Chapter 6 Choosing Corporate Scope

Shortcomings on SBU view 1) No single SBU feels that it is responsible for maintaining a viable position in core products or core competencies that cross business boundaries 2) Competencies developed within SBU are not shared across SBU and opportunities on growth are missed. Shortcomings on Core Competence Doctrine 1) Definition of a firms core competence should not be based on an internal assessment of which activity of all the activity the company performs best. It should be a harsh external assessment of what it does better than competitors for which the term distinctive competence is more appropriate. 2) Every company can identify one activity that it does relatively better than other activities and claim it as core competence. 3) Core competence argument implies that diversifying in related business will yield higher returns than unrelated diversification. Yet opp has also succeeded. Tests to find out membership in a particular corporate family is likely to hamper or help a specific business unit Managers should focus intently on the corporate strategys impact on individual business units. Competition occurs at the level of individual business unit in a particular industry Tests for scope 1) Better off test a. Creates more value b. Also called as Corporate Added Value c. Do combining and coordinating the activities of multiple business units enable the units to create and capture more value than they could as independent un associated units. d. Compares commonly owned business units with standalone business units e. Incremental value should be more than the incremental costs f. Scope expansion increases the aggregate volume of business on which it is possible to earn positive or negative economic margins. g. Scope expansion can improve the structure of industries in which the company competes. h. Scope expansion can also increase the added value of business units within industries i. Scope expansion can create value for businesses by reducing the risks. j. Better off tests asks whether a particular set of business should be working together. 2) Best alternative test a. Focus on Value appropriation

b. Realises that common ownership is not the only possible basis for coordinating c. Business units instead may be independently owned but partnered with one another, form strategic alliances, sign long term contracts and so d. Best alternative test asks whether the set must be jointly owned in order to maximise the amount of value created and captured. 3) Best Parent Test: a. The appropriate benchmark for a value creation is not what would happen without a corporate parent, but what the best available parent would achieve. 4) Good Parent Test: a. Milder formulation of the third test. b. Even if a proposed opportunity to expand scope apparently satisfies the first two tests, it is worth asking yourself whether company is well placed to observe or act upon the opportunity before you move to actually capitalise on it. 5) IMPACT OF SCOPE EXPANSION better off tests a. Mitigate the five forces i. Rivalry is muted because of the fear of aggressive behaviour in one market provoke fierce competition everywhere. ii. New entry threat is reduced by denying the new firms access to complementary inputs iii. Broad scope may give the opportunity to migrate out of a structurally poor industry to a more attractive industry. iv. Horizontal diversification can also bring efficient and creative players into sleepy industries. b. Competitive Advantage: Improving a companys position within its industry i. The wedge between willingness to pay and costs must be increased and should be wider than that of competitors for CA ii. CA can be achieved by decreasing costs, increasing willingness to pay or by influencing both.

6) Cost Effects: How horizontal scope helps reduce costs? a. Shared Cost Economies: i. Shared cost economies typically occur 1. when business units can coordinate activities for efficiency or 2. Spread the cost of some lumpy, underutilised resource over the volume of multiple business units. ii. Resource may be tangible or intangible iii. Shared cost economies can arise anywhere in the value chains of the business units. 7) How horizontal scope increases willingness to pay a. Conveniences of one stop shopping. b. Cross promotion and cross branding

c. Umbrella Branding: Umbrella branding enables multiple businesses to reap the willingness to pay of a strong brand. d. Limits: i. Conflicts, compromise and co ordination ii. Fear of cannibalisation if substitutes are used instead of complementors. iii. Cognitive conflicts

Effects of Horizontal Diversification in Competitive Advantage Effects Levers for Value Creation Limits across Businesses Cost effects Shared cost economies 1) Diseconomies of 1) Shared activities scale 2) Shared Resources 2) Costs of Conflicts, Compromise, coordination Willingness to Pay/Price - One stop shop - Mixed motives effects - Cross selling - Cognitive conflicts - Cross promotion - Reputation risk - Umbrella branding - Bundling particularly of complements Dual effects - Superior internal - Availability of resource markets/ market/interfirm transfer alternatives mechanisms - Typical breadth - Other superior versus depth trade skills and off capabilities - Internal/inside the - Cross business box biases learning - Antitrust - Political influence laws/political backlash Transaction Costs and Ownership- Best Alternative test 1) The relationship between two business unit (under single ownership or not) can be thought of as a set of transactions 2) Governing a transaction involves certain costs including the cost of finding a transaction partner and making sure that the transaction is completed to the parties satisfaction 3) Different governance arrangement involves different transaction costs. 4) Transactions are expected to migrate toward the form of governance that permits them to be completed effectively and at low cost. 5) Cost of preventing opportunistic behaviour can be prevented by contracting to some extent Impediments to Contracting efficiency 1) Contractual complexity and incompleteness

2) Unclear property rights 3) Poor enforcement of property rights and contracts 4) Relation specific or co specialised resources. Models of Corporate World Increasing Horizontal Scope 1) Dominant Business Corporation a. Consists of a few business units surrounded by a number of peripheral units b. Strives to achieve best alternative test by i. Investing in highly specialised resources. ii. Achieving extensive cross unit coordination c. Have sizeable corporate staff 2) Related Business corporation a. More number of business units than the dominant business corporation b. One or more common threads that link their businesses c. Strives to meet best alternative test by i. One time transfer of specialised resources ii. One time transfer of skills to new line of business or an ongoing sharing of the same. iii. Operating as well as financial control systems with corporate managers striving for cross business management. iv. Aims for broader sharing and coordination across more businesses. 3) Unrelated business corporation a. Sprawling business portfolio with many units and sparse relation between them b. Strive to meet best alternative test by i. Building corporate strategies around relatively unspecialised resources or generic resources c. Control systems are financial d. Corporate offices are small Arms length trading: MNEs objective is to maximise the Profit after tax. They try to save on taxes. They make profit through transfer pricing in countries that have low tax rates. Arms length transfer pricing: Selling to own subsidiary as it is any other company is arm length transfer pricing. d