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Strategic Management

Corporate Strategy and


Diversification
Strategy Directions
Diversification involves increasing the range of products or markets served by an

organization.
Related diversification involves expanding into products or services with

relationships to the existing business. For ex:


 Related activities (ex: Pepsi: drink → food)

 Unrelated activities (ex: Philip Morris: tobacco → beer, food)

Conglomerate (unrelated) diversification involves mainly diversifying into

products or services with no relationships to existing businesses


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Market Penetration
For undiversified business, the most obvious strategic option is often

increased penetration of its existing market, with its existing products


Market penetration implies increasing share of current markets with

the current product range - The organization’s scope is exactly the


same

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Market Penetration
Organizations seeking greater market penetration may face two constraints:

Retaliation from competitors - increasing market penetration is likely to

exacerbate industry rivalry as other competitors in the market defend their share
→ leads to price wars
Organization which wants to penetrate the market must have strategic capabilities

that can give them competitive advantage


In low-growth or declining markets, it can be more effective simply to acquire

competitors. For ex: Indian steel company LNM (Mittal) acquired struggling steel
companies and became largest global steel producer in the 2000s 5
Market Penetration
Legal constraints:

Most countries have regulators with the powers to restrain powerful companies or

prevent mergers and acquisitions that would create such excessive power
In the UK, the Competition Commission can investigate any merger or acquisition

that would account for more than 25 per cent of the national market, and either halt
the deal or propose measures that would reduce market power
The European Commission has an overview of the whole European market and

can similarly intervene

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Market Penetration
The optimal strategy option for market penetration during a market

downturn or public-sector crisis is Retrenchment: withdrawal from


marginal activities in order to concentrate on the most valuable
segments and products within their existing business.

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Product Development
Product development is where organizations deliver modified or new

products (or services) to existing markets


Developing its products from the original iPod, through iPhone to iPad and

iWatch involved little diversification for Apple → Apple was targeting the
same customers and using very similar production processes and distribution
channels

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Product Development
Product development can be an expensive and high-risk activity for at least two

reasons:

1) New resources and capabilities - Product development strategies typically involve


mastering new processes or technologies that are unfamiliar to the organization. For
ex: Online classes at Universities.

Success is likely to depend on a willingness to acquire new technological


capabilities, to engage in organizational restructuring and new marketing
capabilities to manage customer perceptions → product development typically
involves heavy investments and can have high risk of project failures
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Product Development
Product development can be an expensive and high-risk activity for at least two

reasons:
2) Project management risk - Even within fairly familiar domains, product
development projects are typically subject to the risk of delays and increased
costs due to project complexity and changing project specifications over time.

For ex: Boeing’s Dreamliner 787 aircraft made innovative use of carbon-fibre
composites but had a history of delays even before launch in 2010 and required
$2.5bn write-offs due to cancelled orders. Since then, batteries catching fire has
resulted in fleets being grounded
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Market Development
Market development can be more attractive by being potentially cheaper

and quicker to execute – involves offering existing products to new markets


The degree of diversification varies along Figure 8.2’s downward axis →

entails some product development as well, if only in terms of packaging


or service
Market development is a form of related diversification given its origins in

similar products

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Market Development
Market development takes two basic forms:

1) New users. Here an example would be aluminum, whose original users,


packaging and cutlery manufacturers, are now supplemented by users in
aerospace and automobiles

2) New geographies. The prime example of this is internationalization, but it


would also include the spread of a small retailer into new towns.

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Market Development
It is essential that market development strategies be based on products or services

that meet the critical success factors of the new market (see Section 3.4.3).
Strategies based on simply off-loading traditional products or services in

new markets are likely to fail


In terms of strategic capabilities, market developers often lack the right

marketing skills and brands to make progress in a market with unfamiliar


customers.
On the management side, the challenge is coordinating between different

users and geographies, which might all have different needs


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Conglomerate Diversification
Conglomerate diversification strategies can create value as businesses may

benefit from being part of a larger group.


This may allow consumers to have greater confidence in the business units'

products and services.


Larger size may also reduce the costs of finance (the cost, interest, and

other charges involved in the borrowing of money to build or purchase


assets).

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Conglomerate Diversification
Doubts related to conglomerate diversification:
There are no obvious ways in which the businesses can work together to generate

additional value
There is often an additional bureaucratic cost of the managers at headquarters who

control them → leads to ‘conglomerate discount’ - a lower valuation than the combined
individual constituent businesses would have on their own
Relationships that might have seemed valuable in related diversification may not turn out

to be as valuable as expected. For ex: large accounting firms have often struggled in
translating their skills and client contacts developed in auditing into effective consulting
practices (see Illustration 8.2 - From sat nav to driverless cars) 15
Baking change into the community. Page 246
What were the motivation(s) for Greyston Bakery’s

diversifications?
Referring to the Ansoff matrix, how would you classify these

diversifications?

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Sat nav manufacturer TomTom diversifies to survive.
Page 249
Explain the ways in which relatedness informed TomTom’s post-2008

strategy.
Were there alternative strategies open to TomTom post 2008?

