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Module 8

Strategic Analysis of Diversified Companies

Module Outline

• Identifying Present Corporate Strategy

• Matrix Techniques for Evaluating Diversified Portfolios

• Comparing Industry Attractiveness

• Comparing Business Unit Strength

• Comparing Business Unit Performance

• Strategic Fit Analysis

• Ranking Business Unit on Investment Priority

• Crafting a Corporate Strategy

• Guideline for Managing Corporate Strategy Formation Process

Building Shareholder Value

Three questions to be addressed:

1. How attractiveness is group of business firm is in?

2. How good is overall performance outlook over next 5 years?

3. If previous 2 answers are not satisfactory, what should firm do to

• Get out of some businesses,

• Strengthen positions of remaining ones, and

• Acquire new businesses to boost prospects for better performance?

How to Evaluate a Diversified Company’s Strategy

Step 1:

Step 2:

Step 3:

Step 4:

Step 5:

Identify present corporate strategy Use business portfolio matrixes to analyze firm’s business portfolio Compare long-term attractiveness of each industry firm has diversified into Compare competitive strength of firm’s business unit Rate performance units on basis of historical performance and future prospects

How to Evaluate a Diversified Company’s Strategy

Step 6:

Step 7:

Step 8:

Assess each business unit’s compatibility with corporate strategy and determine value of strategic fit relationships Rank business units in terms of priority for new capital investment and decide on general strategic posture Decide if new strategic moves are needed to improve overall performance

Step 1: Identifying Present Corporate Strategy

• Extent to which fir is diversified

• Whether portfolio is keyed to related or unrelated diversification or both

• Whether scope of operations is mostly domestic or increasingly global

• Nature of recent moves to boost performance of key business units

Step 1: Identifying Present Corporate Strategy

• Moves to add new businesses and build positions in new industries

• Moves to divest weak / unattractive businesses

• Moves to pursue strategic fit benefits and use diversification to create competitive advantage

• Capital expenditures for each different business unit

Step 2: Drawing Business Portfolio Matrixes

Basic Concept

• A 2-dimensional graphical display of comparative strategic positions of different businesses

• Strategically relevant variables used in matrixes

– Industry growth rate

– Market share

– Long-term industry attractiveness

– Competitive strength

– Stage of product / market evolution

Types of Business Portfolio Matrixes

1. Four-Cell Growth-Share Matrix

2. Industry Attractiveness-Business Strength Matrix

3. Industry Life Cycle Matrix

The BCG Growth-Share Business Portfolio Matrix

Relative Market Share Position

HIGH

LOW

HIGH

LOW

Stars

Stars Question Marks Cash Cow Dog

Question Marks

Stars Question Marks Cash Cow Dog
Stars Question Marks Cash Cow Dog

Cash Cow

Stars Question Marks Cash Cow Dog

Dog

BCG Growth-Share Matrix

Two variables used:

1. Industry Growth Rate

• Plotted on vertical axis

2. Relative Market Share

• Plotted on horizontal axis

Constructing a BCG Growth-Share Matrix

Industry Growth Rate

– “High growth” businesses are in industries growing faster than economic – “Low growth” businesses are in industries growing slower than economy

Constructing a BCG Growth-Share Matrix

• Relative Market Share

– Calculated by dividing firm’s market share by market share of firm’s largest rival

– “Typical” dividing line between “high” and “low” relative market share businesses placed at .75 or .8

– Businesses on left are market share leaders

– Businesses on right are in below-average relative market share positions

• Each business is a “bubble” with size scaled to portions of total corporate revenues generated

Question Marks / Problem Children / Cash Hogs

Basic Concept Internal cash flows are inadequate to fund needs for working capital and new capital investment

• Operate in a high growth market but have low relative market share – Upper right cell of matrix

• Rapid industry market growth makes businesses attractive, but low relative share positions raise questions about future potential

• Cash needs are high and internal cash generation is low, making them cash hogs

Question Marks / Problem Children / Cash Hogs

Strategy Prescriptions • Aggressive invest-and-expand strategy

– Most attractive question marks

• Divestiture

– Weak question marks

Stars

Basic Concept Star Businesses

• Have strong competitive positions in rapidly growing industries • Are major contributors to corporate revenue and profit growth

• May or may not be cash hogs

Stars

• Market leaders situated in high growth market with high relative market share – Upper left cell of matrix

• Offer excellent growth opportunities

• Offer excellent profit opportunities • Vary as to whether they are

– Self-sustaining, or – Require infusions of investment funds from corporate parent

Cash Cows

• Situated in low growth market but have high relative market share – Lower left cell of matrix

• Can generate cash surpluses over and above that needed for reinvestment and growth in business

• Valuable portfolio holding because they can be “milked” for cash to

– Pay corporate dividends and overhead

– Finance new acquisition

– Invest in young stars or problem children

Cash Cows

• Should not be “harvested” but maintained in healthy position for long-term cash flow

• Weak cash flow may become candidates for harvesting and eventual divestiture

The goal is to fortify and defend a cash cow’s market position while efficiently generating dollars to reallocate to business investment elsewhere!

