Lecture 8: Corporate strategy Titel der Präsentation Prof. Dr. oec. Matthias Brauer Untertitel All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise – without the written permission of the copyright owner. © Brauer - University of Mannheim 1 Course overview Lecture Date Topic 1 09/03/2018 Introduction 2 09/10/2018 What is strategy and why is it important? (incl. vision, mission, objectives) 3 09/17/2018 Evaluating a company’s resources, capabilities and competitiveness 4 09/24/2018 Evaluating a company’s external environment 5 10/01/2018 The five generic competitive strategies 6 10/08/2018 Technology and innovation strategy 7 10/15/2018 Guest lecture, Dr. Klaus Peter Meier, CEO, FREUDENBERG HOME AND CLEANING SOLUTIONS GMBH 8 10/22/2018 Corporate strategy: Managing a group of businesses 9 10/29/2018 Global Strategy I: Market entry strategies 10 11/05/2018 Global strategy II: Managing MNEs 11 11/12/2018 Guest lecture, ANDERSCH AG: Digital Strategy I 12 11/19/2018 Guest lecture, BEIERSDORF AG: Digital Strategy II 13 11/26/2018 Strategy implementation 14 12/03/2018 Exam preparation (Q&A session) © Brauer - University of Mannheim 2 Learning objectives Understand the purpose and nature of corporate strategies Understand the challenges associated with crafting a successful corporate strategy Understand the different diversification strategies Become familiar with the tools companies can use to actively manage their business portfolio © Brauer - University of Mannheim 3 Agenda: Lecture 8: Corporate Strategy 1 Introduction toas diversification Diversification a corporate strategy 2 Motives and types of diversification 3 Outcomes of diversification 4 Managing business portfolio scope © Brauer - University of Mannheim 4 Recap: The strategy process Mission statement Target planning Environmental analysis Stage of mission building Corporate analysis Stage of strategic analysis Strategy formulation • Corporate strategy • Business unit strategy • Functional strategy • Project strategy Stage of strategy formulation Validation/Selection of a strategy Strategy implementation/Operative planning • Functional planning • Project planning • Budget planning Stage of strategy implementation Check on strategy © Brauer - University of Mannheim 5 Recap: Business strategy vs. corporate strategy Business strategy Corporate strategy • Key question of business level strategy: How to create a competitive advantage in specific, individual product markets • Focus on a single industry: 1) Which customers to serve (who?) – segmentation 2) Which customers needs to satisfy (what?) – differentiation 3) Resources and value chain activities necessary to satisfy customer needs (how?) – “core competencies” • Key question of corporate strategy: How to create a competitive advantage for the whole company • Focus on multiple industry environments and the development of a set of business strategies: 1) What businesses should we be in? 2) How should these be managed? 3) How to create value for the corporation as a whole? Diversification is a corporate strategy to create a corporate advantage! © Brauer - University of Mannheim 6 Corporate strategy of Munich Re Our aim is sustained profitable growth Munich Re brings together what belongs together. Our integrated business model realises synergies and economies of scope along the whole value chain. This is propelled by our three business fields: primary insurance, reinsurance and Munich Health as the third pillar for the challenges of the global healthcare market. As a result, we build lasting value for our clients, shareholders and staff. Each of our fields of business is among the best in its class Munich Re is one of the world’s leading players in the reinsurance industry. Some 40 million clients in over 30 countries place their trust in the services and security it provides. In Munich Re’s newest business field, Munich Health, the Group draws on the experience it has gained throughout the world in health insurance and reinsurance over a period of more than 20 years. Munich Health represents Munich Re’s health expertise and develops cutting-edge solutions for what is one of the industry’s fastest-growing markets. … © Brauer - University of Mannheim 7 What is a good Corporate Strategy? © Brauer - University of Mannheim 8 Evaluation criterion 1: Conglomerate Premium “Corporate strategy is what makes the corporate whole add up to more than the sum of its business unit parts.” (Michael Porter, 1987) © Brauer - University of Mannheim 9 Value added The challenge of corporate strategy Corporate surplus Most of the larger companies are diversified in different businesses. This makes only sense if the company is