Growth Strategy

Growth Strategy
sex-selection tests. The penalty is up to three months in prison and a ne of 1,000 rupees. Both companies deny wrongdoing and say they comply with Indian laws. A GE spokesman said its legal team would be looking into the charges. Vivek Paul, who helped build the early ultrasound business in India, rst as a senior executive at GE and then at Wipro, says blame should be pinned on unethical doctors, not the machine’s suppliers. “If someone drives a car through a crowded market and kills people, do you blame the car maker?” says Paul, who was Wipro’s chief executive before he left the company in 2005. Paul is now a managing director at private equity specialists TPG Inc., formerly known as Texas Paci c Group. India has been a critical market to GE. Its outsourcing opera- tions have helped the Fair eld, Connecticut, giant cut costs. The country also is a growing market for GE’s heavy equipment and other products. The company won’t disclose its ultrasound sales, but Wipro GE’s overall sales in India, which includes ultrasounds and other diagnostic equipment, reached about $250 million in 2006, up from $30 million in 1995. Annual ultrasound sales in India from all vendors also reached $77 million last year, up about 10 percent from the year before, according to an estimate from consulting rm Frost & Sullivan, which describes GE as the clear market leader. Other vendors include Siemens AG, Philips Electronics NV, and Mindray Inter- national Medical Ltd., a new Chinese entrant for India’s price- sensitive customers. India has long struggled with an inordinate number of male births, and female infanticide—the killing of newborn baby girls—remains a problem. The abortion of female fetuses is a more recent trend, but unless “urgent action is taken,” it’s poised to escalate as the use of ultrasound services expands, the United Nations Children’s Fund said in a report. India’s “alarming de- cline in the child sex ratio” is likely to exacerbate child marriage, traf cking of women for prostitution, and other problems, the report said. The latest of cial Indian census, in 2001, showed a steep de- cline in the relative number of girls aged 0 to 6 years compared with the decade earlier: 927 girls for every 1,000 boys compared with 945 in 1991. In much of northwest India, the number of girls has fallen below 900 for every 1,000 boys. In the northern state of Punjab, the gure is below 800. Only China today has a wider gender gap, with 832 girls born for every 1,000 boys among infants aged 0 to 4 years, according to UNICEF. GE sells about three times as many ultrasound machines in China as in India. In January, the Chinese government pledged to improve the gender balance, including tighter monitoring of ul- trasounds. Some experts predict China will be more effective than India in enforcing its rules, given its success at other population- control measures. Boys in India are viewed as wealth earners during life and lighters of one’s funeral pyre at death. India’s National Family Health Survey, released in February, showed that 90 percent of parents with two sons didn’t want any more children. Of those Ultrasound Machines, India, China, and a Skewed Sex Ratio CASE 28 General Electric Co. and other companies have sold so many ul- trasound machines in India that tests are now available in small towns like Indergarh, where there is no drinking water, electricity is infrequent, and roads turn to mud after a March rain shower. A scan typically costs $8, or a week’s wages. GE has waded into India’s market as the country grapples with a dif cult social issue: the abortion of female fetuses by families who want boys. Campaigners against the practice and some government of cials are linking the country’s widely reported skewed sex ratio with the spread of ultrasound ma- chines. That’s putting GE, the market leader in India, under the spotlight. It faces legal hurdles, government scrutiny, and thorny business problems in one of the world’s fastest-growing economies. “Ultrasound is the main reason the sex ratio is coming down,” says Kalpana Bhavre, who is in charge of women and child welfare for the Datia district government, which includes Indergarh. Having a daughter is often viewed as incurring a lifetime of debt for parents because of the dowry payment at marriage. Compared with that, the cost of an ultrasound “is nothing,” she says. For more than a decade, the Indian government has tried to stop ultrasound technology from being used as a tool to determine gender. The devices use sound waves to produce images of fetuses or internal organs for a range of diagnostic purposes. India has passed laws forbidding doctors from disclosing the sex of fetuses, required of cial registrations of clinics, and stiffened punishments for offenders. Nevertheless, some estimate that hundreds of thou- sands of girl fetuses are aborted each year. GE, by far the largest seller of ultrasound machines in India through a joint venture with the Indian outsourcing giant Wipro Ltd., introduced its own safeguards, even though that means for- saking sales. “We stress emphatically that the machines aren’t to be used for sex determination,” says V. Raja, chief executive of GE Healthcare South Asia. “This is not the root cause of female feticide in India.” But the efforts have failed to stop the problem, as a grow- ing economy has made the scans affordable to more people. The skewed sex ratio is an example of how India’s strong economy has, in unpredictable ways, exacerbated some nagging social problems, such as the traditional preference for boys. Some activists are ac- cusing GE of not doing enough to prevent unlawful use of its ma- chines to boost sales. “There is a demand for a boy that’s been completely exploited by multinationals,” says Puneet Bedi, a New Delhi obstetrician. He says GE and others market the machines as an essential pregnancy tool, though the scans often aren’t necessary for mothers in low- risk groups. Prosecutors in the city of Hyderabad brought a criminal case against the GE venture with Wipro, as well as Erbis Engineering Co., the medical-equipment distributor in India for Japan’s Toshiba Corp. In the suits, the district government alleged that the compa- nies knowingly supplied ultrasound machines to clinics that were not registered with the government and were illegally performing cat2994X_case2_019-046.indd 44cat2994X_case2_019-046.indd 44 8/27/10 2:05 PM8/27/10 2:05 PM Cases 2 The Cultural Environment of Global Marketing The owner, Sarawathi Devi, acknowledged in an interview that her clinic, Rite Diagnostics, was not of cially registered at the time of the inspection. She said the ultrasound machine was owned by a “freelance” radiologist who had obtained proper docu- mentation for the Wipro-GE machine but was not there when the inspectors had arrived. She denied the clinic has conducted sex determination tests. Later, Dr. Devi’s records show, she registered the clinic with the government and bought a Wipro-GE machine, a sale the company con rms. The court case was part of a wider dragnet spearheaded by Hyderabad’s top civil servant, District Magistrate Arvind Kumar. During an audit last year, Kumar demanded paperwork for 389 local scan centers. Only 16 percent could furnish com- plete address information for its patients, making it almost im- possible to track women to check if they had abortions following their scans. Kumar ordered the seizure of almost one-third of the ultrasound machines in the district due to registration and paperwork problems. A suit also was lodged against Erbis, the Toshiba dealer. GE’s Raja says that, in general, if there’s any doubt about the customer’s intent to comply with India’s laws, it doesn’t make the sale. “There is no winking or blinking,” he says. A Wipro-GE representative is scheduled to appear at the Hyderabad court hearing. An Erbis spokesman said he was unaware of the case in Hyderabad. A court date for Erbis had not been set. A visit to the clinic in Indergarh, a town surrounded by elds of tawny wheat, shows the challenges GE faces keeping tabs on its machines. Inside the clinic, a dozen women wrapped in saris awaited tests on GE’s Logiq 100 ultrasound machine. The line snaked along wooden benches and down into a darkened base- ment. On the wall, scrawled in white paint, was the message: “We don’t do sex selection.” Manish Gupta, a 34-year-old doctor, said he drives two hours each way every week to Indergarh from much larger Jhansi City, where there are dozens of competing ultrasound clinics. He said even when offered bribes, he refuses to disclose the sex of the fetus. “I’m just against that,” Dr. Gupta said. But he is not complying with Indian law. Although the law re- quires that clinics display their registration certi cate in a conspic- uous place, Dr. Gupta’s was nowhere to be seen. When Dr. George, the social activist, asked for the registration, he was shown a dif- ferent document, an application. But the application was for a dif- ferent clinic: the Sakshi X-ray center. Dr. Gupta said the proper document wasn’t with him, adding: “I must have forgotten it at home.” Asked by The Wall Street Journal about the clinic, the local chief magistrate of Datia district called for Dr. Gupta’s dossier later in the day. When a local of cial arrived, “Sakshi X-Ray cen- ter” had been crossed out on the application. In blue pen was writ- ten the correct name, “Sheetal Nagar,” the part of Indergarh where the clinic is located. It’s not clear how Dr. Gupta procured the GE machine. Dr. Gupta said he bought it from a GE company representative, but he declined to show documents of ownership. GE says it does not comment on individual customers. Like the rest of India, the Datia district government has taken a number of steps to try to boost the number of girls in the district. For girls of poor families, the local government provides a place to live, free school uniforms, and books. When they enter ninth grade, the government buys bicycles for them. Yet the low ratio of girls born had not budged much over with two daughters, 38 percent wanted to try again. Although there are restrictions on abortions in this Hindu-majority na- tion, the rules offer enough leeway for most women to get around them. GE took the lead in selling ultrasounds in the early 1990s soon after it began manufacturing the devices in India. It tapped Wipro’s extensive distribution and service network to deliver its products to about 80 percent of its customers. For more remote locations and lower-end machines, it used sales agents. The company also teamed with banks to help doctors nance the purchase of their machines. GE now sells about 15 different models, ranging from machines costing $100,000 that offer so- phisticated color images to basic black-and-white scanners that retail for about $7,500. To boost sales, GE