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How To Build A Profitable Business Using Natural Justified Growth | Hackernoon

By | 03/09/2022

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  • Corporate strategy, the overall plan for a diversified company, is both the darling and the stepchild of gimmicky direction practice—the darling because CEOs take been obsessed with diversification since the early 1960s, the stepchild because most no consensus exists about what corporate strategy is, much less about how a visitor should formulate information technology.

    A diversified company has two levels of strategy: business unit (or competitive) strategy and corporate (or companywide) strategy. Competitive strategy concerns how to create competitive advantage in each of the businesses in which a company competes. Corporate strategy concerns two different questions: what businesses the corporation should be in and how the corporate role should manage the array of business units.

    Corporate strategy is what makes the corporate whole add together upwards to more than than the sum of its business organization unit parts. The rail record of corporate strategies has been dismal. I studied the diversification records of 33 large, prestigious U.South. companies over the 1950–1986 period and found that most of them had divested many more acquisitions than they had kept. The corporate strategies of nearly companies have dissipated instead of created shareholder value.

    The need to rethink corporate strategy could hardly exist more than urgent. By taking over companies and breaking them up, corporate raiders thrive on failed corporate strategy. Fueled by junk bond financing and growing acceptability, raiders tin can expose whatsoever company to takeover, no matter how large or blue flake.

    Recognizing past diversification mistakes, some companies take initiated big-scale restructuring programs. Others take done nothing at all. Whatsoever the response, the strategic questions persist. Those who have restructured must determine what to do next to avoid repeating the past; those who have done aught must awake to their vulnerability. To survive, companies must understand what good corporate strategy is.

    A Sober Flick

    While in that location is disquiet about the success of corporate strategies, none of the available evidence satisfactorily indicates the success or failure of corporate strategy. Most studies take approached the question by measuring the stock market valuation of mergers, captured in the movement of the stock prices of acquiring companies immediately before and after mergers are announced.

    These studies show that the marketplace values mergers equally neutral or slightly negative, hardly crusade for serious concern.ane
    Yet the curt-term market reaction is a highly imperfect measure of the long-term success of diversification, and no self-respecting executive would judge a corporate strategy this mode.

    Studying the diversification programs of a company over a long period of fourth dimension is a much more than telling manner to determine whether a corporate strategy has succeeded or failed. My study of 33 companies, many of which have reputations for good direction, is a unique look at the track record of major corporations. (For an explanation of the research, see the insert “Where the Data Come From.”) Each visitor entered an boilerplate of 80 new industries and 27 new fields. But over lxx%
    of the new entries were acquisitions, 22%
    were outset-ups, and 8%
    were joint ventures. IBM, Exxon, Du Pont, and 3M, for instance, focused on start-ups, while ALCO Standard, Beatrice, and Sara Lee diversified about solely through acquisitions (Exhibit i has a complete rundown).

    Exhibit 1 Diversification Profiles of 33 Leading U.South. Companies, 1950–1986

    Notes: Beatrice, Continental Grouping, General Foods, RCA, Scovill, and Signal were taken over as the report was beingness completed. Their data cover the menses upwards through takeover but not subsequent divestments. The percentage averages may not add up to 100% considering of rounding off.

    My information pigment a sobering picture of the success ratio of these moves (run into Showroom ii). I found that on average corporations divested more than than half their acquisitions in new industries and more 60%
    of their acquisitions in entirely new fields. 14 companies left more than 70%
    of all the acquisitions they had fabricated in new fields. The rails record in unrelated acquisitions is even worse—the average divestment rate is a startling 74%
    (run across Exhibit iii). Even a highly respected visitor like Full general Electric divested a very high percentage of its acquisitions, specially those in new fields. Companies near the top of the list in Showroom 2 achieved a remarkably low rate of divestment. Some show to the success of well-idea-out corporate strategies. Others, yet, enjoy a lower rate only because they accept not faced up to their problem units and divested them.

    Exhibit 2 Acquisition Track Records of Leading U.S. Diversifiers Ranked by Percent Divested, 1950–1986

    Note: Beatrice, Continental Grouping, General Foods, RCA, Scovill, and Indicate were taken over every bit the report was being completed. Their data cover the period up through takeover but not subsequent divestments.

    Exhibit 3 Diversification Performance in Joint Ventures, Outset-ups, and Unrelated Acquisitions, 1950–1986 (Companies in same order as in Showroom 2)

    Note: Beatrice, Continental Group, Full general Foods, RCA, Scovill, and Signal were taken over as the written report was beingness completed. Their data encompass the menstruation upwardly through takeover, but non subsequent divestments.

    I calculated total shareholder returns (stock cost appreciation plus dividends) over the catamenia of the report for each company and so that I could compare them with its divestment charge per unit. While companies near the top of the list have above-average shareholder returns, returns are non a reliable measure out of diversification success. Shareholder return oftentimes depends heavily on the inherent attractiveness of companies’ base of operations industries. Companies like CBS and General Mills had extremely profitable base businesses that subsidized poor diversification track records.