able to create a “corporate surplus”, what means that the value of the company is higher than the sum of its parts. Sum of the internal values of SBU A-C (“stand-alone-values”) Costs of the corporate level © Brauer - University of Mannheim Market capitalization 10 Evaluation criterion 2: Parenting advantage “Multi-business companies create value by influencing - or parenting - the businesses they own. The best parent companies create more value than any of their rivals would if they owned the same businesses. Those companies have what we call parenting advantage.” (Michael Porter; Campbell, Goold, Alexander, 1995) © Brauer - University of Mannheim 11 Competing corporate parents Parenting advantage Corporate surplus Competing corporate parents Sum of the internal values of SBU A-C (“stand-alone-values”) Costs of the corporate level Market capitalization © Brauer - University of Mannheim Max. value of a competing parent 12 Parenting advantage (fictitious example) Rival Allianz “Corporate parents” (Corporate Center Munich) Axa (Corporate Center Paris) Diversification into a new service: People 50+ (“grey panther”): Allianz Life (Spain) Key question:: Which corporate parent creates more value for its daughters? Axa Life (Spain) Parenting advantage Stand alone Stand alone © Brauer - University of Mannheim 13 “Reality check” Diversification/Conglomerate The problem discount Sum of the internal values of SBU A-C (“stand-alone-values”) Costs of the corporate level © Brauer - University of Mannheim Market capitalization 14 Agenda: Lecture 8: Corporate Strategy 1 Diversification as a corporate strategy 2 Motives and types of diversification 3 Outcomes of diversification 4 Managing business portfolio scope © Brauer - University of Mannheim 15 Why do firms diversify if the challenges are that high? © Brauer - University of Mannheim 16 Motives for diversification Conceptualization Product development Motives for diversification Diversification New Growth Existing Products Meeting stakeholders’ expectations Strategic renewal Motives Firm Market development Existing Spreading risks New Markets Efficiency gains Responding to declining markets Diversification initiatives can be the recipe for long-term success! © Brauer - University of Mannheim 17 Measuring the degree of product diversification Basis: Standard Industrial Classification Code List (SIC)* Total Entropy Total Entropy captures the extent of diversity across a firm’s Eactivities. It is calculated as follows: 1 ∑Si ln(1/ Si) E e =1 P TE = where Si is the share of a firm’s total sales in 4-digit SIC industry and N is the number of 4-digit SIC industries in which the firm operates. Total Entropy equals zero for a single business firm and it rises with the extent of diversity. Herfindahl Index (HI) The Herfindahl Index of diversity is calculated as: E 1 ∑ (Si)^2 E e =1 P HI = where si is the share of a firm’s total sales in 4-digit SIC segment i and N is the number of 4-digit SIC industries in which the firm operates. 6411 Insurance adjusters 6411 Insurance advisory services 6411 Insurance agents 6411 Insurance brokers 6512 Insurance buildings, operation of 6321 Insurance carriers, accident 6321 Insurance carriers, health 6311 Insurance carriers, life 6331 Insurance carriers: fire, marine, and casualty 6411 Insurance claim adjusters, not employed by insurance companies 9651 Insurance commissions-government 6411 Insurance educational services 6411 Insurance information bureaus 6411 Insurance inspection and investigation services 6411 Insurance loss prevention services 6411 Insurance patrol services 8099 Insurance physical examination service, except by physicians 6411 Insurance professional standards services 6411 Insurance rate making services 6411 Insurance reporting services 6411 Insurance research services 6411 Insurance services 6321 Insurance, accident and health 6399 Insurance, bank deposit or share 6351 Insurance, credit or other financial responsibility 6351 Insurance, fidelity 6311 Insurance, life 6351 Insurance, surety 6361 Insurance, title protection 6331 Insurance: fire, marine, and casualty © Brauer - University of Mannheim 18 Defining the “right” diversification scope Steel Energy Building Technology Shipping Tourism 18.53 Logistics and Retail Revenue Distribution in 1995 in billion EUR Revenue Distribution in 2017 in billion EUR Source: Thompson Financials; TUI Annual Report © Brauer - University of Mannheim 19 Types of diversification DIVERSIFICATION INTO RELATED BUSINESSES • DIVERSIFICATION TYPES Enhance shareholder value by capturing cross-business strategic fits: • Transfer skills and capabilities from one business to another • Share facilities or resources