has targeted small-town doctors. The company has kept prices down by refurbishing old equipment and marketing laptop machines to doctors who travel frequently, including to rural areas. GE also offered discounts to buyers in- clined to boast about their new gadgets, according to a former GE employee. “Strategically, we focused on those customers who had big mouths,” said Manish Vora, who then sold ultra- sounds in the western Indian state of Gujarat for the Wipro-GE joint venture. Without discussing speci c sales tactics, Raja, of GE Health- care South Asia, acknowledges the company is “aggressive” in pursuing its goals. But he points out that ultrasound machines have broad bene ts and make childbirth safer. As the machines become more available, women can avoid making long trips into cities where healthcare typically is more expensive, he says. Indian authorities have tried to regulate sales. In 1994, the gov- ernment outlawed sex selection and empowered Indian authorities to search clinics and seize anything that aided sex selection. Today any clinic that has an ultrasound machine must register with the local government and provide an af davit that it will not conduct sex selection. To date, more than 30,000 ultrasound clinics have been registered in India. GE has taken a number of steps to ensure customers comply with the law. It has educated its sales force about the regulatory regime, demanded its own af davits from customers that they will not use the machines for sex selection, and followed up with periodic audits, say executives. They note that in 2004, the rst full year it began implementing these new measures, GE’s sales in India shrank by about 10 percent from the year before. The sales decline in the low-end segment, for black-and-white ultrasound machines, was especially sharp, executives say. Only in 2006 did GE return to the sales level it had reached before the regulations were implemented, according to Raja. Complying with Indian law is often tricky. GE cannot tell if doctors sell machines to others who fail to register them. Different states interpret registration rules differently. GE also is under close scrutiny by activists battling the illegal abortion of female fetuses. Sabu George, a 48-year-old activist who holds degrees from Johns Hopkins and Cornell universities, criss-crosses the country to spot illegal clinics. The criminal case in Hyderabad against Wipro-GE, a company representative, three doctors, and an ultrasound technician fol- lowed an inspection that found one clinic could not produce proper registration and had not kept complete records for two years. A team of inspectors seized an ultrasound supplied by Wipro-GE. The inspection team’s report said it suspected the clinic was using the machines for illegal sex determination. cat2994X_case2_019-046.indd 45cat2994X_case2_019-046.indd 45 8/27/10 2:05 PM8/27/10 2:05 PM Part 6 Supplementary Material Most recently, both Siemens and GE have introduced handheld ultrasound machines, only slightly larger than an iPhone. Initially they will sell for under $10,000. QUESTION What should GE management do in India about this problem, if anything? In China? Source: Peter Wonacott, “Medical Quandry: India’s Skewed Sex Ratio Puts GE Sales in Spotlight,” The Wall Street Journal , April 18, 2007, pp. A1, A8. Licensed from Dow Jones Reprint Services, Document J000000020070418e34i00032; Paul Glader, “GE Is Latest to Make Handheld Ultrasound,” The Wall Street Journal , February 12, 2010, online. the past decade, according to Bhavre, the district government off icial. Ultimately, says Raja, head of GE Healthcare in South Asia, it’s the job of the government, not companies, to change the prevailing preference for boys. “What’s really needed is a change in mind- sets. A lot of education has to happen and the government has to do it,” he says. India’s Ministry of Health, which is now pursuing 422 different cases against doctors accused of using ultrasounds for sex selec- tion, agrees. “Mere legislation is not enough to deal with this prob- lem,” the ministry said in a statement. “The situation could change only when the daughters are not treated as a burden and the sons as assets.” cat2994X_case2_019-046.indd 46cat2994X_case2_019-046.indd 46 8/27/10 2:05 PM8/27/10 2:05 PM
Growth Strategy
Chapter 4 Value Strategies for the New Economy Exhibit 4.x Value Strategies for the New Economy Castrol, the world’s leading lubricants company, had a problem. As part of its differentiation efforts, Castrol had segmented its market by major clusters of business applications – cement, sugar, pulp and paper, textile, food and beverage, wood, mining, and glass. However, its business was now becoming commoditized. Castrol found that within each cluster, it had different types of customers having different attitudes towards how much they wished to engage with it. Broadly, its customers could be grouped into three tiers, based on their attitudes towards engagement with Castrol. (1) Tier 1: productivity-conscious customers, seeking to enhance productivity, lower costs, and grow sales. (2) Tier 2: cost-conscious customers, seeking to lower their total costs of operations. (3) Tier 3: price-conscious customers, seeking to shop for suppliers with lowest prices. How should Castrol adapt its strategy to better target different tiers of customers? For Tier 1 customers, Castrol developed a new personalized pre- and post- sales customer engagement process. The process begins with joint dialog between the Castrol and the customer teams, and a survey of the customer plant-specific personalizations needed in the generic plant platform. Metrics for tracking customer’s return on investments are established, and personalized package of solutions comprising of products and services is developed to realize the expected returns. Previously, only the customers performed the task of diagnosing the plant-specific needs, building the solution, and tracking the performance. As Castrol integrated this function to build long-term contracts based on trust, learning, and accountability, it was able to decommoditize its products. For Tier 2 customers, Castrol offered customized solutions based on a combination of its products and services. It provided documented case studies demonstrating how these products and services were most appropriate for specific types of plant conditions. It thus built credibility and confidence with these customers. For Tier 3 customers, Castrol automated the sales and delivery processes, to simplify and speed up the customer process of ordering its products and services. It reassigned its sales processing team to service the first tier of customers, and reduced prices for the third tier customers. Source: Adapted from Hax (2002) We are now in the age of new economy. In the new economy, the environment is volatile, uncertain, chaotic, and ambiguous. It is difficult and risky for the firms to rely on its past resources, capabilities and core competencies. Successful firms in the new economy know how to leverage not only their own strengths, but also the strengths of others. In other words, they know how to leverage differences for collective benefits. The work of several scholars (Fjeldstad and Stabell, 1998; Hax, 2002) shows that in the new economy, traditional value chains have evolved into three distinct forms of value strategies: Product stream positions: Firms have several product stream positions; each stream has its own business-level strategy. Product stream positions allow a firm to develop a portfolio of products, which improves the economics of its operations. (Why? – due to the economies of scale, scope and experience). However, as more and more firms in an industry grow product stream positions, they experience a rising rivalry and race to manage the speed and cost of development of the product portfolio. Custom solutions integrators: Firms integrate internal and external resources to design integrative custom solutions; each solution is customized for the distinct needs of a broad group of customers. This custom integration helps firms improve their customer portfolio and economics. It also helps improve cooperation among firms, for designing one-stop personalized solutions for customers. The opening case of Castrol is illustrative of this approach. Network exchange systems: Firms act as network exchange systems by enabling other firms to find their customers directly using its technology or marketing platform. Network exchange system helps firms improve their overall network portfolio and economics. It also helps improve the market dominance of firms who are successful network exchanges. Hax (2002) portrays the integrated approach of leveraging all three types of value strategies, in the shape of a triangle, referred to as the Delta model. Driver: Network economics Tactics: Gain complementor share Consequence: Market dominance Driver: Product economics Tactics: Gain product share Consequence: Rivalry Driver: Customer economics Tactics: Gain customer share Consequence: Cooperation Exhibit 4.x: Hax’s Delta Triangle – Integrating the Three Value Strategies Two important system-level dimensions of value strategies are the issues of inclusions (micro-foundations) and of impacts (macro foundations). Whose resources, capabilities and core competencies are valued and included, and whose is not valued as much and excluded? What is the impact of the value linkages on economic, social and environmental criteria? Exhibit 4.2 offers an integrated snapshot of the research on the meso-foundations of strategic advantage, based on this and the previous chapter. Value System Analysis: Inclusions (micro foundations) Impacts (macro foundations) Exhibit 4.2: Value Strategies for the New Economy Product Stream Positions Contemporary markets are hyper-competitive – technologies and globalization have intensified the competition among firms. As shown in Exhibit 4.x, in hyper-competitive markets, firms need to develop and introduce a stream of products on a continual basis. Else, they may not be able to sustain their competitive advantage. Faster product cycles require frequent disruption of value chains in order to avoid becoming too similar and undifferentiated commodities. To do so, investment is needed on an ongoing basis into research and development of innovative product streams. Firms, however, can’t afford to spread too thin and become too complex. They must consider ways to cash and phase out product streams with limited future potential. Each value chain in the stream achieves a best product positioning, improving the product economics. Emerging Product stream Customers Growing Product stream Mauring Product stream Exhibit 4.x Product-based Value Streams : Increasing the Product Share Each of the product streams may have a different business strategy. The business strategy