    I would similar to make ane comment on the use of shareholder value to gauge performance. Linking shareholder value quantitatively to diversification operation just works if you compare the shareholder value that is with the shareholder value that might have been without diversification. Because such a comparison is virtually impossible to make, measuring diversification success—the number of units retained by the company—seems to exist as good an indicator as any of the contribution of diversification to corporate performance.

    My data give a stark indication of the failure of corporate strategies.two
    Of the 33 companies, 6 had been taken over equally my written report was being completed (see the notation on Exhibit 2). But the lawyers, investment bankers, and original sellers accept prospered in almost of these acquisitions, not the shareholders.

    Premises of Corporate Strategy

    Whatever successful corporate strategy builds on a number of premises. These are facts of life about diversification. They cannot be contradistinct, and when ignored, they explain in part why so many corporate strategies fail.

    Competition Occurs at the Business Unit Level.

    Diversified companies do non compete; only their concern units exercise. Unless a corporate strategy places primary attending on nurturing the success of each unit, the strategy will fail, no matter how elegantly constructed. Successful corporate strategy must grow out of and reinforce competitive strategy.

    Diversification Inevitably Adds Costs and Constraints to Business Units.

    Obvious costs such as the corporate overhead allocated to a unit may not be every bit important or subtle as the hidden costs and constraints. A business unit must explain its decisions to top management, spend time complying with planning and other corporate systems, live with parent company guidelines and personnel policies, and forgo the opportunity to motivate employees with direct equity buying. These costs and constraints can be reduced but not entirely eliminated.

    Shareholders Can Readily Diversify Themselves.

    Shareholders tin diversify their ain portfolios of stocks past selecting those that all-time lucifer their preferences and risk profiles.iii
    Shareholders tin frequently diversify more cheaply than a corporation considering they can buy shares at the market cost and avoid hefty acquisition premiums.

    These premises mean that corporate strategy cannot succeed unless it truly adds value—to business units past providing tangible benefits that offset the inherent costs of lost independence and to shareholders by diversifying in a way they could not replicate.

    Passing the Essential Tests

    To understand how to formulate corporate strategy, information technology is necessary to specify the weather condition nether which diversification will truly create shareholder value. These atmospheric condition can exist summarized in three essential tests:

    1.

    The attractiveness examination.

    The industries chosen for diversification must be structurally attractive or capable of being made attractive.

    2.

    The toll-of-entry test.

    The toll of entry must non capitalize all the future profits.

    3.

    The meliorate-off test.

    Either the new unit must proceeds competitive advantage from its link with the corporation or vice versa.

    Of course, nearly companies will make sure that their proposed strategies pass some of these tests. But my study clearly shows that when companies ignored ane or two of them, the strategic results were disastrous.

    How Bonny Is the Manufacture?

    In the long run, the rate of render bachelor from competing in an industry is a office of its underlying construction, which I have described in another HBR commodity.4
    An attractive industry with a high average return on investment will exist difficult to enter because entry barriers are high, suppliers and buyers accept only modest bargaining power, substitute products or services are few, and the rivalry among competitors is stable. An unattractive industry similar steel will accept structural flaws, including a plethora of substitute materials, powerful and price-sensitive buyers, and excessive rivalry caused past high stock-still costs and a large grouping of competitors, many of whom are country supported.

    Diversification cannot create shareholder value unless new industries have favorable structures that support returns exceeding the toll of capital. If the industry doesn’t have such returns, the company must exist able to restructure the industry or gain a sustainable competitive advantage that leads to returns well above the industry boilerplate. An industry need not be attractive earlier diversification. In fact, a company might benefit from entering earlier the industry shows its full potential. The diversification can so transform the manufacture’s structure.

    In my research, I often found companies had suspended the attractiveness exam considering they had a vague belief that the industry “fit” very closely with their own businesses. In the hope that the corporate “comfort” they felt would pb to a happy event, the companies ignored fundamentally poor manufacture structures. Unless the close fit allows substantial competitive advantage, notwithstanding, such comfort will plough into pain when diversification results in poor returns. Purple Dutch Shell and other leading oil companies have had this unhappy feel in a number of chemicals businesses, where poor industry structures overcame the benefits of vertical integration and skills in process technology.

    Some other common reason for ignoring the attractiveness examination is a depression entry cost. Sometimes the buyer has an within rail or the owner is anxious to sell. Even if the price is really low, even so, a one-shot gain will not kickoff a perpetually poor business organisation. Nigh always, the company finds information technology must reinvest in the newly acquired unit, if only to supplant fixed assets and fund working capital.

    Diversifying companies are likewise prone to use rapid growth or other simple indicators equally a proxy for a target industry’s bewitchery. Many that rushed into fast-growing industries (personal computers, video games, and robotics, for example) were burned because they mistook early on growth for long-term profit potential. Industries are profitable not because they are sexy or high tech; they are assisting only if their structures are attractive.

    What Is the Cost of Entry?

