Corporate Advantage[1]
The test of a good corporate diversification strategy is called corporate advantage. It is a multi-dimensional test appropriate for evaluating multi-business strategy that is analogous to the tests of competitive advantage that are used to evaluate the strategy of a single line of business.(Within any particular line ofbusiness,a successful competitive strategy strives to attain competitive advantage – which is evaluated relative to the success of other firms’ business units that are serving the same customers in the same competitive marketplace.)An effective competitive strategy takes offensive (or defensive) action against profit-eroding industry forces before competitors can pre-empt the firm from influencing the balance of competitive forces to its advantage. In brief, the successful competitor makes superior choices concerning how to serve its customers that sustains their willingness to pay for the business unit’s unique products over time.
Corporate strategypertains to the firm’s choices concerning the composition of its corporate family and how it supports members’ respective efforts to implement their competitive strategies (or not). Superior corporate strategy yields superior corporate performance. The firm that has superior corporate performance enjoys a higher market valuation if it is publicly-traded(which enables the corporation to have better access to the resources that will be needed for organizational renewal). For the purposes of this discussion, corporate advantage is treated as a relative rather than absolute condition.The efficacy of a particular diversified firm’s corporate strategy is judged relative to the successes enjoyed by other diversified firms (since the firm vies for capital against all other firms and alternative forms of investment opportunities).
Diversification describes the relatedness of a firm’s corporate family members to each other. When a firm invests its profits in the same line of business that produced them – even if it funds expansion in the same line of business in a new geography – the resulting family members are horizontally-related to each other (because they engage in the same activities). When a firm invests its profits in lines of business that supply goods or services to the business unit that produced the profits, the resulting family members are vertically-related to each other (because they have a supplier-buyer relationship to each otherwhereby the cash-generating business unit is customer to the upstream, sister business unit that is its supplier). Vertical diversification can also pertain to investments in a business unit that consumes, distributes or adds value to goods and services made by its supplying, sister business unit. Corporate family members also have supplier-buyer relationships to each other in such diversifications (although the respective roles have changed between the cash-generating business, which becomes the supplier, and its customer which is the downstream, sister business unit).
Vertical diversifications are analyzed with respect to a particular, core business unit within the corporate family which is presumed to make especially good use of the family‘s extant corporate resources in attaining its respective competitive success. Upstream diversifications (investments in supplying activities) build more heavily on commonalities in technologies sharedamong corporate family members. Downstream diversifications (investments in consuming, distributing or value-adding activities) exploitcommonalities in customer knowledgeshared among corporate family membersmore heavily.
Even where corporate family-member business units have no supplier-buyer relationships among them, similarities in the success requirements of competing within theirrespective marketplaces determine the business units’relatedness to each other.Closely-related business units frequently use common resources provided by their corporate family to enhance their respective competitiveness. Although each respective business unit possesses its own set of unique, competitive resources that create competitiveadvantage in its respective marketplace, access to the corporate resources that become available through membership in a superior corporate family may give the business unit an inimitable corporateadvantage that competitors from inferior corporate families cannot match.
In summary, corporateadvantage is the construct that measures the optimality of the firm’s diversification (its corporate strategy). Evaluation of a firm’s geographic diversification (or diversification into industries of varying relatedness to each other) uses several tests to determine its overall level of corporate advantage.
Strict Test of Corporate Advantage
The corporate advantage model assumes that corporate value is created by the choices that headquarters managers make. In the Corporate Growth & Organizational Development course, the strict test of attaining corporate advantage specifies that this condition of advantage is attained when (1) a multi-business firm’s headquarters managers createcorporatevalue from the membership of each business unit in the corporation,(2) the benefit suchcorporatevaluecreates exceeds the cost of corporate overhead incurred in doing so (including the cost of headquarters staff who may coordinate certain intrafirm activities, or not), (3) the corporate parentunder analysis adds more valueto its corporate family members than any other potential corporate parent could offer (or vice versa), and (4) thecorporate valuethat the family under analysis adds in its particular enterprise form is greater than any alternative corporate form of enterprise could add to its family members.
Headquarters decisions concerning diversification are presumed to create value. Investments in corporate resources used by corporate family members are presumed to create value. The organizational infrastructure created -- and headquarters activities undertaken to implement a firm’s corporate strategy -- are presumed to create value. These investments are the active drivers of the corporation’s strategy. If they are effective, the interactions of these drivers create conditions that enhance the realization of corporate advantage through the astute exploitation of resource renewals and operating synergies that further strengthen the corporate family’s competitive advantage in their respective lines of business.