may vary across the lifecycle of each product stream. Products in the emerging phase are often launched in a focus niche at a premium end (focus strategy. As they take-off, they may be offered to a broader market, although still with a premium associated with new product innovations (differentiation strategy). Further, with greater scalability, improved processes tend to improve cost-effectiveness, and allow the products to reach even the mass market. Gradually, as the scope for further scale is exhausted, lower cost becomes the key profitability driver (cost leadership strategy). Lastly, when a disruptive change in market or technology takes place, it becomes imperative to focus on market segments where the product continues to offer value for money (focus strategy). Product life cycle analysis is an important tool to manipulate the economics of value strategies based on a stream of products. One way of applying this tool is through a typology of strategy profiles advanced by Miles and Snow (1978). Miles and Snow Typology of Strategy Profiles Firms face three basic problems in their value strategies. The entrepreneurial problem: deciding value proposition and target markets The engineering problem: designing value infrastructure, including technologies The administrative problem: developing organizational and management structures Firms may be classified into four strategy profiles, based on their approach to these problems. These are: the prospector, the analyzer, the defender, and the reactor. The Prospector A Prospector firm values being ‘first’ more than anything else. It thrives in VUCA environments – volatile, uncertain, complex, and ambiguous. A prospector firm addresses the entrepreneurial problem by testing new value propositions and new target markets. It manages the engineering problem by diversifying its value infrastructure and investing in multiple different technologies. It tackles the administrative problem by adopting decentralized and collaborative organizational structures with very flat management hierarchy. An exemplar prospector firm is 3M. Slater et al. (2010 p. 470) stated, “in 1916, 3M invented Wetordry… Other successful 3M discoveries include; masking tape, Scotch cellophane tape, the Thermo-Fax copying process, Scotchgard Fabric Protector, Post-it Notes and a variety of pharmaceutical products.” The Analyzer An analyzer firm is agile at quickly following prospectors into new domains. According to Slater et al. (2010 p. 475), Analyzers “target the early adopter and early majority segments with a creative strategy that enables the Analyzer to both steal early adopter customers from prospectors and attract members of the early majority”. An exemplar analyzer firm is Microsoft. Slater et al. (2010 p. 475) noted, “Microsoft has a very broad product line, with many of its best known products (e.g., DOS, Word, Excel, PowerPoint, Internet Explorer, X-Box) entering the market as second – or, even later – movers… Microsoft expends considerable effort identifying emerging product-market opportunities that have been established by traditional market innovators [Prospectors] – such as Apple, Sony, and Nintendo – and then pursuing sales in the mainstream market.” The Defender A defender firm manages the entrepreneurial problem by aggressively protecting their market share. It addresses engineering problem by specializing in a particular single core technology, standardizing its processes, and vertically integrating for cost efficiency. It tackles the Administrative problem through high degree of centralization, rigid and formal procedures, discrete functions, and lengthy, long-term planning processes ((Jurgens-Kowal, 2010). A firm exemplifying this approach is VIZIO, who during the 2000s became the market share leader with low manufacturing costs, low price, good quality, low advertising, and an intense focus on its distribution strategy. An example of the period where the defender strategy proved most successful was the 1960s and 1970s for the airline industry, because the government regulation resulted in minimum changes in the environment (Jurgens-Kowal, 2010). The Reactor A reactor firm does not address the problems of entrepreneurship, engineering or administration effectively. Major disruptive changes in markets or in technologies push many firms into the Reactor trap. These firms may perceive changes in the environment to be too drastic to allow for a deliberate response. An exemplar is the Finnish firm Nokia, that was once a leader in the mobile smartphones. However, with the shift towards Android and iOS based cellular technology, Nokia was unable to keep up and lost its advantage to Apple and Samsung. Reinterpreting Miles and Snow (1978) Typology using the Dynamic Capabilities View Miles and Snow (1978) held that firms develop a systematic, identifiable approach to environmental adaptation. They develop stable set of processes undergirding the value chain demands of the environments in which they operate. Therefore, when the value chain demands shift, firms face difficulties. Sollosy (20131) re-examined Miles and Snow (1978) typology, and noted that Analyzers tend to have the ability to both develop new capabilities (explore) and improve existing capabilities (exploit). Firms that have the Analyzer capabilities are referred to as ambidextrous organizations (Tushman and O’Reilly’s, 1996). They develop a steady stream of new products-markets, while also finding creative ways to improve their processes. They engineer both radical as well as incremental innovations in their value chain processes, thereby generating a stream of value chains, each of which are being continuously improved. In contrast, the Defenders tend to have a narrow and focused emphasis on exploitation, directing their attention to a limited segment of the potential market that they can protect. They tend to sustain the growth of this limited portfolio by engineering a continuous stream of incremental innovations. Similarly, the Prospectors tend to have a narrow and focused emphasis on exploration, directing their attention on reputation for new product-market development. They continuously develop new products and markets, but are also quick to exit the older ones. Their exploration abilities allow them to engineer a constant stream of radical innovations. Finally, the Reactors lack ability to consistently pursue an explorative focus (the Prospector), an exploitive focus (the Defender), or a systematic combination of the two (the Analyzer). Because of an inappropriate response to their environments, the Reactors face a permanently declining performance. Lacking strategic direction and facing resource erosions, they are neither able to explore new opportunities nor exploit their existing capabilities. Custom Solutions Integrator Contemporary markets are referred to as knowledge economy. Firms are moving away from selling standardized and isolated products to depersonalized customers and are offering integrated solutions comprising of customized products and services. Designing customized solutions requires the integrated concurrent processes that mobilize all relevant complementary resources, in place of the traditional sequential processes of a value chain. Custom solutions help customers achieve improved performance and economics through integrated services, thereby generating customer loyaltye (Hax, 2002). To offer total solutions to their customers, the firms need to work with and integrate not only their own product-based value chains, but also the value chains of diverse partners. As illustrated in Exhibit 4.x, value should be co-created with different players, instead of being sequentially created by suppliers, firms, and their customers. Partner/ Supplier Customers Firm Partner/ Supplier Exhibit 4.x Custom Solution Integrators: Increasing the Customer Share Exhibit 4.x illustrates how the world’s largest copper firm learnt the need to be a Custom Solutions Integrator, after it faced a growing threat of substitutes. Exhibit 4.x The World Copper Leader Learns to be a Custom Solutions Integrator Codelco (Corporación del Cobre) the largest and most profitable copper company in the world that is owned and managed by the Chilean government. During the 1990s, their competitive advantage was grounded primarily in the excellent quality of their copper mining plants. Their business strategy was to invest in the most effective cost infrastructure so that they could retain the significant cost advantage over their competitors. They were so cost efficient that they had to employ only six sales people to market $3 billion of copper annually, and they still believed they could deliver even with just four. This was possible because their customers were giant metal traders, with whom they had long-term contracts and relationships. They had no connections with or deep understanding of how the customers used copper. As all the major copper firms were similarly disconnected from the real needs and problems of the customers, the copper industry faced a growing threat of substitutes, such as aluminum, steel, plastic and fiber optics. The aluminum industry in particular had been investing in technologies for successfully substituting copper in many applications, such as the radiator and chassis in the auto industry. Recognizing the folly of its business strategy based solely on gaining a low cost leadership position in the value chain, Codelco decided to identify and form direct connections with the most innovative and largest multinational industrial users of copper, like Alcatel, ABB, Electrolux, Carrier, General Electric and Siemens. Source: Adapted from Hax (2002) To manipulate customer economics, custom solution integrators may pursue three distinct business strategies – with varying or equal emphasis (Hax, 2002). Customer engagement: constantly innovate around the processes for segmenting their customers that reflect distinct priorities, and offer a differentiated treatment to each segment. For example: firms selling auto parts work intrinsically with auto assemblers to design, manufacture, and deliver parts that meet the particular specifications of each vehicle. Customer integration: have a deep understanding as well the ability to solve customer problems either by themselves or with complementing partners, thereby enabling the customers to have a superior experience. Customer shop: understand different products and services each customer needs and wants. Thus, their offer should include the entire gamut of products and services as a one-stop total service shop. For example: financial services firms offering the entire range of financial solutions to their customers. Exhibit 4.x illustrates a leading consumer products firm that applied the Custom Solutions Integrator approach to redefine its value strategy for not only to its