    Diversification cannot build shareholder value if the price of entry into a new business eats up its expected returns. Strong market forces, however, are working to practice but that. A visitor tin can enter new industries by acquisition or start-up. Acquisitions expose it to an increasingly efficient merger market. An acquirer beats the market if information technology pays a price not fully reflecting the prospects of the new unit. Yet multiple bidders are commonplace, information flows quickly, and investment bankers and other intermediaries work aggressively to make the market equally efficient as possible. In recent years, new fiscal instruments such as junk bonds have brought new buyers into the market place and fabricated even large companies vulnerable to takeover. Conquering premiums are loftier and reflect the caused company’due south future prospects—sometimes also well. Philip Morris paid more than 4 times book value for Seven-Up Company, for case. Simple arithmetics meant that profits had to more than quadruple to sustain the preacquisition ROI. Since there proved to be little Philip Morris could add in marketing prowess to the sophisticated marketing wars in the soft-drink industry, the result was the unsatisfactory financial performance of Seven-Up and ultimately the decision to divest.

    In a start-up, the company must overcome entry barriers. It’s a existent catch-22 situation, however, since attractive industries are attractive because their entry barriers are loftier. Bearing the full cost of the entry barriers might well misemploy whatever potential profits. Otherwise, other entrants to the industry would have already eroded its profitability.

    In the excitement of finding an appealing new concern, companies sometimes forget to apply the price-of-entry test. The more attractive a new industry, the more expensive information technology is to get into.

    Will the Business Be Better Off?

    A corporation must bring some significant competitive reward to the new unit of measurement, or the new unit must offer potential for significant advantage to the corporation. Sometimes, the benefits to the new unit of measurement accrue merely once, well-nigh the time of entry, when the parent instigates a major overhaul of its strategy or installs a beginning-rate management team. Other diversification yields ongoing competitive reward if the new unit can market its production through the well-developed distribution system of its sis units, for instance. This is one of the of import underpinnings of the merger of Baxter Travenol and American Hospital Supply.

    When the do good to the new unit comes merely one time, the parent visitor has no rationale for holding the new unit in its portfolio over the long term. Once the results of the one-time comeback are clear, the diversified visitor no longer adds value to get-go the inevitable costs imposed on the unit of measurement. Information technology is best to sell the unit and complimentary upward corporate resources.

    The better-off test does non imply that diversifying corporate take a chance creates shareholder value in and of itself. Doing something for shareholders that they can do themselves is not a ground for corporate strategy. (Only in the case of a privately held visitor, in which the visitor’southward and the shareholder’s risk are the aforementioned, is diversification to reduce run a risk valuable for its own sake.) Diversification of adventure should only exist a by-production of corporate strategy, not a prime motivator.

    Executives ignore the better-off test most of all or deal with it through arm waving or trumped-up logic rather than hard strategic analysis. One reason is that they confuse visitor size with shareholder value. In the drive to run a bigger company, they lose sight of their real job. They may justify the suspension of the better-off exam by pointing to the way they manage diversity. By cutting corporate staff to the os and giving business units near complete autonomy, they believe they avoid the pitfalls. Such thinking misses the whole point of diversification, which is to create shareholder value rather than to avoid destroying it.

    Concepts of Corporate Strategy

    The 3 tests for successful diversification gear up the standards that any corporate strategy must meet; meeting them is then difficult that most diversification fails. Many companies lack a clear concept of corporate strategy to guide their diversification or pursue a concept that does not address the tests. Others fail considering they implement a strategy poorly.

    My study has helped me identify four concepts of corporate strategy that have been put into practice—portfolio management, restructuring, transferring skills, and sharing activities. While the concepts are not e’er mutually exclusive, each rests on a different mechanism by which the corporation creates shareholder value and each requires the diversified company to manage and organize itself in a different style. The first two require no connections among business organisation units; the second two depend on them. (See Exhibit 4.) While all four concepts of strategy take succeeded under the right circumstances, today some make more sense than others. Ignoring whatsoever of the concepts is peradventure the quickest road to failure.

    Exhibit 4 Concepts of Corporate Strategy

    Portfolio Management

    The concept of corporate strategy most in employ is portfolio management, which is based primarily on diversification through acquisition. The corporation acquires sound, bonny companies with competent managers who concur to stay on. While acquired units practise non take to be in the same industries as existing units, the best portfolio managers generally limit their range of businesses in some way, in function to limit the specific expertise needed by top direction.

    The acquired units are autonomous, and the teams that run them are compensated according to the unit results. The corporation supplies upper-case letter and works with each to infuse it with professional management techniques. At the same fourth dimension, top management provides objective and dispassionate review of business organization unit of measurement results. Portfolio managers categorize units past potential and regularly transfer resources from units that generate greenbacks to those with high potential and greenbacks needs.

    In a portfolio strategy, the corporation seeks to create shareholder value in a number of ways. It uses its expertise and analytical resources to spot attractive acquisition candidates that the private shareholder could not. The visitor provides capital on favorable terms that reflect corporatewide fundraising power. It introduces professional direction skills and discipline. Finally, it provides high-quality review and coaching, unencumbered past conventional wisdom or emotional attachments to the business.

    The logic of the portfolio management concept rests on a number of vital assumptions. If a company’s diversification plan is to meet the attractiveness and cost-of-entry exam, it must find good merely undervalued companies. Caused companies must exist truly undervalued considering the parent does little for the new unit of measurement one time information technology is acquired. To meet the better-off exam, the benefits the corporation provides must yield a significant competitive advantage to acquired units. The style of operating through highly autonomous business units must both develop sound business strategies and motivate managers.