Dogs

• Situated in low growth market and have low relative market share – Lower right cell of matrix

• Have weak competitive position and low profit potential

• Unable to generate attractive cash flows on a long-term basis

Dogs

Strategy Prescriptions

• Harvest

• Divest or spin off

• Liquidate or close down

Strategy Implications of Growth-Share Matrix

• Draws attention to cash flow and investment characteristics of various type of businesses

• Encourages strategist to view diversified firm as collection of cash flows and cash requirements

• Explain why priorities for corporate resource allocation can be different for each business

• Success sequence – Question mark to young star to self-supporting star to cash cow

• Two disaster sequences

– Star’s position erodes to problem child and then falls to a dog

– Cash cow losses leadership and becomes a dog

Present Versus Future Positions in the Portfolio Matrix

Relative Market Share Position

HIGH

LOW

HIGH LOW Stars Question Marks A E D B F C G Cash Cow Dog
HIGH
LOW
Stars
Question Marks
A
E
D
B
F
C
G
Cash Cow
Dog

Weaknesses of Growth-Share Matrix

• Four-cell matrix fact that many businesses

– Are in “average” growth rate markets, and – Have “average” relative market share positions

• Misleading simplification to categorize businesses into just four types

• Matrix doesn’t identify which businesses offer best investment opportunities

• Being a leader in a slow-growth industry does not guarantee cash flow status

Weaknesses of Growth-Share Matrix

• Assessment of relative long-term attractiveness of business units requires examining more than

– Industry growth, and

– Relative market share

• Connection between relative market share and profitability is not as tight as experience curve effects implies

– Many firms with small relative market shares are very profitable!

General Electric’s Industry Attractiveness

Business Strength Matrix

Industry

Attractiveness

• Market Size

• Growth Rate

• Profit Margin

• Competitive Intensity

• Seasonality

• Cyclicality

• Technology & Capital

• Social Impact

• Regulation

• Environment

• Opportunities & Threats

• Barriers to Exit / Entry

Business Strength

• Market Share

• Core Competencies

• Profit Margin vs. Competitors

• Ability to Match Price / Service

• Relative Costs

• Knowledge

• Technological Ability

• Management Caliber

High

Medium

Low

Strong Average Weak
Strong
Average
Weak

Industry Attractiveness – Business Strength Matrix

Two variables used:

1. Long-Term Industry Attractiveness

• Plotted on vertical axis

2. Business Strength – Competitive Position

• Plotted on vertical axis

Constructing Attractiveness – Business Strength Matrix

• Quantitative measures of industry attractiveness and business strength used to

– Plot each business unit’s location in matrix

• Each business unit appears as a “circle”

– Area of circle is proportional to size industry – Pie slices within circle reflect business’s market share in industry

Procedure: Rating Industry Attractiveness

Step 1:

Step 2:

Step 3:

Step 4:

Select factors to compare long-term attractiveness of each industry Assign weighs to each attractiveness factor Rate each industry on each attractiveness factor, using scale of 1 to 10 Calculate weighted ratings; sum to get an overall industry attractiveness rating for each industry

Procedure: Rating Business Position / Competitive Strength

Step 1:

Step 2:

Step 3:

Step 4:

Select factors to compare competitive strength of each business unit Assign weighs to each competitive strength factor Rate each business on each competitive strength factor, using scale of 1 to 10 Calculate weighted ratings; sum to get an overall business unit attractiveness rating for each business

Strategy Implication of Attractiveness / Strength Matrix

• Businesses in three cells at upper left of matrix

– Accorded top investment priority

– General strategic prescription is “grow and build”

• Business in three diagonal cells

– Given medium investment priority

– If a business has an attractive opportunity, it can win higher investment priority

• Business in lower right of matrix

– Strong candidate for harvesting or divestiture

– May be candidates for an “overhaul and reposition” strategy

Advantages of Attractiveness / Strength Matrix

• Allows for intermediate rankings between high and low, and between strong and weak • Incorporates wider variety of strategically relevant variables

• Stresses channeling of corporate resources to businesses with greatest potential for

– Competitive advantage, and – Superior performance

Weaknesses of Attractiveness / Strength Matrix

• No real guidance on specific of business strategy

• Most to be concluded is general strategic posture

• Leaves issue of strategic coordination across businesses wide open, as well as

– Issue of specific competitive approaches and actions to take at business-unit level

• Tends to obscure businesses about to emerge as winners

WeakAverageStrong

The Life Cycle Portfolio Matrix

WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline
WeakAverageStrong The Life Cycle Portfolio Matrix Early Industry Rapid Shake Maturity Market Decline

Early

Industry

Rapid

Shake

Maturity

Market

Decline

Development

Takeoff

Growth

Out

Saturation

Stage in Life Cycle

Life-Cycle Matrix

Two variables used:

1. Industry’s Stage in Life Cycle

– Plotted in vertical axis

– Development, takeoff / grown, competitive shakeout, maturity / saturation, decline

2. Business Unit’s Competitive Position

– Plotted on horizontal axis

– Strong, average, weak

• Each business unit appear as a “circle”

– Area of circle is proportional to size of industry

– Pie slices within circle reflect business’s market share in industry

Life-Cycle Matrix

The power of the life-cycle matrix is the story it tells about the distribution of the firm’s businesses across the stages of industry evolution!