customers, but also its customers’ customers – i.e. the end users. Exhibit 4.x Extending the Custom Solutions Integrator Approach to Customers’ Customers For its Asian Home and Personal Care business division, Unilever identified three tiers of channel partners and three tiers of consumers that these partners serve. It has then developed a targeted approach to addressing the needs of each tier using different tactics. This approach has helped Unilever de-average its customers, and to de-commoditize the products and services it offers. Three tiers of Channel Partners Unilever identified three tiers of channel partners. Tier 1 comprises of powerful global retailers, such as Wal-Mart and Carrefour, who wield huge power on the suppliers in their home markets and enjoy a tremendous advantage in the terms of bargaining. Tier 2 comprises of regional and local modern-trade retailers, such as chain stores, who are enthusiastic to carry top brands offered by leading companies such as Unilever to pull in their customers. Tier 3 comprises of independent small local retailers, wholesalers and drug stores, which are fragmented and given low priority by major corporations. For Tier 1, Unilever uses its knowledge of the Asian market and its technological capabilities to offer a personalized portfolio of products for each of the local stores of the big global retailers. This allows it to foster a compelling win-win position. For Tier 2, Unilever offers customized reports on the changing customer preferences, and on products that are likely to grow in particular markets. This allows it to lock in the channel partners by helping them establish business in new markets, and manage these businesses effectively. For Tier 3, Unilever is investing in information technology and people for building connections, so that it is able to offer them a better service experience and improve their viability. The tiered approach has helped Unilever maintain a productive relationship with the top global retailers, to enjoy a consistent growth in the tier 2 channels, and to accelerate its growth using the tier 3 channels. As tier 3 channel partners grow into the mainstream, Unilever is well-placed not to be caught off-guarded and excluded. Three Tiers of Customers’s Customers – the End Consumers Unilever has also identified three tiers of end consumers. Tier 1 comprises of the most affluent members of society, who are price insensitive and have sophisticated needs in terms of quality of time, health, physical appearance, and vitality. Tier 2 is the upward socially mobile middle class who aspires to a better standard of living. Tier 3 is the deprived group of consumers who seek to satisfy basic and essential needs. Unilever is seeking to connect directly with the Tier 1 customers through beauty consultants situated in luxury retail chains and salons. These consultants are fully trained in the range of products offered by Unilever, and in offering personalized need assessment and application service to the end consumers. For the Tier 2 customers, Unilever is offering a range of products under different brands that are each in sync with the diverse emerging values and needs of the customers, thereby reaffirming their emotional lock-in. For the Tier 3 customers, it is working on including the members of the deprived communities in its value chain. It is introducing new product lines that offer value for money, and that come in affordable smaller packages for single use. Source: Adapted from Hax (2002) Network Exchange System A third feature of contemporary markets is the role of inter-firm relationships and cooperative behaviors as an important source of value added service. The cost of collaboration has declined significantly as technology and globalization has reduced the transaction costs of doing business outside the boundaries of a firm. For instance, Intel must cultivate software developers who write applications that leverage the new processing capability, as well as hardware manufacturers who build systems that can accommodate the new chip. Close relationships with complementors encourage software developers to write applications to leverage the new chip capability. In Network Exchange Systems, the emphasis is on adding value through interconnectivity with partners and end-customers. The interconnectivity can at times even be with competitors; for example: when a telecom firm offers interconnections to the networks of other competing telecom firms; or with complementors, like an airline offering interconnections to the networks of hotels and tourist operators to enable travelers to make a single booking for their entire travel arrangements. Firms in a Network Exchange System are independent, yet cooperative relationships among them are critical. A notable example is Apple, who collaborates with Samsung for outsourcing some of the key components for its iphones, even as it is engaged in an acrimonious legal battle where it accuses Samsung of illegal and unauthorized use of its technologies in Samsung’s Galaxy smartphones. Customers also benefit from both explicit (such as social media platforms and applications like facebook and linkedin) and implicit (such as insurance firms that are able to offer lower premium protection by pooling risks across a larger network of customers) forms of exchanges. Firms in Network Exchange Systems recognize that they cannot be successful by keeping their technological capabilities to themselves. They need to make them more accessible to allow other firms to design and manufacture a stream of innovative parts, applications, and services in a cost efficient, timely, and customer-focused way. Network Exchange Systems therefore democratize value linkages and offer better opportunities to smaller firms. Thus, they support the Long Tail hypothesis, which states that if the customers have an enhanced choice, they will gravitate towards niches because they satisfy focused needs better. As a result, the sales of low demand and uncommon products and services will exceed those of the relatively few current bestsellers and blockbusters (Anderson, 20062). For example, more than half of Amazon’s book sales come from outside its top 130,000 titles, which other bookstores typically stock in their physical stores. Similarly, more than half of Rhapsody’s music streams per month are outside its top 10,000 songs. Anderson (2009)3 notes how the network-effects and exchanges created by low-cost flights, online travel information and social-media driven word of mouth, are creating a long tail in the travel industry, as tourists explore less traveled destinations.. To manipulate network economics, Network Exchange Systems may pursue three distinct business strategies – with greater emphasis on one or equal emphasis on all (Hax, 2002). Restricted channel: firms may develop exclusive relationships with complementors, thus restricting the ability of the competitors to offer effective solutions to the customers. This approach may not stand up to regulatory scrutiny, as it may have an unfair effect of hindering competition. A more effective approach is to build linkages with under-served and invisible channels. Wal-Mart, for instance, initially opened stores in isolated rural areas with 5,000 to 10,000 people – all rivals were ignoring these channels. Dominant exchange: firms may provide an interface for exchange between buyers and sellers, making it difficult for any other firm to break-in. Wal-Mart, for instance, during its formative years as a rural chain, created a dominant exchange by investing in UPC code scanner, in RFID and other technologies. These allowed vendors to know which products were in greater demand and needed shelf replenishment more frequently, thereby assuring customers that the products they need will be available in a rural setting where stores tend to stock fewer items and fewer quantities of each item. Thus, both vendors and customers were locked-in. Proprietary standard: firms may engage an extensive network of complementors to support their proprietary products, such as the app providers of Apple iphone. Value exchanges can be portrayed using a Value map of direct and indirect linkages among different participants (Peppard and Ryland, 2006). Exhibit 4.x illustrates how telecom operators have become Network exchange systems. Exhibit 4.x Telecom Operators Become Network Exchange Systems Traditionally, the large European and US mobile operators pursued “content ownership” or “content control” strategies, working with a small number of content owners and aggregators. However, because of the Long Tail, the stranglehold of the big content providers over operators and service providers is diminishing. The risks of Big hits strategy are increasing, and it is becoming more profitable to offer a wide variety of content from many different sources. The mobile operators are being challenged to shift their view of connection to customers as a ‘dumb pipe’ to a ‘smart pipe”, by brokering out their key assets such as search, personalization, and device management to content developers. Further, they are being challenged to design new value sharing arrangements with various exchange participants, in order to facilitate the flow of resources and knowledge throughout the network. Increasingly, network operators are not providing all content and services themselves. Some are being bundled from third-party providers, while customers are choosing their own providers for the others. Some of the content and service providers are conglomerate media organizations, others are smaller start-ups or aggregators. The walled-garden approach, where the network operators select specific providers to provide them with content and service, which they then integrate with their own network platform for delivery to the customers, is no longer viable. The customers want choice, variety, and control over the cost, ease, speed, and security of access to content and services. But the customers are also not interested in the complexity of the mobile systems and transmission network. To address customer needs, network operators form service level agreements with multiple third-party content and service providers, which allow them to secure more granular segmented content and service for various focused target markets. Network Exchange System for a Mobile Operator Source: Peppard & Ryland, 2006 1 Sollosy, M (2013). A Contemporary Examination Of The Miles And Snow Strategic Typology Through The Lenses Of Dynamic Capabilities And Ambidexterity. Unpublished Doctoral Dissertation. Coles College of Business, Kennesaw State University, Kennesaw, GA. 2 Anderson, C. (2006). The Long Tail: Why the Future of Business is Selling Less of More, New York, NY: Hyperion. 3 Anderson, C (October 2, 2009). “The Long Trail of Travel” Wired Blog Network, http://www.longtail.com.