    In nigh countries, the days when portfolio management was a valid concept of corporate strategy are by. In the face of increasingly well-developed capital markets, attractive companies with good managements show upwards on anybody’southward computer screen and attract top dollar in terms of acquisition premium. Simply contributing capital letter isn’t contributing much. A sound strategy can hands be funded; small to medium-size companies don’t demand a munificent parent.

    Other benefits have likewise eroded. Large companies no longer corner the market for professional management skills; in fact, more than and more observers believe managers cannot necessarily run anything in the absenteeism of industry-specific knowledge and feel. Another supposed reward of the portfolio management concept—dispassionate review—rests on similarly shaky ground since the added value of review alone is questionable in a portfolio of sound companies.

    The benefit of giving business organization units complete autonomy is also questionable. Increasingly, a company’due south business units are interrelated, drawn together by new technology, broadening distribution channels, and changing regulations. Setting strategies of units independently may well undermine unit operation. The companies in my sample that have succeeded in diversification accept recognized the value of interrelationships and understood that a strong sense of corporate identity is as important as slavish adherence to parochial business unit fiscal results.

    Just it is the sheer complexity of the management task that has ultimately defeated even the best portfolio managers. Every bit the size of the company grows, portfolio managers need to find more and more than deals just to maintain growth. Supervising dozens or fifty-fifty hundreds of disparate units and under chain-alphabetic character pressures to add together more than, management begins to make mistakes. At the same time, the inevitable costs of being role of a diversified company take their price and unit performance slides while the whole company’s ROI turns downward. Eventually, a new management team is installed that initiates wholesale divestments and pares down the company to its core businesses. The experiences of Gulf & Western, Consolidated Foods (now Sara Lee), and ITT are just a few comparatively recent examples. Reflecting these realities, the U.South. capital markets today advantage companies that follow the portfolio management model with a “conglomerate discount”; they value the whole less than the sum of the parts.

    In developing countries, where large companies are few, capital markets are undeveloped, and professional direction is scarce, portfolio direction however works. Only information technology is no longer a valid model for corporate strategy in advanced economies. Nevertheless, the technique is in the limelight today in the Britain, where it is supported so far past a newly energized stock marketplace eager for excitement. But this enthusiasm will wane—equally well information technology should. Portfolio management is no style to behave corporate strategy.

    Restructuring

    Different its passive function every bit a portfolio managing director, when it serves equally broker and reviewer, a company that bases its strategy on restructuring becomes an active restructurer of business concern units. The new businesses are not necessarily related to existing units. All that is necessary is unrealized potential.

    The restructuring strategy seeks out undeveloped, sick, or threatened organizations or industries on the threshold of pregnant modify. The parent intervenes, ofttimes changing the unit management team, shifting strategy, or infusing the company with new technology. Then information technology may make follow-upward acquisitions to build a critical mass and sell off unneeded or unconnected parts and thereby reduce the effective acquisition toll. The result is a strengthened company or a transformed manufacture. Every bit a coda, the parent sells off the stronger unit once results are clear because the parent is no longer adding value and top management decides that its attending should be directed elsewhere. (See the insert “An Uncanny British Restructurer” for an case of restructuring.)

    When well implemented, the restructuring concept is sound, for it passes the 3 tests of successful diversification. The restructurer meets the cost-of-entry examination through the types of visitor it acquires. It limits acquisition premiums by buying companies with problems and lackluster images or by buying into industries with equally yet unforeseen potential. Intervention by the corporation conspicuously meets the better-off examination. Provided that the target industries are structurally attractive, the restructuring model can create enormous shareholder value. Some restructuring companies are Loew’southward, BTR, and General Cinema. Ironically, many of today’southward restructurers are profiting from yesterday’southward portfolio management strategies.

    To work, the restructuring strategy requires a corporate management team with the insight to spot undervalued companies or positions in industries ripe for transformation. The aforementioned insight is necessary to actually turn the units effectually even though they are in new and unfamiliar businesses.

    These requirements betrayal the restructurer to considerable risk and usually limit the fourth dimension in which the company can succeed at the strategy. The most skillful proponents understand this trouble, recognize their mistakes, and move decisively to dispose of them. The best companies realize they are non simply acquiring companies but restructuring an industry. Unless they can integrate the acquisitions to create a whole new strategic position, they are just portfolio managers in disguise. Some other important difficulty surfaces if so many other companies join the action that they deplete the pool of suitable candidates and bid their prices up.

    Peradventure the greatest pitfall, nevertheless, is that companies observe it very hard to dispose of concern units once they are restructured and performing well. Human nature fights economic rationale. Size supplants shareholder value as the corporate goal. The visitor does not sell a unit even though the visitor no longer adds value to the unit. While the transformed units would be better off in some other company that had related businesses, the restructuring visitor instead retains them. Gradually, it becomes a portfolio manager. The parent company’south ROI declines as the need for reinvestment in the units and normal business risks eventually starting time restructuring’s ane-shot proceeds. The perceived need to go along growing intensifies the stride of conquering; errors event and standards fall. The restructuring company turns into a conglomerate with returns that only equal the average of all industries at best.

