic strategic position of different
businesses
Simplicity: Pro & Con
Managing the Corporate Portfolio (cont.)
Ashridge Portfolio Display
Value-creating potential of a subsidiary
business; dependent on
characteristics of the business and
parent company
The focus is the fit between a business
and its parent company
Horizontal: parent’s potential for creating
additional profit
Vertical: potential for value destruction;
mismatch between management
Summary
Competition: Product,
Geographical, & Vertical Scope
Economics of Scale vs Scope
Economies of scope provide cost
savings from staring resources
and capabilities
Diversification Is Fun
“Corporate Strategy is about
deciding which businesses to
engage and often represents
some of the most important
and difficult decisions
management are likely to
make.”
Questions?