Growth Strategy
Growth Strategy b Growth strategy of a firm is concerned with answering two questions: (a) what businesses should a firm participate in so as to maximize its long-run profitability? and (b) what strategies should the firm use to enter or exit those businesses? By following these strategies, the firm seeks to add shareholder value. In order to ad d valu e, a corporate strategy should enable a company, or o ne or more of its business units, to establish and/or sustain its competitive advantag e. Firms enter businesses either related or unrelated to their core or flag ship business, leading to related or unrelated diversification. Related diversification can als o take the shape of vertical integration, where the firm enters the businesses of its suppliers or it s customers, as it seeks to gain control over the supply and delivery systems. On the other hand, fi rms can enter businesses that are complementary to their businesses, but are not necessarily form s of vertical integration. Take the case of ICICI Bank entering the life insurance business through its subsidiary, ICICI Prudential Life Insurance. Here, the banking and financial services comp any (ICICI Bank) enters the life insurance business with an intention of leveraging its e xisting assets (including customer base) and competencies to its advantage in the life insurance business.* Growth Strategy b f b f b f b b b f b fb f b b b b b f b b b b f f *http://www.iciciprulife.com/ipru/about.jsp (accessed on July 11, 2004). Business Policy and Strategic Management: Concepts and Applications It is not uncommon to see firms entering businesses that are not related to their core business. For instance, the Ramco group in India with its dominance in c ement, fiber, cement- products, cotton yarn, software systems, and surgical systems, entered t he wind power business.* As firms continue their unrelated diversification, they may build a port folio of businesses and eventually evolve into a conglomerate, where the distinction between cor e business and allied businesses ceases to exist. For instance, the Tata Group ( www.tata.com) has interests in a variety of businesses, ranging from software, steel, automobiles, and tea to consulting services. It is hazardous to guess what the core business of the Tata group is! Having decided to enter a new business, firms also take multiple ways of developing their businesses—internal development, acquisitions, mergers, joint venture s, or strategic alliances. There are both advantages and disadvantages of these methods, and the ch oice of the method is dependent on a variety of firm and industry-level factors. In th is chap ter, we exp lore the differen ces b etween sing le-busin ess and multiple-business firms; p urposes, advantages, and disadvantages of vertical integration; why an d how do firms d iversify; and elucidate the valu e added through diversification. TYPOLOGY OF GROWTH STRATEGY A common typology of g rowth strategy is based on “specialization ratio” (th e firm’s sales within its major activity as a proportion o f its total sales) and “relatedness ratio” (the proportion of the firm’s total sales that are related to each other). This is s hown in Table 8.1. TABLE 8.1 Classification of Growth Strategy Type of company Specialisation Ratio Relatedness and Sub-Types (Share of major business in total revenue) Low 1. Single Business SR > 95% Companies 2. Vertically Integrated Vertically-related Companies sales > 70% 3. Dominant Business 95% < SR < 70% (3.1) “Dominant-constrained” Companies Majority of other businesses share linkages (3.2) “Dominant-linked” Majority of other businesses related to at least one other business (3.3) “Dominant-unrelated” Majority of other businesses unrelated 4. Related-Business SR < 70% (4.1) “Related-constrained Companies Majority of businesses share linkages (4.1) “Related-linked” Majority businesses linked to at least one other business 5. Unrelated-Business SR < 70% High Companies Source: Adapted from Rumelt (1974). Level of Diversification * http://www.blonnet.com/2003/11/28/stories/2003112802380200.htm (accessed on July 11, 2004). Chapter 8 Corporate Strategy Formulation Firm infrastructure Human Resource Management Technology Development Procurement Inbound Logistics Coerations Outbound Logistics Marketing and Sales Service Shared Logistics Shared Technology Development Shared Procurement Shared Marketing Functions Inbound Logistics Coerations Outbound Logistics Marketing and Sales Service Margin Margin Firm infrastructure Procurement Technology Development Human Resource Management Several studies show that during 1950s–1970s, the number of single bu siness companies fell, as diversification became the preferred form of growth, while the number of diversified firms increased. The percentage of both related and unrelated diversified firms increased dramatically over this period, as can be seen from the Table 8.2, which shows the largest companies in the US and the UK. TABLE 8.2 Ch anges in the Growth Strategy of the largest US an d UK firms durin g 1950s–1970s UK–largest 305 US–Fortune 500 firms manufacturing firms 1949 1974 1960 1975 Single business firm 42.0% 14.4%34.2% 12.5% Vertically integrated companies 12.8% 12.4% 2% 3.4% Dominant business companies 15.4% 10.2% 23.5% 21.6% Related business companies 25.7% 42.3% 32.0% 49.0% Unrelated business companies 4.1% 20.7% 7.4% 13.5% Total100% 100%100% 100% Source: Rumelt, R. (1982), Diversification strategy and profitability, Strategic Management Journal, 3: 359–370 and Jammine, A.P. (1984), Product diversification, inter national expansion and performance: a study of strategic risk management in U.K. Manufacturing, Ph.D. disser tation, London Business School. Research also shows that while the related diversified firms improved th eir performance, the unrelated diversified firms were unprofitable. During the 1980s, unrelat ed diversified firms in the US came under attack from leveraged buyouts, and were restructured a nd focused around fewer, related set of businesses, through sale of unrelated businesses. Proctor and Gamble (P&G) restructured during the 1980s to focus on bus inesses that had a high degree of relatedness ratio, i.e., sharing of physical resources an d market power, and Business Policy and Strategic Management: Concepts and Applications transfer and exchange of knowledge and learning. An example was the pape r towels business and the baby diapers business. Value chain analysis as shown above indic ated the extent of relatedness. Both these businesses shared procurement, in-bound logistic s, and technology development (both used paper, sourced from common vendors), as well as marketing functions (both were consumer products, marketed through common channels). Source: Porter, M.E. (1985), Competitive Advantage: Creating and sustaining superior performance , New York: Free Press. The restructuring trend diffused to the European companies in the 1990s, as the companies sought to refocus and mobilize resources from sale of unrelated businesses for a pan-European or internationalization strategy. After the East Asian crisis of 1997, many Asian companies have also become more conscious of the need for restructuring and achieving relate dness to be able to compete on a global scale. Consequently, a variety of corporate strategy patterns are becoming evident within each industry. Different companies within an industry may pursue different paths of corporate growth through diversification, based on diverse bases of r elatedness in their businesses. Thus, hospitals have gone into hotels, oil companies into fo od retailing, car companies into finance, and electric suppliers into telecom and other utilities ( see Exhibit). Hotels Catering Hospitals Managed Care Pharma industry Biotech Agro industry Nutraceuticals Consumer goods Supermarkets Car industry Car Fleet Management Transport services “Car bank” Bank All-finance Insurances Gas station shops Gasolin Food retailing Oil industry WaterMulti utility Electricity Telekom TV, Hifi Multimedia Software Computer Outsourcing IT-consulting b f The primary concern o f growth strategy in a sin gle business firm lies in answering a basic q uestion—is there value added? Most firms begin their operations as a single busin ess, usually fo r wan t of resources (financial, operating, or managerial) or capabilities. As firms grow, they seek to Source: Bruche, G. (2000), Corporate Strategy, Relatedness and Diversificatio n, Working Paper #13 of the Business Institute, Berlin. Chapter 8 Corporate Strategy Formulation expand their businesses. As a firm invests in building industry-specific capabilities, it seeks to secure its competitive advantage in that business. With its current resources and capabilities, the firm grows with the market, and adds significant value to its shareholders, customers, and employees. On the other hand, a significant market risk is associated with the focus on a single business. As the market grows and the firm continues to secure and sustain its competitive advantage, it continues to add value. But if either the market begins to shrink or the company begins to lose its competitive advantage (either due to changes in technology, customer preferences, new or improved product/service offers from competitors, or regulatory changes that disfavor the firm and its strategies), the firm ceases to add value. This market risk could have been hedged by investing in other businesses that would not be affected together with this particular business. Another disadvantage of a single-business is the extent and depth of relationships that the firm needs to maintain with its raw material suppliers, technology vendors, business partners, marketing channel partners (wholesalers, distributors, and retailers), and other such firms and agencies. What Single Business is Not! A large number of manufacturers in India operate in one dominant business