    Transferring Skills

    The purpose of the outset two concepts of corporate strategy is to create value through a company’southward human relationship with each autonomous unit. The corporation’s role is to be a selector, a banker, and an intervenor.

    The terminal two concepts exploit the interrelationships betwixt businesses. In articulating them, all the same, one comes face-to-face with the often ill-defined concept of synergy. If yous believe the text of the countless corporate almanac reports, merely almost anything is related to just about anything else! Just imagined synergy is much more common than real synergy. GM’s purchase of Hughes Aircraft simply considering cars were going electronic and Hughes was an electronics concern demonstrates the folly of paper synergy. Such corporate relatedness is an ex mail facto rationalization of a diversification undertaken for other reasons.

    Even synergy that is clearly defined often fails to materialize. Instead of cooperating, business units ofttimes compete. A company that can define the synergies it is pursuing still faces significant organizational impediments in achieving them.

    But the demand to capture the benefits of relationships betwixt businesses has never been more important. Technological and competitive developments already link many businesses and are creating new possibilities for competitive advantage. In such sectors as fiscal services, calculating, office equipment, entertainment, and wellness care, interrelationships amongst previously singled-out businesses are perhaps the central business of strategy.

    To understand the role of relatedness in corporate strategy, we must give new meaning to this ill-defined idea. I have identified a skilful way to beginning—the value chain.5
    Every business unit of measurement is a collection of discrete activities ranging from sales to bookkeeping that allow it to compete. I call them value activities. It is at this level, not in the company as a whole, that the unit achieves competitive advantage. I grouping these activities in ix categories.
    Principal
    activities create the product or service, deliver and market information technology, and provide after-sale support. The categories of primary activities include entering logistics, operations, outbound logistics, marketing and sales, and service.
    Support
    activities provide the inputs and infrastructure that allow the master activities to take place. The categories are company infrastructure, human being resource management, applied science development, and procurement.

    The value concatenation defines the two types of interrelationships that may create synergy. The outset is a company’s ability to transfer skills or expertise amid like value chains. The second is the ability to share activities. 2 business concern units, for example, tin can share the same sales strength or logistics network.

    The value chain helps expose the last two (and most important) concepts of corporate strategy. The transfer of skills among business units in the diversified visitor is the basis for one concept. While each business unit has a separate value chain, knowledge about how to perform activities is transferred among the units. For case, a toiletries business organisation unit of measurement, expert in the marketing of convenience products, transmits ideas on new positioning concepts, promotional techniques, and packaging possibilities to a newly acquired unit that sells cough syrup. Newly entered industries can benefit from the expertise of existing units and vice versa.

    These opportunities arise when business units have similar buyers or channels, like value activities like government relations or procurement, similarities in the broad configuration of the value concatenation (for instance, managing a multisite service organization), or the same strategic concept (for example, low toll). Fifty-fifty though the units operate separately, such similarities allow the sharing of knowledge.

    Of course, some similarities are common; one tin imagine them at some level between nigh any pair of businesses. Countless companies have fallen into the trap of diversifying too readily because of similarities; mere similarity is not plenty.

    Transferring skills leads to competitive advantage only if the similarities among businesses meet three conditions:

    1. The activities involved in the businesses are like enough that sharing expertise is meaningful. Broad similarities (marketing intensiveness, for instance, or a common core procedure technology such as angle metal) are not a sufficient footing for diversification. The resulting power to transfer skills is likely to have piffling touch on on competitive advantage.

    2. The transfer of skills involves activities important to competitive advantage. Transferring skills in peripheral activities such as regime relations or real estate in consumer goods units may be beneficial simply is not a basis for diversification.

    3. The skills transferred represent a significant source of competitive advantage for the receiving unit of measurement. The expertise or skills to be transferred are both advanced and proprietary plenty to be beyond the capabilities of competitors.

    The transfer of skills is an agile process that significantly changes the strategy or operations of the receiving unit. The prospect for change must exist specific and identifiable. Most guaranteeing that no shareholder value volition be created, too many companies are satisfied with vague prospects or faint hopes that skills volition transfer. The transfer of skills does not happen by accident or by osmosis. The visitor will have to reassign critical personnel, even on a permanent basis, and the participation and support of high-level direction in skills transfer is essential. Many companies accept been defeated at skills transfer because they accept not provided their business units with any incentives to participate.

    Transferring skills meets the tests of diversification if the company truly mobilizes proprietary expertise across units. This makes sure the company can starting time the acquisition premium or lower the cost of overcoming entry barriers.

    The industries the visitor chooses for diversification must pass the attractiveness test. Even a close fit that reflects opportunities to transfer skills may non overcome poor industry structure. Opportunities to transfer skills, yet, may help the company transform the structures of newly entered industries and send them in favorable directions.

    The transfer of skills can be one-time or ongoing. If the visitor exhausts opportunities to infuse new expertise into a unit of measurement after the initial postacquisition period, the unit should ultimately exist sold. The corporation is no longer creating shareholder value. Few companies have grasped this point, withal, and many gradually endure mediocre returns. Yet a company diversified into well-called businesses can transfer skills eventually in many directions. If corporate management conceives of its part in this manner and creates appropriate organizational mechanisms to facilitate cantankerous-unit interchange, the opportunities to share expertise will be meaningful.