to reduce costs • Leverage use of a common brand name • Combine resources to create new strengths and capabilities DIVERSIFICATION INTO UNRELATED BUSINESSES • • Spread risks across completely different businesses Build shareholder value by doing a superior job of choosing businesses to diversify into and of managing the whole collection of businesses in the company’s portfolio DIVERSIFICATION INTO BOTH RELATED AND UNRELATED BUSINESSES Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 245. © Brauer - University of Mannheim 20 Diversification into related businesses Value chain activities Conceptualization • Diversify into an industry because of strategic reasons • Involves diversifying into businesses with − Strategic fit − Potential to leverage economies of scope − Meaningful value chain relationships − Unifying strategic theme Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 246. © Brauer - University of Mannheim 21 Core concepts: Strategic fit and economies of scope Strategic fit • Economies of scope A strategic fit exists whenever one or more activities in the value chains of different businesses are sufficiently similar to present opportunities for… − Transferring expertise or technological know-how from one business to another − Cross-business collaboration to create competitively valuable resource strengths and capabilities − Combining performance of common value chain activities to achieve lower costs − Using of a well-known brand name • Economies of scope are cost reductions that result from operating in multiple businesses • Stem directly from strategic fit efficiencies along the value chains of related businesses • Sources of economies of scope: − Use of one or more common resources (or inputs) in the production of both outputs − Spreading fix costs over more products − Application of knowledge and core capabilities to the production of several outputs © Brauer - University of Mannheim 22 Types of cross-business strategic fit along the value chain (1/2) R&D and technology fits • • • • • Strategic fits in R&D and technology: Potential for sharing common technology Exploiting the full range of business opportunities associated with a particular technology Transferring technological know how Benefits: − Cost-savings in technology and new product R&D − Shorter times in getting new products to market − Interdependence between resulting products leads to increased sales Supply chain fits • • Strategic fits in supply chain activities: Potential for skill transfer and/or cost reductions : − − − − Procurement of materials Greater bargaining power in negotiating with common suppliers Benefits of added collaboration with supply chain partners Added leverage with shippers in securing volume discounts on incoming parts and components © Brauer - University of Mannheim Manufacturing fits • • Manufacturing related strategic fit Transfer of a diversifier’s expertise to another business − − − Quality manufacture Cost efficient production methods Consolidation of production/ assembly activities to significantly reduce overall production costs 23 Types of cross-business strategic fit along the value chain (2/2) Distribution fits • • Distribution-related strategic fits Potential for cost saving opportunities via: − Sharing of same distribution facilities − Sharing of wholesale distributors and retail dealers to access customers Sales and Marketing fits • − Strategic fits in sales and marketing activities Cost saving opportunities through − Single sales force and advertising for related products − Combined after-sale service and repair − Joint delivery, shipping, order processing and billing − Joint promotion tie-ins − Transfer selling and advertising skills − Transfer of a strong company’s brand name and reputation © Brauer - University of Mannheim Managerial support fit • Strategic fits in managerial and administrative support activities • Different business units require comparable types of entrepreneurial, administrative or operating know-how • Usage of same types of administrative support facilities e.g.: − Customer data network − Billing and customer accounting systems − Customer service infrastructure 24 Diversification into unrelated businesses Value chain activities Conceptualization • • • Diversification into businesses that allow the company as a whole to grow its revenues and earnings Involves diversifying into businesses with no meaningful strategic fit Criteria: − Businesses that meet corporate targets for profitability and ROI − Industries with attractive growth potentials − Businesses that are big enough for substantial contributions − Required capital − Union and labor situation − Industry