related to some agriculture product. For instance, many companies are engaged in the primary processing of castor seed and oil. A growing number of firms have over the years sought to diversify, seeking opportunities for value addition. While the law makes it mandatory to provide segment results, most of these companies claim that they operate in a single business. For instance, Tata Motors, which operates in Heavy and Light Commercial Vehicles and passenger cars, claims that it operates in a single business segment. However, it discusses the environments of these markets separately in management discussion and analysis part of the annual report, suggesting that the market for these products is independent. A major reason is that the firms do not wish their competitors to find out about the performance of their individual businesses. Source: Narasimhan, M.S. and S. Vijayalakshmi (2004), The baggage of opaqueness, February 5, Business Line. When a corporation performs activities in multiple lines of business spanning more than one block of the industry value chain, it is considered vertically integrated. In an industry value chain, different firms could perform the various activities that add value to the consumer. This industry structure gives rise to various forms of transaction costs as each firm makes its profits, and builds in inefficiencies in the transfer of goods and services from one firm to another. Vertical integration is an attempt at reducing these transaction costs in delivering the final value to the end-consumers. Vertical integration helps an organization integrate its businesses efficiently so that output of one business feeds into the other. Vertical integration could be either backward integration—through coordinating upstream operations (operations closer to the sources of raw materials), or forward integration—through coordinating downstream operations (operations closer to the end-customers). Business Policy and Strategic Management: Concepts and Applications Before an organization decides to vertically integrate, it needs to answer the following questions. (a) Are our existing suppliers (or customers) meeting the needs of the end-customers? When specific skills and competencies are required to perform certain activities in the industry value chain that are not easy to learn/imitate/replicate, it would be better to have those set of activities performed by specialists. For instance, the shoe maker Nike has effectively used this strategy of outsourcing its production to units in South East Asia, and its logistics to Federal Express, while focusing on brand building and marketing. On the other hand, if ensuring the right quality of raw materials or providing the right products/service to one’s customers through a tight control of activities is important, integrating vertically might be necessary. Vertical integration into performing such critical activities of the businesses ensures that the firm is able to provide the requisite quality of products/services at appropriate prices. Sometimes, vertical integration may also significantly help in entering into that set of activities that provide high volumes or high margins in that business. For instance, in the Indian dairy business, the Gujarat Cooperative Milk Marketing Federation (GCMMF) is vertically integrated through promotion of cattle health, cattle feed, collection of milk from farmers, pasteurization, processing into milk powders, producing value added products including butter, cheese and ice cream, their distribution, and their marketing under the brand name ‘Amul’. In this industry, vertical integration helps GCMMF, a traditionally milk collection and processing firm, to enter into activities with significant value addition—manufacturing and marketing of milk products. (b) How volatile is the competitive situation? When the competitive environment is volatile, i.e., when competitors’ actions and counter- actions are not easily predictable, or when the technology in the industry is changing fast, or when the basis of competition in the industry is changing frequently, it is best to keep to one’s specialization, rather than commit one’s resources into activities that span the industry value chain. In such cases of volatile environments, flexibility is maintained by outsourcing, and consolidation, so that as things change, the firm could easily adapt to the new bases of competition and/or even exit the business easily if required. (c) Is it possible to influence the behavior of our upstream/downstream businesses? Many times a firm could significantly influence the activities of its suppliers and customers. For instance, a firm could enter into long-term relationships with its suppliers whereby their businesses become mutually interdependent. This mutual interdependence paves the way for a cooperative relationship where both the firms learn from each other, while maintaining market relationships using periodic renegotiation of the contracts. Control over supply and quality of critical inputs could be maintained through establishing such relationships with at least two significant suppliers, and similarly assurance of a minimum level of business could be built in the contract. In such conditions, it would be mutually beneficial for firms to invest in vendor Chapter 8 Corporate Strategy Formulation development and assuring the quality of the inputs/services, rather than getting into those activities themselves. (d) Will vertical integration enhance the structural position of the business? Vertical integration has the potential to take firms into such businesses that could have been traditionally wielding significant market power or the potential for high volumes or high margins. For example, the erstwhile Gramophone Company of India (GCI) integrated forward to distribution of music through the internet through their e-commerce website www.saregama.com in order to reap the high margins available in the distribution business, as well as capitalize on their large library of copyrighted music. Effective vertical integration may offer several benefits to a firm: (a)Build entry barriers:Verticalintegration could create entry barriers for new entrants (or existing competitors) by denying them either sources of supply of critical inputs, or access to significant customers. (b)Reduce transaction costs:Vertical integration could reduce transaction costs, such as buying and selling costs, inventory holding costs, and ordering costs. (c)Better control and coordination of operations:With vertical integration of critical activities either upstream or downstream, firms can have tighter control over the supply of critical inpurts, or the quality of products/services delivered. (d)Spread fixed and/or overhead costs over a large number of products/services:Vertical integration can help in apportioning fixed and/or overhead costs (like distribution costs, or branding and marketing expenses) over a large number of products and services. Vertical integration is not free of limitations. Many firms are forced to disintegrate vertically because they underestimated these limitations. The major limitations are as follows: (a) When the different lines of businesses operate with different minimum efficient scales, ‘balancing the line’ across the various businesses is difficult, and therefore ineffi- ciencies might creep in. When plants of minimum efficient scales create a situation where one of the lines in the business has a larger capacity than those of its customers, the excess production has to be sold in the market to its competitors, resulting in transaction costs that vertical integration was originally designed to avoid. (b) Vertical integration can force organizations to commit to particular technologies/ products, and risk losing their flexibility in times of technological obsolescence or changes in customers’ tastes and preferences. In order to remain competitive and up-to- date with the market, the vertically integrated corporation has a responsibility to be innovative and efficient at all the lines of businesses it operates in, in comparison to its tightly focused competitors in each of the lines of businesses. (c) Vertically integrated firms have to deal with the problem of integrating significantly Business Policy and Strategic Management: Concepts and Applications different lines of business into a coherent whole. Each of these lines of business could be faced with different critical success factors, and the internal organizing, structure, and cultures could be different across different business lines. For a vertically integrated firm to become truly integrated, it must manage these differences through a robust system of organizing, culture building, and performance management across all its business lines. The challenge can be daunting, as in the following case: Take, for example, the pharmaceutical industry, where conducting basic research involves managing scientists working in a collegiate culture; doing product development involves managing pharmacists and chemists working in an informal culture; manufacturing the drugs involves managing engineers and workers in a formal hierarchy; and marketing and distribution of the drugs involves managing logistics partners, and a field force of medical representatives selling the products to the physicians and retailers. Many firms, in order to balance the advantages and limitations of vertical integration follow a strategy of tapered or hybrid form of vertical integration (see Figure 8.1). As opposed to full vertical integration, a hybrid strategy allows the firm to integrate some elements fully, while depending on suppliers or customers for others. While helping the firm reap some of the benefits of vertical integration, this strategy also brings in the benefits of outsourcing to the firm— controlling some of the bureaucratic costs of running an organization. Bureaucratic costs that outsourcing controls include the lack of insiders’ incentive to learn and reduce their operating costs, and the lack of strategic flexibility for the firm in times of changing technology or uncertain market demand. Hybrid or tapered vertical integration helps balance the reduction in transaction costs and bureaucratic costs through keeping the internal suppliers ‘on their toes’, as they are constantly benchmarked against their more focused external counterparts. A similar pressure is exerted on the suppliers, as they are also aware that the firm has a potential to fully integrate, and they could Chapter 8 Corporate Strategy Formulation b lose their business if they are not competitive. This constant pressure on both sides to remain competitive could significantly accentuate the significant benefits of v ertical integration, viz., elimination of transaction costs, and ensuring control over critical sup pliers and customers. The public transportation and electricity distribution services in Mumba i are carried out by BEST Undertaking— the Brihanmumbai Electric Supply and Transport Undertaking.