    By using both acquisitions and internal development, companies can build a transfer-of-skills strategy. The presence of a potent base of skills sometimes creates the possibility for internal entry instead of the acquisition of a going concern. Successful diversifiers that utilise the concept of skills transfer may, however, often acquire a company in the target industry every bit a beachhead and and so build on it with their internal expertise. Past doing then, they can reduce some of the risks of internal entry and speed up the process. Ii companies that have diversified using the transfer-of-skills concept are 3M and Pepsico.

    Sharing Activities

    The 4th concept of corporate strategy is based on sharing activities in the value chains among business organisation units. Procter & Risk, for instance, employs a common concrete distribution arrangement and sales force in both paper towels and dispensable diapers. McKesson, a leading distribution visitor, will handle such diverse lines every bit pharmaceuticals and liquor through superwarehouses.

    The ability to share activities is a potent footing for corporate strategy because sharing frequently enhances competitive advantage by lowering price or raising differentiation. Simply non all sharing leads to competitive advantage, and companies can encounter deep organizational resistance to even benign sharing possibilities. These hard truths have led many companies to reject synergy prematurely and retreat to the false simplicity of portfolio management.

    A cost-benefit analysis of prospective sharing opportunities tin can determine whether synergy is possible. Sharing can lower costs if information technology achieves economies of calibration, boosts the efficiency of utilization, or helps a company movement more than chop-chop down the learning bend. The costs of Full general Electric’s advertizing, sales, and subsequently-sales service activities in major appliances are depression because they are spread over a broad range of appliance products. Sharing can also heighten the potential for differentiation. A shared order-processing system, for example, may allow new features and services that a buyer volition value. Sharing can also reduce the cost of differentiation. A shared service network, for example, may make more advanced, remote servicing technology economically viable. Often, sharing will allow an activeness to be wholly reconfigured in means that can dramatically raise competitive advantage.

    Sharing must involve activities that are meaning to competitive advantage, not just any activeness. P&One thousand’due south distribution system is such an example in the diaper and paper towel concern, where products are bulky and plush to transport. Conversely, diversification based on the opportunities to share merely corporate overhead is rarely, if ever, appropriate.

    Sharing activities inevitably involves costs that the benefits must outweigh. One cost is the greater coordination required to manage a shared activity. More of import is the need to compromise the design or performance of an activity so that it can exist shared. A salesperson handling the products of 2 business units, for example, must operate in a way that is usually not what either unit would choose were it independent. And if compromise profoundly erodes the unit’due south effectiveness, and then sharing may reduce rather than enhance competitive advantage.

    Many companies have simply superficially identified their potential for sharing. Companies also merge activities without consideration of whether they are sensitive to economies of scale. When they are not, the coordination costs kill the benefits. Companies chemical compound such errors past not identifying costs of sharing in accelerate, when steps tin be taken to minimize them. Costs of compromise can frequently be mitigated past redesigning the activity for sharing. The shared salesperson, for instance, tin be provided with a remote computer terminal to boost productivity and provide more customer information. Jamming business units together without such thinking exacerbates the costs of sharing.

    Despite such pitfalls, opportunities to proceeds advantage from sharing activities have proliferated because of momentous developments in engineering science, deregulation, and competition. The infusion of electronics and data systems into many industries creates new opportunities to link businesses. The corporate strategy of sharing can involve both acquisition and internal development. Internal development is often possible because the corporation can bring to bear articulate resource in launching a new unit. Offset-ups are less hard to integrate than acquisitions. Companies using the shared-activities concept can also make acquisitions equally beachhead landings into a new industry and and then integrate the units through sharing with other units. Prime examples of companies that have diversified via using shared activities include P&M, Du Pont, and IBM. The fields into which each has diversified are a cluster of tightly related units. Marriott illustrates both successes and failures in sharing activities over time. (Run across the insert “Adding Value with Hospitality.”)

    Following the shared-activities model requires an organizational context in which business organization unit collaboration is encouraged and reinforced. Highly autonomous business units are inimical to such collaboration. The visitor must put into identify a multifariousness of what I call horizontal mechanisms—a strong sense of corporate identity, a clear corporate mission statement that emphasizes the importance of integrating business concern unit strategies, an incentive system that rewards more than just business concern unit results, cross-business-unit job forces, and other methods of integrating.

    A corporate strategy based on shared activities conspicuously meets the ameliorate-off exam because business units gain ongoing tangible advantages from others within the corporation. It also meets the toll-of-entry exam by reducing the expense of surmounting the barriers to internal entry. Other bids for acquisitions that do not share opportunities will accept lower reservation prices. Even widespread opportunities for sharing activities do non permit a visitor to suspend the attractiveness test, however. Many diversifiers have made the critical mistake of equating the shut fit of a target industry with attractive diversification. Target industries must pass the strict requirement examination of having an attractive construction too as a close fit in opportunities if diversification is to ultimately succeed.