vulnerability to recession, inflation, high interest rates, government regulations, other potential negative factors Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 251. © Brauer - University of Mannheim 25 Discussion of unrelated diversification Advantages 1 Disadvantages Business risk is spread over different industries • The greater the number and diversity of businesses, the more demanding the managerial requirements − Discern good acquisitions 2 − Select capable managers Financial resources can be directed to those industries offering best profit prospects 3 If bargain-priced firms with big profit potential are bought, share-holder wealth can be enhanced 4 Stability of profits. Hard times in one industry may be offset by good times in another industry − Judge strategies of business-units − Know what to do if a business subsidiary stumbles • The lack of cross-business strategic fits offers no potential for competitive advantage − Consolidated performance of unrelated businesses tends to be no better than individual businesses − Promise of greater sales-profit stability over business cycles is seldom realized © Brauer - University of Mannheim 26 Example of unrelated diversification: Virgin Group Product range Virgin Group 1984: Virgin Atlantic 2010: Virgin Racing 2004: Virgin Galactic Developed Business Fields 1970: Virgin Records 2007: Virgin Money 2008: Virgin Health With a high willingness to take risks by constantly establishing new companies, Richard Branson has created a conglomerate of global reach. © Brauer - University of Mannheim 27 Agenda: Lecture 8: Corporate Strategy 1 Diversification as a corporate strategy 2 Motives and types of diversification 3 Outcomes of diversification 4 Managing business portfolio scope © Brauer - University of Mannheim 28 Product diversification and firm performance © Brauer - University of Mannheim 29 After more than 30 years of portfolio research… Empirical findings on the advantageousness of different degrees of diversification have remained equivocal. Increasingly, scholars have begun to realize that it is not so much the degree of diversification that matters but rather the capability of a firm to actively manage the scope of diversification. © Brauer - University of Mannheim 30 Agenda: Lecture 8: Corporate Strategy 1 Diversification as a corporate strategy 2 Motives and types of diversification 3 Outcomes of diversification 4 Managing business portfolio scope © Brauer - University of Mannheim 31 Managing the business portfolio Smaller compared to main competitor Bigger compared to main competitor Question marks Stars Norm strategy: selective behavior Market growth Poor dogs Norm strategy: support, invest Above average Cash cows Norm strategy: disinvest, liquidate Norm strategy: hold position, harvesting Below average Relative market share Source: Henderson, 1971 © Brauer - University of Mannheim 32 Portfolio management at Bayer AG Source: Bayer AG © Brauer - University of Mannheim 33 6-step evaluation process to manage a business portfolio Step 1 Evaluate industry attractiveness Step 2 Assess competitive strength of firm’s business unit Step 3 Check competitive advantage of cross-business strategic fits Step 4 Check whether firm’s resources fit requirements Step 5 Rank performance prospects of business units and determine priority for resource allocation Step 6 Craft new strategic moves to improve overall company performance © Brauer - University of Mannheim 34 Step 1: Evaluate attractiveness of industry Strategic business unit’s (SBU) attractiveness Attractiveness of each SBU in portfolio Each SBU’s attractiveness relative to the others Attractiveness of all SBUs as a group © Brauer - University of Mannheim Industry attractiveness factors • Market size and projected growth • Intensity of competition • Emerging opportunities and threats • Presence of cross-industry strategic fits • Resource requirements • Seasonal and cyclical factors • Social, political, regulatory, and environmental factors • Industry profitability • Degree of industry uncertainty and business risk 35 Step 1: Calculating attractiveness scores for each industry Step A Select industry attractiveness factors Step B Assign weights to each factor (sum of weights = 1.0) Step C Rate each industry on each factor, using a scale of 1 to 10 Step D Calculate weighted ratings; sum to get an overall industry attractiveness rating for each industry © Brauer - University of Mannheim 36 Calculating weighted industry attractiveness scores Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 260. © Brauer - University of Mannheim 37 Interpreting industry attractiveness scores Interpreting industry attractiveness scores • Industries with a score much below 5.0 do not pass the attractiveness test • If a company’s industry attractiveness scores are all above 5.0, the group of industries the firm operates in is attractive as a whole • To be a strong performer, a diversified firm’s principal businesses should be in attractive industries with − A good outlook for growth and − Above-average profitability Difficulties • • © Brauer - University of Mannheim Deciding on appropriate weights for industry attractiveness factors − Different analysts have different weights − Different weights appropriate for different companies Gaining sufficient command of an industry to assign objective ratings − Statistical data to assign objective ratings is straightforward for e.g. market size, growth rate, industry profitability − Assessing the intensity of competition factor is more difficult due to the different types of competitive influences 38 Step 2: Evaluate each business-unit’s competitive strength Objectives • • Competitive strength factors Appraise how well each business is positioned in its industry relative to rivals Evaluate whether it is or can be competitively strong enough to contend for market leadership © Brauer - University of Mannheim • Relative market share • Costs relative to competitors • Beat rivals on key product attributes • Benefit from strategic fits with sister businesses • Exercise bargaining leverage with key suppliers or customers • Caliber of alliances and collaborative partnerships • Brand image and reputation • Competitively valuable capabilities • Profitability relative to competitors 39 Calculating competitive strength scores for each business Step A Select competitive strength factors Step B Assign weights to each factor (sum of weights = 1.0) Step C Rate each business on each factor, using a scale of 1 to 10 Step D Calculate weighted ratings; sum to get an overall strength rating for each business © Brauer - University of Mannheim 40 Calculating weighted competitive strength scores Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 263. © Brauer - University of Mannheim 41 Interpreting competitive strength scores Ratings above 6.7 Business units are strong market contenders Ratings between 3.3 & 6.7 Businesses have moderate competitive strength vis-à-vis rivals Ratings below 3.3 Business units are in competitively weak market positions Scores above 5.0 All business units are fairly strong market contenders in their respective industries © Brauer - University of Mannheim 42 Integrating industry attractiveness and competitive strength Plotting procedure • Industry attractiveness plotted on vertical axis • Competitive strength plotted on horizontal axis • Each business unit appears as a “bubble”: size of each bubble is scaled to percentage of revenues the business generates relative to total corporate revenues Visualization in a nine-cell matrix © Brauer - University of Mannheim 43 Strategy implications of industry attractiveness – competitive strength matrix Businesses in upper left corner Businesses in three diagonal cells Businesses in lower right corner • • Accorded top investment priority Strategic prescription – grow and build • • Given medium investment priority Invest to maintain position • Candidates for harvesting or divestiture Potential candidates for an overhaul and reposition strategy • © Brauer - University of Mannheim Overall consequences: • Concentrate resources in businesses with high industry attractiveness and competitive strength • Make selective investments in businesses with intermediate positions • Withdraw resources from businesses low in attractiveness and strength unless they offer exceptional potential 44 Step 3: Check competitive advantage potential of crossbusiness strategic fits Value chain activities Identification of value chain match-ups • Identify businesses with value chain match-ups offering opportunities to − Reduce costs − Transfer skills / technology / intellectual capital from one business to another − Share use of a powerful brand name − Create valuable new competitive capabilities Source: Thompson/ Strickland/ Gamble: Crafting and Executing Strategy, 17th edition, 2010, p. 267 © Brauer - University of Mannheim 45 Step 4: Check resource fit Companywide performance Does the business adequately contribute to achieving companywide performance targets? Financial strength Does the company have adequate financial strength to fund its different businesses and maintain a healthy credit rating? Specific resource strengths Does the company have or can it develop the specific resource strengths and competitive capabilities needed to be successful in each of its businesses? Competitive