* The operation wing of the transportation engineering department of BEST consists of 25 bus depots spread over the areas of greater Mumbai. All the depots carry out various maintenanc e functions, including preventive maintenance, unit replacement, and body damage repairs of bus es. They also stock various units, important chassis/bus components. BEST faces higher in-ho use labor cost; therefore it gives many jobs, such as body building, body repairs, tyre re-treading, tyre cut repairs and reclaimation of spares, to outside contractors. This allows it to have benchmarks to control internal costs, and to gain learning about the alternative appro aches and best practices. b f The corporate diversification is driven by an assumption that good managers would be able to manage any business irrespective of the product/service, and that multip le businesses would balance cash flows of the corporate. In the case of related diversificat ions, where the output or processes of one business would feed into one or more businesses, the di versified corporation would look for synergies across different businesses. ‘A fundamental role of diversification is for corporate managers to create value for shareholders in ways sharehol ders cannot do better for themselves.’ (Lubatkin, 1998). It could be argued that sharehol ders do not need corporate managers to create value through diversification; instead, they could cr eate a portfolio of stocks to ensure balanced cash flows. Therefore, a diversification that does not c reate a value greater than a shareholder’s portfolio would ideally not be justified. This value ad dition would be possible only when diversification results in either the improvement in the core proce sses, or in enhancing the structural position of the business leading to significant competitive a dvantage. For instance, with their highly qualified pool of managers (like the Tata Administrative S ervices) and state-of-the-art business practices (the Tata Excellence Business Model), business hous es like the Tatas are able to add significant value to the variety of businesses they are in. A significant feature of competition is as follows—‘competition occurs at the business unit level, and not at the corporate level.’ A successful g rowth strategy should appreciate th is fact, and facilitate and reinforce the comp etitive strategies of individ ual business units. The nature o f competitive strategies for each of the business units co uld vary depending on the specific indu stry context of th ose businesses, and th e corporate strategy sho uld be able to provide adequate emphasis on the comp etitive success o f each of th e business units. Diversification results in the increase in costs of coordination, planni ng, of building the corporate brand/image along with the product/business unit image, and of alignment of financial reporting and personnel policies with the existing corporate systems of the firm. Therefore, diversification cannot succeed unless it provides for significant value addition: (a) to business units by reinforcing and complementing their competitive strategies, and providing for tangible benefits to the business units in return to their loss of independence; and (b) to shareholders by providing them the portfolio of business that they could not replicate i n the capital market. *http://www.bestundertaking.com/trans_engg.asp#OrganisationalSetup , (Accessed June 20, 2005). Business Policy and Strategic Management: Concepts and Applications As an organization decides to diversify, there are three means available to them—mergers/ acquisitions, strategic alliances/joint ventures, and internal development. Mergers and Acquisitions Merger and acquisition refer to the outright purchase of a company already in operation by another company, where there is only one company existing after the transaction. Acquisitions are the quickest way to diversify into a new business, as managers get to buy established brands, production facilities, trained and experienced employees, and distribution channels in one deal. Take for example the acquisition of Qutub Hotel (earlier an ITDC property) by the Indian writing instruments market leader, Luxor Writing Instruments Private Limited. With this acquisition and more to follow, Luxor intends to diversify into hotels and other related businesses.* Such acquisitions of existing firms help acquiring companies readily gain access to cash flows immediately, as compensation to the cost paid for the acquisition. Strategic Alliances and Joint Ventures Strategic alliances refer to agreements between companies to form collaborative arrangements and partnerships. When a new legal entity is created in a strategic alliance, the partnership is called a joint venture. Strategic alliances/joint ventures are entered into when firms see complementarities amongst their competences. Collaborative synergies are the dominant basis for firms entering into strategic alliances or joint ventures. For example, Indian diversified business group TATA has entered into a joint venture with American International Group Inc. (AIG), the leading US based international insurance and financial services organization and largest underwriter of commercial and industrial insurance in America, to form a new entity called TATA-AIG Life Insurance Company. † It represents the trust and integrity of TATA Group combined with the international expertise and financial strength of AIG Inc. ‡ Internal Development Internal development occurs when firms diversify into other businesses through a process of developing their own skills and resources, and making fresh investments into creating the appropriate manufacturing and/or marketing infrastructure. Companies like Reliance Industries Limited (www.ril.com) have grown into a variety of businesses through internal development of greenfield ventures, and internally building the requisite skills and competencies for managing those businesses. *http://www.blonnet.com/catalyst/2002/12/19/stories/2002121900140300.htm (accessed on July 11, 2004). †http://www.tata.com/tata_aig_life/ (accessed on July 11, 2004). ‡http://www.tata-aig.com (accessed on July 11, 2004). Chapter 8 Corporate Strategy Formulation b b f There are three forms of diversification—vertical, horizontal, and ge ographic. When firms diversify across the value chain, either forward or backward, it is know n as vertical diversifi- cation. When firms diversify into business that complement their existin g business(es), it is known as horizontal diversification. When firms expand their existing products /services to other geographic areas, it is referred to as geographic diversification. Take for instance, the diversification of NTPC in areas related to their core business of power generation, including hydro power, power distribution, trading, coal min ing, LNG etc. Through a series of acquisitions and joint ventures, NTPC has forayed into busin esses both backward and forward of power generation, as well as horizontal into hydro power (from their core business of thermal power), as well as its international operations in countries including Bangladesh and Oman.* Table 8.3 describes, with examples, the three means and modes of diversi fication. Firms can either diversify vertically, horizontally, or geographically (into new markets). The means of diversification could be either through acquisitions and mergers, strate gic alliances and joint ventures, or through internal development. Vertical HorizontalGeographic Acquisitions Strategic alliances Internal development Dr. Reddy’s Laboratories has grown through acquiring their raw material suppliers. State Bank of India entered credit card business, through a JV with GE Capital. 2 Reliance Industries has significantly backward integrated through greenfield ventures. Sterlite group has grown over different businesses through acquisitions like BALCO, and HZL. 1 Tata group’s alliance with AIG for Tata-AIG insurance. 3 GAIL India Limited’s diversification into petrochemicals and telecommunication businesses. Ranbaxy is expanding into the US market through a series of acquisitions. Maruti Suzuki as a route for Suzuki to enter the Indian automobile market. Auto majors like Ford and Hyundai invested in India through their own manufacturing facilities. TABLE 8.3 Means and modes of diversification f When a firm decides to diversify, it could decide to diversify either in business related to its existing lines of businesses, or in businesses that are unrelated to its existing businesses. Related diversification presents opportunities for a firm to levarage th e assets, capabilities, and strengths in another business, in a manner such that more value woul d be generated with both 1. http://www.frontlineonnet.com/fl1806/18060320.htm (accessed on July 11, 2004). 