    Choosing a Corporate Strategy

    Each concept of corporate strategy allows the diversified visitor to create shareholder value in a different fashion. Companies tin can succeed with any of the concepts if they conspicuously ascertain the corporation’s role and objectives, have the skills necessary for meeting the concept’s prerequisites, organize themselves to manage diversity in a fashion that fits the strategy, and detect themselves in an appropriate uppercase marketplace environment. The caveat is that portfolio management is only sensible in express circumstances.

    A company’s choice of corporate strategy is partly a legacy of its past. If its business units are in unattractive industries, the company must start from scratch. If the company has few truly proprietary skills or activities it can share in related diversification, then its initial diversification must rely on other concepts. Yet corporate strategy should not be a once-and-for-all selection simply a vision that can evolve. A visitor should choose its long-term preferred concept and and then proceed pragmatically toward it from its initial starting point.

    Both the strategic logic and the experience of the companies studied over the final decade suggest that a visitor will create shareholder value through diversification to a greater and greater extent as its strategy moves from portfolio management toward sharing activities. Because they practise not rely on superior insight or other questionable assumptions about the company’south capabilities, sharing activities and transferring skills offer the best avenues for value creation.

    Each concept of corporate strategy is not mutually exclusive of those that come before, a potent advantage of the third and 4th concepts. A company can utilize a restructuring strategy at the same time it transfers skills or shares activities. A strategy based on shared activities becomes more powerful if business organisation units tin can as well exchange skills. Equally the Marriott case illustrates, a company can ofttimes pursue the 2 strategies together and even incorporate some of the principles of restructuring with them. When it chooses industries in which to transfer skills or share activities, the company can besides investigate the possibility of transforming the industry structure. When a visitor bases its strategy on interrelationships, information technology has a broader basis on which to create shareholder value than if information technology rests its entire strategy on transforming companies in unfamiliar industries.

    My study supports the soundness of basing a corporate strategy on the transfer of skills or shared activities. The data on the sample companies’ diversification programs illustrate some important characteristics of successful diversifiers. They have fabricated a unduly low percentage of unrelated acquisitions,
    unrelated
    being defined as having no clear opportunity to transfer skills or share important activities (meet Exhibit 3). Even successful diversifiers such as 3M, IBM, and TRW have terrible records when they have strayed into unrelated acquisitions. Successful acquirers diversify into fields, each of which is related to many others. Procter & Run a risk and IBM, for example, operate in 18 and 19 interrelated fields respectively and so enjoy numerous opportunities to transfer skills and share activities.

    Companies with the best acquisition records tend to make heavier-than-average use of commencement-ups and joint ventures. Most companies shy away from modes of entry too acquisition. My results bandage doubt on the conventional wisdom regarding commencement-ups. Exhibit 3 demonstrates that while joint ventures are about as risky as acquisitions, start-ups are non. Moreover, successful companies often accept very adept records with start-upwards units, every bit 3M, P&G, Johnson & Johnson, IBM, and United Technologies illustrate. When a visitor has the internal strength to start up a unit, it tin can be safer and less costly to launch a company than to rely solely on an acquisition and then have to deal with the problem of integration. Japanese diversification histories support the soundness of start-up as an entry alternative.

    My data too illustrate that none of the concepts of corporate strategy works when industry construction is poor or implementation is bad, no matter how related the industries are. Xerox acquired companies in related industries, but the businesses had poor structures and its skills were bereft to provide enough competitive advantage to beginning implementation issues.

    An Action Programme

    To interpret the principles of corporate strategy into successful diversification, a company must first take an objective look at its existing businesses and the value added by the corporation. But through such an assessment can an understanding of good corporate strategy abound. That understanding should guide hereafter diversification also every bit the evolution of skills and activities with which to select further new businesses. The post-obit action program provides a concrete approach to conducting such a review. A visitor can choose a corporate strategy past:

    ane. Identifying the interrelationships among already existing business units.

    A company should begin to develop a corporate strategy by identifying all the opportunities it has to share activities or transfer skills in its existing portfolio of business concern units. The visitor will not only observe ways to enhance the competitive advantage of existing units but also come upon several possible diversification avenues. The lack of meaningful interrelationships in the portfolio is an as of import finding, suggesting the need to justify the value added past the corporation or, alternately, a fundamental restructuring.

    two. Selecting the core businesses that volition be the foundation of the corporate strategy.

    Successful diversification starts with an understanding of the core businesses that will serve as the basis for corporate strategy. Core businesses are those that are in an attractive industry, have the potential to reach sustainable competitive advantage, have important interrelationships with other business units, and provide skills or activities that represent a base from which to diversify.

    The visitor must first make sure its cadre businesses are on sound ground by upgrading management, internationalizing strategy, or improving technology. The written report shows that geographic extensions of existing units, whether by acquisition, joint venture, or start-upwardly, had a essentially lower divestment rate than diversification.

    The company must so patiently dispose of the units that are not cadre businesses. Selling them volition gratuitous resources that could be better deployed elsewhere. In some cases disposal implies immediate liquidation, while in others the visitor should clothes up the units and await for a propitious market or a particularly eager buyer.

    3. Creating horizontal organizational mechanisms to facilitate interrelationships among the cadre businesses and lay the background for future related diversification.