capabilities Are recently acquired businesses acting to strengthen a company’s resource base and competitive capabilities or are they causing its competitive and managerial resources to be stretched too thin? © Brauer - University of Mannheim 46 Step 5: Rank business units based on performance and priority for resource allocation Sales growth Industry and business strength ratings Profit growth Factors to consider in judging business-unit performance Cash flow generation Economic value added © Brauer - University of Mannheim Contribution to company earnings Return on capital employed in business 47 Role appointments Criteria for role assignment Growth driver Cash-champion Turnaround candidate High contribution to growth of the group. Potential for positive future cash flow from year 4 on and for RONOA > WACC. Essential for company profitability. Sources of cash to finance growth drivers. Stagnating or shrinking market growth. Subcritical market position. Sales growth > 1%. Defense of market position. Immediate action (e.g. asset sales) to gain freedom of action. Develop scenarios. Has a portfolio of promising technologies. Hierarchy of strategic goals Sales growth > 8%. Achievement of leading market position: At least nr. 3. Return clearly exceeds cost of capital in the medium run. Hierarchy of financial goals Control rules NPV-Business Plan > 0. Increase in profitability or exit. RONOA > average group target > target return. Keep FCF > 0. FCF optimization. RONOA < RONOA in the case of cashchampions accepted. From year 5 on expected: FCF > 0. FCF (over 3-year average) > 0. Optimization of FCF. Payback investments < years. Watchlist for growth. CapEx > Operating cashflow. CapEx < Operating cashflow. Protection of a positive cash contribution for the company. Year 1-4: FCF < 0 accepted. Realization of M&A to achieve leading market position. Payback Investments < 5 years. M&A to defense market position. Minimization of cash- and profitability cost. Restrictive investment planning. No growth investments. M&A only to achieve strategic solutions. Legend: RONOA = Return on Net Operating Assets; WACC = Weighted Average Cost of Capital; NPV = Net Present Value; FCF = Free cashflow; CapEx = Capital Expenditure © Brauer - University of Mannheim 48 Step 6: Craft new strategic moves to improve overall company performance Stick closely with existing business lineup and pursue these opportunities Pursue multinational diversification, striving to globalize operations of business units Broaden the business scope by making new acquisitions in new industries Strategic options Divest certain businesses and retrench to a narrower base of business operations Restructure company’s business lineup, putting a new face on business makeup © Brauer - University of Mannheim 49 Portfolio scenarios at Linde (2003) Scenario I Scenario II Scenario III Scenario IV Pure Gas Pure Engineering Technology Holding Status Quo Product orientation in gas business (most profitable division; would result in higher industry multiple); Would probably result in the divestiture of the forklift truck and engineering business; Possible need for a large acquisition in order to become Nr. 1; Focus on gas as global player. Mutation to mechanical engineering public limited company; Spread of the offer for the existing customer group; Divestiture of gas and material handling; Usage of revenues to acquire a competitor (e.g., MAN or Heidelberger Druck; Focus on maintaining and expanding market position. Flexible technology group; Maintaining of all four business units; Maintaining of gas and material handling (and possibly engineering); Acquisition of further technology companies; Increasing productivity in these business units; Possible M&A in material handling business; Focus on collecting a portfolio of attractive technologies and technology companies. No larger restructuring activities required; Maintaining of conglomerate discount; © Brauer - University of Mannheim Focus on improvement of operational business. 50 Portfolio scenarios at Linde (2011-2020) Source: Linde Group © Brauer - University of Mannheim 51 Learning objectives Understand the purpose and nature of corporate strategies Understand the challenges associated with crafting a successful corporate strategy Understand the different diversification strategies Become familiar with the tools companies can use to actively manage their business portfolio © Brauer - University of Mannheim 52 Contact Prof. Dr. oec. Matthias Brauer University of Mannheim Chair of Strategic and International Management L4, 1 D-68131 Mannheim E-mail: sekretariat.brauer(at)bwl.uni-mannheim.de © Brauer - University of Mannheim 53