2. http://careers.gecapitalindia.com/careers/businesses/sbi.htm (accessed on July 11, 2004). 3. http://www.tata-aig.com (accessed on July 11, 2004). *http://www.ntpc.co.in/aboutus/jointventures.shtml (accessed on July 11, 2004). Business Policy and Strategic Management: Concepts and Applications businesses being part of the same firm, rather than as different firms. For example, it would add significant value to a steel company to enter into iron ore mining, as long as the critical capabilities required in steel manufacturing (such as scheduling and logistics) could be leveraged in their iron ore mining business as well. It is also possible for related diversification to add value through leveraging complementary capabilities across the businesses. For example, airline firms would largely benefit from diversification into resorts and hotels in tourist destinations, as both the businesses would share similar customers, and they could leverage each others’ specialized capabilities. Related diversification adds value through: 1. Transferring skills, expertise, and capabilities from one business to another: Firms can leverage their capabilities across different businesses to reduce costs, enhance value-added, enlarge the market, or enhance customer satisfaction. 2. Combining the value chains:Firms can significantly lower costs and increase efficiencies by combining the value chains of multiple businesses (such as manufactur- ing multiple products in the same manufacturing plant; using the same logistics — warehousing and transportation, across multiple products; and marketing and selling multiple products and services through the same sales force and channels.) 3. Leveraging strong brand names:Firms could leverage their existing strong brand names across multiple businesses to help achieve significant market share and customer loyalty. For instance, the Indian telecom major Bharti Televentures Ltd. (www.bharti.com), now leverages their leading brand name “AirTel” (that was originally their brand name for mobile services) across all its other telecom businesses, that include fixed-line services, broadband and internet services, and enterprise voice and data solutions. 4. Creating stronger capabilities:Firms can create stronger competitive capabilities by combining the relative strengths of multiple businesses. For instance, Hindustan Lever Limited (www.hll.com) leverages its strong distribution network that was built for FMCG products to distribute their ice-cream brand “Kwality Wall’s”. This combines the brand strength of Kwality Wall’s with the distribution muscle of Hindustan Lever Limited (HLL) to create a competitive capability difficult for competitors to imitate. For related diversification to add value, firms need to exploit economies of scope across businesses. Economies of scope are costs savings or efficiency improvements that are attributed to transferring the capabilities from one or more businesses to another. Such economies of scope can exist at the operational level through sharing of activities (in research and development, manufacturing, and distribution and logistics); or at the corporate level through transfer of core capabilities (such as know-how, market power, financial resources, and project management capabilities); or both. For instance, firms like HLL might share packaging and distribution facilities for all its food products, as well as leverage their corporate brand management skills and marketing resources across multiple brands. Unrelated diversification adds value to firms through ensuring consistently good financial returns, with little or no opportunity to integrate and synergize across businesses. Unrelated diversification is adopted when the senior management of the firm believes in their managerial capability to seek and exploit a growth and earnings opportunity in any industry. For example, firms like the Tata Sons in India (www.tata.com) have diversified into a variety of industries, under a common corporate umbrella. Chapter 8 Corporate Strategy Formulation The criteria for choosing unrelated industries to diversify typically include: (a) growth and earnings potential; (b) contribution to the corporate’s top-line and bottom-line growth; (c) attractiveness of the industry in terms of sustainable growth and earnings, competitive pressures, regulatory changes, and capital requirement; and (d) the cost of entering the business (either the cost of setting up a new business, or the cost of acquisition of an existing firm). Quite often, unrelated diversification is pursued through acquisition of existing firms, rather than setting up new firms in unrelated business. Typically, soft acquisition targets are those firms (a) with investment constraints (including cash-shortages) in a high growth industry, (b) that are significantly undervalued and could be acquired at low acquisition premiums, and (c) that are sick/struggling and could be turned around by the acquiring firms with their managerial capabilities and financial resources. Unrelated diversification adds value through: 1. Spreading business risk across multiple businesses:The financial and business risk of the corporate is spread across industries, markets, and consumers who are relatively distinct from each other. This largely helps when the firms is active in industries that are volatile and fast-changing. 2. Optimization of financial investments:The corporates can prioritize and optimize their financial investments across multiple businesses, including diverting cash flows from cash-rich businesses to investment-hungry businesses (see the next section on portfolio techniques for more details). 3. Exploiting corporate resources and management capabilities:The financial resources and managerial capabilities of the corporate top management can be effectively leveraged across multiple businesses, to enhance shareholder wealth. Unrelated diversification adds value only when at least one of the above three conditions are fulfilled. Unrelated diversification works under the assumption that the senior managers in the firm possess the capabilities to manage a diverse set of businesses. Quite often, there is a need for specialized managerial skills for specific industries (especially those in high-growth or volatile businesses such as chemicals, pharmaceuticals, high technology, or knowledge-based industries). In such cases, the corporate office (senior mangager) might not be quite capable of evaluating the growth opportunities, investment requirements, or earnings potentials in specialized industries, and their decisions might be counter-productive. Portfolio techniques refer to the set of tools used by a multi-business firm to assess, monitor, and evaluate the performance and contribution of its various businesses to its corporate goals and objectives. Bourgeois III, L.J. (1988) summarized the methodology of portfolio planning as follows: Identify separate business units [(divisions, departments, or strategic business units (SBUs)] that correspond to markets or industries that the company serves. Classify the various SBUs on a two-dimensional grid based on competitive position and market potential. Assign to each SBU a strategic mission—growth, maintain the position, harvest the market, or divest, depending on their position on the grid. Based on these strategic missions, allocate resources to each of the SBUs. b Business Policy and Strategic Management: Concepts and Applications called stars. They operate in high profitability, with high potential fo r cash generation. These businesses need a lot of cash to be put back into the business to mainta in their dominant position in the market. Businesses with high market shares in low growth markets are called cash cows. They have a high potential for generating cash with very little new investment in assets; or in other words, they require much lesser cash to be invested back into their businesses. The proper strategy is to generate cash out of the cash cows for investing in other businesses. Businesses with low market shares in low growth businesses are called do gs. Their low market shares indicate that they do not have a high potential to generat e cash, although they do not need any cash to be invested to stay in the business. But, there is also very little opportunity to alter the market share relationships, even if large amount of cash is invested in the business. Businesses with low market shares in high growth businesses are known as question marks. The business has low potential to generate cash, whereas the cash demand s to stay in the business are very high. The company should either invest heavily in this business to ensure that a dominant market position is achieved (become stars), or get out to avo id becoming dogs as the market matures and the market growth rate slows down. The major shortcoming in the BCG approach is that it forces managers to treat each of the businesses as independent businesses with no relationship at all amongst them, which is rarely so. Multiple businesses might share a manufacturing facility, distributi on system, or even brand names, so such a segmented approach would not work. The second shortcomi ng is that the BCG approach depends on just two factors—market shares, and market growth potential. There is a danger of managers taking huge financial decisions based on just two fac tors. b The BCG approach is based on the experience curve effect. The experience curve effect holds that a firm should seek a dominant market position in a business. If the firm does not have a dominant market position, it should either seek a dominant position or e xit that business. Having attained a dominant position, the emphasis should be on retaining that p osition. As shown in Figure 8.2, businesses with high market shares in high growt h markets are b f b f f !f ” # fb ” # $ % b b &’f b b ( b f fb) b * + , ,bf – b b . $ b bf b