Dimensions of Corporate Strategy
As Figure 1 illustrates, the corporate advantage paradigm is driven by three corporate strategy choices–(1) industries, (2) resources and(3)organizational structure, systems and policies [OSSP] --that affect three moderating corporate choicesregarding how to use, control and coordinate the family’s corporate resources to enhance corporate performance. Effective choices among these six dimensions will produce three desirableoutcomes [enhanced operating synergies, robustresource renewal and sustainable competitive advantages] that create corporate advantage in a particular firm’s diversification. Analysis of the dimensions of a firm’s corporate strategy considers the efficacy of each respective driverdimension in its own right [resources, industries and organizational structure, systems and processes] as well as in light of how that particular driver dimension interacts with the adjacent moderating dimensions [controls, coordination and competitive advantage] to produce the outcomes that contribute to the family’s corporate advantage [enhanced operating synergies, robustresource renewal and sustainable competitive advantages].
In order to assess whether a particular firm has attained relatively high corporate advantage, it is useful to consider how the corporate family fares vis-à-vis certain acid tests that evaluate the efficacy of each respective corporate strategy dimension. Remember that driver strategy dimensions interactwith each other to affect the moderating strategy dimensions; some managerial choices affect both driver and moderating dimensions.It is possible to give each driver strategy dimension a score between 00 and 100 – with higher scores awarded when the driver strategy dimension that interacts favorably with moderating dimensionsto contribute favorably to the desirable outcomes of sustainable competitive advantage, enhanced operating synergy and robust resource renewal.
If the six scores are posted along the respective scaled lines on the shape shown in Figure 2 and connected by lines between each scale to form the planes of a hexagon, a visual evaluation of the firm’s corporate strategy is created. Strategies that most closely approach optimal corporate advantage will be depicted as balanced and large (since the values of many of their driver and moderating dimensions will approach 99). Inferior corporate strategies will be depicted as unbalanced and smaller (since the values of many of their driver and moderating dimensions will be below average). The corporate strategy shape can function as a diagnostic tool that suggests which dimensions of a firm’s strategy should be strengthened to improve implementation of the management’s strategic vision by increasing balance among the dimensions.
Drivers of Corporate Strategy
Acid test of valuable business scope –choice of industries to compete in and nature of linkages between its lines of business: This dimension considers the relatedness pattern of a corporate family’s members and the attractiveness of the family of businesses that the firm has invested in. Is each line of business competing in an attractive industry?[2] If the industry is deemed attractive, is the business unit enjoying market leadership or is it merely being buoyed up by the high average returns of an inherently attractive industry? (Even if an industry is deemed relatively “unattractive” by the Porter 5-Forces analysis, the firm’s particular business unit could be enjoying above normal profits if it pursues an effective competitive strategy.) Although Figure 3 is a good starting
point for assessing industry attractiveness, analysis of overall demand traits is also important. Is demand growing (or saturated) in the markets where the firm’s businesses compete? Which exogenous forces are likely to change customers’ requirements within them (thereby forcing competitive shifts in the firm’s businesses? Which competitive dynamics are likely to harm industry attractiveness? Is there growing demand for complementary products that could revitalize demand for the products of the firm’s business units? Evaluation of this aspect of the businesses dimension is difficult because attractive industries may be characterized as those with double-digit demand growthor those with industry structures that foster high average profitability or those with a favorable regulatory environment or those having other criteria that please the providers of capital (or some combination of these attractive traits). That is why stock market prices alone are inadequate measures of a successful corporate strategy.A dynamic assessment (that considers the future sustainability of favorable industry traits) is needed to score the businesses dimension effectively.
Evaluation of the businesses dimension of the corporate strategy paradigm can be weighted by the proportion of total investment that each line of business represents (measured by revenues generated, profits generated, capital deployed, or any salient metric that accurately represents the firm’s mix of businesses). Closely-related lines of business may be weighted more heavily in scoring this dimension if their respective success requirements are similar enough to warrant sharing corporate resources among them (or transferring salient knowledge among a cluster of related business units). It may not be necessary to analyze the smaller lines of business if they share no corporate resources with sister business units and contribute only proportionate revenues and profits. The moderating dimension of competitive advantage(for salient business units) draws upon the strength of their inherently-attractive industries as well as the extra competitive boost that business units gain by using their family’s corporate resources (discussed below).
Evaluation of the businesses dimension of the corporate strategy paradigmconsiders linkagesamong the firm’s family of businesses (or lack thereof). When evaluating acquisitions with respect to the businesses dimension, each industry’s success requirements should be matched with the corporate resources that headquarters controls to assess valuable parenting potential. What value can this firm bring to aparticular business unit that is a member of (or is joining)its corporate family (and how should headquarters intervene in the autonomy of each business unit to create such corporate value)?Greater interactions among related business units can be encouraged by the firm’s corporate system of controls (discussed below) and should be enhanced where positive synergies result. Unfortunately, many firms impose heavy-handed corporate controls in situations where greater competitive autonomy is warranted.
