Choosing Corporate Scope

Choosing Corporate Scope

But we must now refer to one question about systems in general, and about organization systems in particular, the answer to which is of fundamental importance. I refer to the question as to whether the whole is more than the sum of the parts . . .

whether there emerge from the system properties which are not inherent in the parts.
Chester Barnard, The Functions Of The Executive (1938), p. 79

Choosing Corporate Scope

Quite a few groups / companies are conglomerates and manufacture /market a variety of diverse range of products /services Eg P & G, GE Godrej, Tatas, Videocon, Birlas

Choosing Corporate Scope

It is planned to examine: the logic that underlies choices of corporate scope Dimensions of scope

horizontal scope
in which industries to compete

vertical scope
make own inputs forward / backward integration Holdup-Contracting : shifting from a transaction based relationship to long term contracts - outsourcing

geographic scope
where to compete

Choosing Corporate Scope

Research suggests that effect of common corporate
ownership on the operating performance of businesses is significant but smaller than within industry differences in performance that operate at business level and Differences in average performance at the industry level

However corporate strategy cannot be ignored because:

1. Corporate-level effects on performance are not

negligible 2. Inferences to be drawn from such estimates remain controversial 3. Focus on operating performance used to isolate

Choosing Corporate Scope

Corporate strategy cannot be ignored
Corporate effects on performance represent: lower bounds on the strategic headroom afforded by corporate strategy wide gap between best and average practices

Evolution of corporate strategy practices

Portfolio planning techniques continued to hold through the 1970s and 1980s e.g. GEs # 1 or #2 or out (market share axis of the growth share matrix)analysis showed that related diversifiers outperformed the unrelated ones portfolio of strategic business units (SBUs) -influenced by liberalisation of U.S. financial markets (1980s), financial innovations (junk bonds), domestic deregulation, intensified foreign competition Specialist consulting firms promoted value-based management and heavy use of financial measures of performance

Evolution of corporate strategy practices

1990s- Economic Value Added (EVA) Prahalad and Hamel - core competencies - attacked SBUlevel foundations of portfolio planning. No single SBU feels responsible for maintainin a viable position in core products or competencies that cross business boundaries; competencies are not shared across SBUs anjd opportunities for growth are missed. Recommended corporate wide strategic architecture for competence building. Successful organisation of the future would be the one s that shifted their focus from SBUs to core competencies, because these formed the foundation of future growth.
8

Evolution of corporate strategy practices

Bain and Company Survey (2002)

25 most popular management tools used7

core competences ranked 11th strategic planning ranked 1st economic value-added analysis ranked 21st

Evolution of corporate strategy practices

Focusing on core competences also was doubted It is a feel good exercise that no one fails Every company can can identify an activity that it does better than other activities and claim that as core competence The definition of core competence should not be be based on internal assessment of which activity of all its activities the company performs best, it should be a harsh external assessment of what it does better than competitors.distinctive competence e.g. Sears, Roebuck and Co. acquired Coldwell, banker, largest real-estate brokerage firm in U.S. and Dean Witter, Reynolds, major securities broker
10

Evolution of corporate strategy practices

Sears acquisitions added to insurance and consumer credit card businesses. It was expected that it would leverage
expertise in data processing credit-card relationships with tens of millions of consumers trust in the eyes of many customers10

Cross-selling efforts stalled -reluctance to share customer lists Sears executives failed to address weakening position in the retail business fiercely competitive industry threat of Wal-Marts rise Struggle to mitigate hostile takeover (1988) Exit financial services scope (1992)

11

Two Tests applied to horizontal corporate strategy

The Better-Off test

whether a particular set of business units should be working together as a broad scope

The Best-Alternative test

whether the set must be jointly owned to maximize the amount of value created and captured These tests are useful whether one is one is considering the addition of a business unit to broaden horizontal scope or Thinking about divesting a unit to narrow scope, or, Deciding how to manage an existing portfolio of businesses portfolio

12

The possible third test

Best parent test: the appropriate benchmark for value creation is not what would happen without a corporate parent, but what the best available parent would achieve The Good parent test : even if a proposed opportunity to expand scope apparently satisfies the earlier two tests, it is worth asking whether your company is particularly is particularly well placed to observe or act on the opportunities identified before you actually move to capitalise on it.

13

The Better-Off Test

To pass, an expansion in horizontal scope must enable a corporations business units to create and capture more value together than they could as separate, singlebusiness entities unrelated to one another.

14

The Better-Off Test

Industry attractiveness
broad horizon scope can improve industry structure by mitigating five forces may provide opportunity to migrate out of a structurally poor industry into a more attractive setting e.g. Nokia getting out of several industries (rubber, electricity generation, cables etc) into mobiles

Competitive advantage
improve position within an industry by creating value increase the gap between price and costs

Cost effects
shared cost economies
15

The Better-Off Test

Willingness-to-pay/price effects Benefits

one-stop shopping cross-promotion umbrella branding Difficulties conflict, cooperation, coordination mixed motives cognitive conflicts reputational risks
16

The Better-Off Test

Duel effects
superior internal resource
markets transfer mechanisms skills and capabilities

cross-business learning and innovation

Risk considerations

17

The Better-Off Test

Effects of Horizontal Diversification on Competitive Advantage
Component Levers for Value Creation
Shared cost economies across