    Top management can facilitate interrelationships by emphasizing cross-unit collaboration, grouping units organizationally and modifying incentives, and taking steps to build a strong sense of corporate identity.

    iv. Pursuing diversification opportunities that permit shared activities.

    This concept of corporate strategy is the most compelling, provided a visitor’s strategy passes all iii tests. A company should inventory activities in existing business organisation units that stand for the strongest foundation for sharing, such every bit strong distribution channels or world-class technical facilities. These will in turn lead to potential new business areas. A company tin can use acquisitions as a beachhead or apply outset-ups to exploit internal capabilities and minimize integrating problems.

    5. Pursuing diversification through the transfer of skills if opportunities for sharing activities are express or exhausted.

    Companies can pursue this strategy through acquisition, although they may be able to use offset-ups if their existing units have of import skills they can readily transfer.

    Such diversification is often riskier because of the tough conditions necessary for it to piece of work. Given the uncertainties, a visitor should avoid diversifying on the basis of skills transfer solitary. Rather it should too be viewed as a stepping-stone to subsequent diversification using shared activities. New industries should exist chosen that will atomic number 82 naturally to other businesses. The goal is to build a cluster of related and mutually reinforcing business units. The strategy’southward logic implies that the company should not set the charge per unit of return standards for the initial foray into a new sector also loftier.

    6. Pursuing a strategy of restructuring if this fits the skills of management or no good opportunities exist for forging corporate interrelationships.

    When a company uncovers undermanaged companies and can deploy adequate management talent and resources to the caused units, then it can use a restructuring strategy. The more developed the capital markets and the more agile the market for companies, the more restructuring will require a patient search for that special opportunity rather than a headlong race to acquire as many bad apples every bit possible. Restructuring can be a permanent strategy, every bit it is with Loew’southward, or a fashion to build a group of businesses that supports a shift to another corporate strategy.

    vii. Paying dividends so that the shareholders can be the portfolio managers.

    Paying dividends is better than destroying shareholder value through diversification based on shaky underpinnings. Tax considerations, which some companies cite to avert dividends, are inappreciably legitimate reasons to diversify if a company cannot demonstrate the capacity to do information technology profitably.

    Creating a Corporate Theme

    Defining a corporate theme is a good way to ensure that the corporation will create shareholder value. Having the right theme helps unite the efforts of business units and reinforces the ways they interrelate as well as guides the option of new businesses to enter. NEC Corporation, with its “C&C” theme, provides a practiced example. NEC integrates its computer, semiconductor, telecommunications, and consumer electronics businesses by merging computers and communication.

    It is all as well piece of cake to create a shallow corporate theme. CBS wanted to be an “amusement company,” for example, and congenital a group of businesses related to leisure time. It entered such industries as toys, crafts, musical instruments, sports teams, and hi-fi retailing. While this corporate theme sounded good, shut listening revealed its hollow ring. None of these businesses had any meaning opportunity to share activities or transfer skills amid themselves or with CBS’s traditional broadcasting and record businesses. They were all sold, often at significant losses, except for a few of CBS’s publishing-related units. Saddled with the worst conquering tape in my study, CBS has eroded the shareholder value created through its strong performance in broadcasting and records.

    Moving from competitive strategy to corporate strategy is the business organisation equivalent of passing through the Bermuda Triangle. The failure of corporate strategy reflects the fact that nigh diversified companies accept failed to think in terms of how they really add value. A corporate strategy that truly enhances the competitive reward of each business unit of measurement is the best defence force against the corporate raider. With a sharper focus on the tests of diversification and the explicit pick of a clear concept of corporate strategy, companies’ diversification runway records from now on can look a lot different.

    1. The studies also prove that sellers of companies capture a large fraction of the gains from merger.
    Run across
    Michael C. Jensen and Richard S. Ruback, “The Market for Corporate Control: The Scientific Bear witness,”
    Periodical of Financial Economics
    (April 1983): 5, and Michael C. Jensen, “Takeovers: Folklore and Scientific discipline,”
    Harvard Business concern Review
    (November–December 1984): 109.

    2. Some recent bear witness also supports the conclusion that acquired companies oftentimes suffer eroding performance afterward acquisition. See Frederick One thousand. Scherer, “Mergers, Sell-Offs and Managerial Beliefs,” in
    The Economic science of Strategic Planning,
    ed. Lacy Glenn Thomas (Lexington, Mass.: Lexington Books, 1986), p. 143, and David A. Ravenscraft and Frederick One thousand. Scherer, “Mergers and Managerial Performance,” paper presented at the Conference on Takeovers and Contests for Corporate Command, Columbia Constabulary School, 1985.

    3. This observation has been made by a number of authors.
    See,
    for case, Malcolm Southward. Salter and Wolf A. Weinhold,
    Diversification Through Acquisition
    (New York: Free Press, 1979).

    4.
    See
    Michael E. Porter, “How Competitive Forces Shape Strategy,”
    Harvard Business Review
    (March–Apr 1979): 86.

    five.
    See
    Michael E. Porter,
    Competitive Advantage
    (New York: Free Press, 1985).

    A version of this article appeared in the May 1987 issue of
    Harvard Concern Review.

    Source: https://hbr.org/1987/05/from-competitive-advantage-to-corporate-strategy