Step 3: Comparing Long-Term Industry Attractiveness

• Judged from three perspectives

1. Attractiveness of each industry in portfolio

2. Each industry’s attractiveness relative to others

3. Attractiveness of all industries as a group

Step 4: Comparing Business Unit Competitive Strength

• Involves comparing specific criteria

– Relative market share

– Ability to compete on price and / or quality

– Technology and innovation capabilities

– How well business unit’s skills and competencies match industry KSFs

– Profitability relative to competitors

– Other pertinent measures of competitive strength

Strategic Management Principle

Shareholder interests are generally best served by concentrating corporate resources on businesses that can contend for market leadership in their industry!

Step 5: Comparing Business Unit Performance

• Involves comparing historical performance with future performance prospects of each business unit

• Most important performance yardsticks

– Sales growth

– Profit growth

– Contribution to company earnings

– Return on assets employed in business

– Cash flow generation

Strategic Fit Analysis

First

– Analyze value chains of each business to identify opportunities for cost sharing, skills transfer, and / or differentiation enhancement

Second

– Identify important interrelationships between firm’s present businesses and other industries not in portfolio

Third

– Decide if existing and potential strategic fit relationships can lead to an attractive advantage

Translating Strategic Fit Into Competitive Advantage

Key Point • It is very difficult to build shareholder value in a diversified enterprise unless diversification involves a deliberate effort to pursue the competitive advantage opportunities of strategic fit!

Translating Strategic Fit Into Competitive Advantage

• Absent meaningful strategic fit opportunities, strategists must try to build shareholder value by

– Doing an exceptionally good job of portfolio management

– Doing such a good job of helping to manage various businesses they perform at a higher level

– Providing such inspirational leadership that all employees are motivated to perform “over their heads”

Step 7: Ranking Business Units on Investment Priority

Objective To draw conclusions about where the corporation should be investing its financial resources

• Consists of

– Ranking business units in terms of priority for new capital investment

– Developing a general strategic direction for each business unit

• Determine how resources can be used to enhance competitive standing and financial performance of business units

Step 8: Crafting a Corporate Strategy

Key Strategy-Making Considerations

• Does portfolio contain enough business in every attractive industries?

• Does portfolio contain too many marginal businesses?

• Is proportion of mature or declining businesses so great corporate growth will be sluggish?

• Does firm have enough “cash cows” to finance stars and emerging winners?

• Do core businesses generate dependable profits and / or cash flow?

Step 8: Crafting a Corporate Strategy

Key Strategy-Making Considerations

• Is portfolio overly vulnerable to seasonal or recessionary influences?

• Does firm have too many businesses it really does not need to be in or needs to divest?

• Does firm have some businesses that are industry leaders or is it burdened with too many average-to-weak businesses?

• Does makeup of business portfolio put firm in good future position?

The Performance Test

The best test of the overall attractiveness of a company’s business portfolio is whether the firm can attain its performance objectives with its current lineup of businesses!

• If answer is yes, no major corporate strategy change are indicated

• If a performance shortfall is likely, actions can be taken to close gap

The Performance Test

• Actions to be taken if performance shortfall is indicated

– Alter strategic plans for one, or all, of businesses – Add new businesses to portfolio

– Divest weak-performing or money-losing businesses from portfolio

– Form alliances

– Lower corporate performance objectives

Finding Additional Diversification Opportunities

Unrelated Diversification Strategies

– Find companies offering attractive financial returns irrespective of industry they are in

Related Diversification Strategies

– Locate an attractive industry having good strategic fit with one or more of firm’s present businesses

– Look for industries whose value chains relate to present businesses in portfolio

Deploying Corporate Resources

Principle

– Achieving ever-higher levels of performance from a diversified business portfolio depends on doing an effective job of corporate resource allocation

Key to Success

– Steering resources out of low opportunity areas into high opportunity areas

Deploying Corporate Resources

Options for Allocating Funds

1. Invest in maintenance and expansion of existing businesses, starting with those having highest ROI potential

2. Make new acquisitions

3. Fund long-range R&D ventures

4. Pay off existing long-term debt

5. Increase dividends

6. Repurchase company’s stock

How Corporate Strategies Form?

• Managers approach major strategic decisions a step at a time, starting from broad concepts and then fine-tuning, and modifying them as

– More information is gathered

– Formal analysis confirms or modifies

– Confidence and consensus build for strategic moves to be made

• Strategy usually doesn’t result from a big brainstorming session – Except in a crisis!

End of Module 8