Limits
Diseconomies of scale or scope -Costs of Conflict/politicking
Compromise Coordination - Mixed motives - Cognitive conflicts - Reputational risk

Cost Effects

businesses -Shared activities -Shared resources

Willingnessto- Pay/Price Effects

One-stop shop/one-vendor sales and support - Cross-promotion/cross-selling - Umbrella branding - Bundling, particularly of complements
-

Dual Effects

- Superior internal resource - Availability of market / inter-firm markets/transfer mechanisms alternatives - Other superior skills and - Typical breadth versus depth capabilities trade-off - Cross-business learning/innovation - Internal/inside-the-box biases - Size-based political influence - Antitrust laws/political backlash

The Best-Alternative Test

The Better-Off test focuses on corporate added value

(value addition)

The Best-Alternative test

common ownership is not the only option business units may choose to remain independently owned (value appropriation) partnered strategic alliances long-term contracts

19

The Best-Alternative Test

Transactions Costs and Ownership

contractual complexity and incompleteness unclear property rights poor enforcement of contracts and property rights relationship-specific or co-specialized resources

20

The Best-Alternative Test

Models of Corporate Management

dominant-business corporations related-business corporations unrelated-business corporations

21

The Best-Alternative Test

Models of Corporate Management
Increasing Horizontal Scope
Single Business Firms DominantBusiness Corporations
Specialized

RelatedBusiness Corporations
Nature of Common Resources

UnrelatedBusiness Corporations

Holding Company (portfolio management)

Generic

Activity / Resource Sharing

Coordination mechanisms Control systems

Cross-Business Management Function

Resource/ Skill transfer

Operating

Financial Small

Large

An Application: Merrill Lynchs Analysis of the AOL Time Warner Merger

Announcing moves that broaden scope

publicizes synergies between sister units many synergy claims are logically flawed highlighted by
better-off tests best-alternative tests

23

An Application: Merrill Lynchs Analysis of the AOL Time Warner Merger

Exhibit 6.3 highlights potential synergies from the AOL Time Warner Merger (in millions of US $)
Revenue Enhancement Ad Sales Upside $200 of $600mm in estimated revenue upside at TW Online properties (CNN, CNNfn, CNNSI, Time, People, InStyle, Entertainment Weekly) More deals on AOL, ICQ through TW relationships Higher Broadband Penetration 1mm more broadband subscriptions for TW relationships from AOL upgrades 500K average for year paying $20 more per month Incremental Subscriptions New subscriptions to AOL and magazines (through cross-promotion) New AOL Premium Services 2mm AOL subscriptions sign up for $5 increase Fee by year-end 2001 (for AOL TV, real time stock quotes, etc.) Music Downloads on early generation music devices Increased Warner Music sales using AOL platform Total Revenue Upside Cost Savings: Reduced Operating Expenses Sales & Marketing, AOL (distribution of AOL software) Sales & Marketing, Time Warner (movies and music) Revenues EBITDA

$200.0 120.0

$160.0 120.0

120.0 25.0

72.0 12.5

60.0 25.0 10.0 $590.0 Revenues $200.0 100.0

30.0 6.3 2.5 $403.3 EBITDA $200.0 100.0

Reduced spending on TW online initiatives (Entertaindom)

Overhead (Finance, Legal, HR) Reduced customer support cost (in COGS) Reduced cost of content purchased by AOL ($600mm over 4 years) Reduced cost of member subscription and renewal Reduced telecom/technology costs across AOL-Time Warner Total Cost Savings

125.0
50.0 50.0 25.0 25.0 25.0 $600.0

125.0
50.0 50.0 25.0 25.0 25.0 $600.0

Source: Stephen P. Bradley and Erin E. Sullivan, AOL Time Warner, Inc., (Harvard Business School Case no. 702-421, Boston, MA, 2002), p. 23.

An Application: Merrill Lynchs Analysis of the AOL Time Warner Merger

explains the rationale behind some of the synergies

1. Sales & Marketing AOL distribution 2. Reduced Customer Support Cost 3. Reduced Cost of Content Purchased by AOL 4. Advertising Sales Upside (Time Warner) 5. Incremental Subscriptions

25

An Application: Merrill Lynchs Analysis of the AOL Time Warner Merger

Logical flaws mutually beneficial arrangements achieved via contracts sales and marking budget cuts assumed that additional business units can tap alreadyheavily-utilized resources with little or no additional investment opportunity costs of common ownership are ignored benefits that are supposed to make the jointly-owned units better off are counted twice often, once in each unit costs and difficulty of cross-unit coordination are ignored cross-unit coordination is assumed to be free
26

Summary

Stakes and level of difficulty are high

when choosing range in which to compete

Corporate-level scope choices

overlay on business-unit strategies choices of scope are effective or ineffective
depending on the extent to which they contribute to the success or failure of individual business units in their specific industries

27

Summary
Broad scope must pass two tests
breadth must bring together business units that are made better off by their union 2. joint ownership must capture the benefits of breadth better than alternate arrangements
1.

arms-length trade licensing strategic alliances joint ventures

28

Summary

Examples demonstrate enormous power of corporate strategy to

create value destroy value

Will see more examples of both

given the complexities of scope choices

29

Summary

Managers can improve odds of value creation and capture

ask whether SBUs are better off
under same corporate umbrella separated coordinated by alternative outright ownership

30

Key Terms
best-alternative test better-off test corporate added value corporate strategy good parent

31