Acid test of valuable resources: The corporate parent possesses resources that it makes available to appropriate business units to enhance their respective competitive advantage. Corporate resources are likely to be intangibles – patents, brand names, corporate logos and trademarks, distribution systems that can be used by several lines of business, databases and information system infrastructures, or other valuable resources that are meaningfully unique from those controlled by other corporate parents.
The lines of business within a corporate family will each have their own resources that are idiosyncratic to their respective industry success requirements and not used by other members of their corporate family. (If two or more lines of business rely on the same valuable resources for success in their respective marketplaces, those resources either were provided by their corporate parent or have been elevated by their parent for use by sister businesses -- in addition to the specific line of business that first developed the valuable resource and contributed its use to the corporate family. Some valuable resources are corporate; most resources belong to the lines of business.) It is important to distinguish between these two levels of resources; if the resources that are most important to competitive success are owned by the respective lines of business and the use of the parent’s corporate resources adds little incremental advantage to a business unit’s strategic posture, then that parent’s corporate resources are not particularly important and the corporate parent adds little of value to the members of its family.
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Corporate resources can be evaluated using the same tests that are used to evaluate the resources of a particular line of business:[3]uniqueness, durability and value that will increase customers’ willingness to pay premiums for the firm’s products and services, among others.Good corporate resources accrue valuablerents that the corporate family appropriates (instead of its individual employees). Corporate resources also create high desirability and are competitively superior to those of other corporate parents.
The resources dimension of the corporate advantage model is enhanced when the firm exploits corporate resources that could be shared with business units. Headquarters identifies and nurtures the critical resources that the corporate parent manages (which may be corporate-level competencies, capabilities, knowledge workers or other resources that are distinctive in ways that contribute positively to the competitive advantages of the firm’s lines of business). As long as the value of the firm’s corporate resources are enhanced -- not destroyed -- by the way in which lines of business use them, corporate advantage is enhanced. (If interactionsamong the firm’s lines of business generate positive spillovers in the benefits of using corporate resources, the firm possesses the potential to enhance operating synergies -- assuming that the right controls are applied to guide business units to work together.)
Acid test of optimal management systems: The firm implements its corporate strategy through the managerial systems and organizational processes that it establishes -- its organizational structure and lines of communication, size and role of corporate staff, nature of performance measures and feedback, use of performance incentives, opportunities for managerial training or promotion or rotation among lines of business, uses of symbolism in developing corporate culture, and other dimensions of organizational design. Organizational structure, management systems and decision-making processes should be appropriate for the type of corporate strategy that the firm is pursuing (e.g., synergistic conglomerate, passive holding company, organic growth via innovation, collecting rents via franchising, joint venture, corporate venture capital to enhance internal entrepreneurship, or other some other type of relatedness and coordination among the firm’s lines of business). To evaluate the efficacy of the firm’s choices of structures, systems and processes,it is necessary toanalyze the role of the corporate officein creating value to corporation. Intervention byheadquarters in the autonomy of its businesses could enhance synergies within/ across the firm’s industry and geographic groups (or destroy it).
Moderating Dimensions of Corporate Strategy
Acid test of appropriate coordination activities: Corporate-level management designs appropriate systems, evaluation procedures, structures and reporting linkages as needed to leverage resources across germane products, markets, technologies, geographiesto exploit potential relatedness among its lines of business. Every organizational arrangement, practice, and intervention of the corporate office into activities of business units should create greater value than if the business units were allowed to operate independently without corporate coordination.
Typically the corporate office encourages coordination among business units (to exploit potential synergies and create future corporate resources). Even in the absence of opportunities to exploit operating synergies and build new corporate resources, headquarters typically acts as central provider of scarce resources (e.g., advantageous access to capital or talent or other necessary items that the parent can acquire more cheaply than each of its business units can do individually) to avoid wasteful redundancies. Oversight is exercised when headquartersuses its control mechanisms to intervene in a particular business unit’s decisions (e.g., refusing a capital request, asking for inventory reduction, proposing new strategic moves, or other centrally-directed change in operations).
Acid test of competitive advantage: Competitive advantage is a moderating dimension in the evaluation of corporate strategy that can be positively affected by the interaction of the corporation’s choices of lines of businesses and which corporate resources to develop, nurture and replenish for the benefit of the corporation’s family members. Multi-business firms contribute positively to the competitive advantage of their attractive lines of business when they contribute superior corporate resources in ways that are more effective than any other corporate parent could do. Although their business units are already configured to perform activities that are unique to create products and services that constitute high “added value” to their customers, a good corporate strategy enhances their respective competitiveness because theuse of the corporation’s resources byits lines of business gives each of their strategic postures a boost that makes a palpable difference in their perceived distinctiveness in each marketplace where they participate.