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Sat nav manufacturer TomTom diversifies to survive.
Page 249
Sales of the company went down by 36% to €959 m and profits down by 71% to

€25.4 m in 2008 due to an increasingly saturated satellite navigation market, plus


smartphone alternatives from Google and Nokia → diversified into fleet
management and vehicle telematics, where it is now a recognized leader
TomTom became market leader in PDA software in just two years with navigation

applications RoutePlanner and Citymaps. In 2002, the TomTom Navigator was


launched, providing European customers for the first time with an easy-to-use,
affordable, portable navigation device (PND)
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Sat nav manufacturer TomTom diversifies to survive.
Page 249
TomTom GO, launched in 2004, revolutionized the way millions of drivers got from

A to B → over 75 million devices have been sold in 35 countries, guiding drivers


over 280 billion kilometers
TomTom evolved from just a hardware business, selling sat navs to stick on

windscreens, to a software and services provider that offered free mapping on


smartphones and integrated traffic management systems
After partnering with Nike on the Nike+ Sport- Watch, TomTom launched its own

TomTom Runner and TomTom Multi-Sport watches in 2013


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Sat nav manufacturer TomTom diversifies to survive.
Page 249
TomTom is now straying further from its roots by launching Bandit, an

action camera, to challenge American market leader GoPro → Bandit’s real


selling point is its video-editing and -sharing capabilities.
They are also working with car manufacturers to build embedded

navigation systems into their vehicles as the era of the ‘connected car and
replace roaming service with stand-alone sat nav

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Sat nav manufacturer TomTom diversifies to survive.
Page 249
Automakers are unwilling to share data with rivals and so rely on third

parties for services such as traffic management


TomTom is currently collaborating with Volkswagen on real-time map

updates for driverless cars although they will face tough competition from
Google and Apple.

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Diversification Drivers
Exploiting economies of scope
Economies of Scope refer to efficiency gains made through applying the

organization's existing resources or competences to new markets or services


If an organization has under-utilized resources or competences that it cannot

effectively close or sell to other potential users, it is efficient to use these


resources or competences by diversification into a new activity.

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Diversification Drivers
Exploiting economies of scope
For ex: A University can use its under-utilized hall of residences (dormitories)

in conference or tourism purposes during the holiday periods


Economies of scope may apply to both tangible resources, such as halls of

residence, and intangible resources and competences, such as brands or


staff skills.

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Diversification Drivers
Stretching corporate management competences (‘dominant logics’)
This is a special case of economies of scope and refers to the potential for

applying the skills of talented corporate-level managers (referred to as


‘corporate parenting skills’ in Section 8.6) to new businesses.
Dominant logic is the set of corporate-level managerial competences

applied across the portfolio of businesses

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Diversification Drivers
Stretching corporate management competences (‘dominant logics’)
For ex: French luxury brand LVMH diversified its business into various fields

such champagne, fashion, jewelry, perfumes, financial media, etc.


But LVMH creates value for these specialized companies by applying

corporate-level competences in developing classic brands and nurturing


highly creative people that are relevant to all its individual businesses

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Diversification Drivers
Exploiting superior internal processes
Internal processes within a diversified corporation can often be more efficient than

external processes in the open market → especially applicable where external


capital and labor markets do not yet work well, as in many developing economies
In these circumstances, well-managed conglomerates can make sense. For ex:

China has many conglomerates because it is able to mobilize internal investment,


develop managers and exploit networks in a way that stand-alone Chinese
companies, relying on imperfect markets, cannot

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Diversification Drivers
Increasing market power
First, having the same wide portfolio of products as a competitor increases the

potential for mutual forbearance (tolerance). Two similarly diversified competitors are
thus likely to forbear from competing aggressively with each other
having a diversified range of businesses increases the power to cross-subsidize one

business from the profits of the others.


The ability to cross-subsidize can support aggressive bids to drive competitors out

of a particular market and, being aware of this, competitors without equivalent power
will be reluctant to attack that business 27
DIVERSIFICATION DRIVERS
Synergies are benefits gained where activities or assets complement each

other so that their combined effect is greater than the sum of the parts (the
famous 2 + 2 = 5 equation)
For ex: Film company and music publisher worth more together than

separately - if the music publisher had the sole rights to music used in the film
company productions for instance

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Better Performance through Synergy

Firm A purchases Firm B in


another industry. A and B’s No
profits are no greater than Synergy
what each firm could have (1+1=2)
Evaluating the earned on its own.
Potential for
Synergy
through
Firm A purchases Firm C in
Diversification
another industry. A and C’s
Synergy
profits are greater than what
each firm could have earned (1+1=3)
on its own.

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DIVERSIFICATION DRIVERS
Three potentially value-destroying diversification drivers are:
Responding to market decline - Rather than let the managers of a declining business

invest spare funds in a new business it is usually best to let shareholders find new
growth investment opportunities for themselves
For ex: Kodak spent billions of dollars on diversification acquisitions such as chemicals,

desktop radiotherapy, photocopiers, telecommunications and inkjet printers in order to


compensate for market decline in its main product but the company went to bankruptcy
Shareholders might have preferred Kodak simply to hand back the large surpluses

generated for decades beforehand rather than spending on costly acquisitions.


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Vertical Integration
Vertical integration describes entering activities where the organization is its own
supplier or customer:
Backward integration is movement into input activities concerned with the

company’s current business (i.e. further back in the value network). For example,
acquiring a component supplier would be backward integration for a car
manufacturer.
Forward integration is movement into output activities concerned with the

company’s current business (i.e. further forward in the value network). For a car
manufacturer, forward integration would be into car retail, repairs and servicing.
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Vertical Integration
Two danger related to Vertical Integration:

1) Vertical integration involves investment - Expensive investments in


activities that are less profitable than the original core business will be
unattractive to shareholders because they are reducing their average or
overall rate of return on investment

2) even if there is a degree of relatedness through the value network, vertical


integration is likely to involve quite different strategic capabilities which are
not so easy to control – vertical dis-integration
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To Integrate or Outsource
Outsourcing is the process by which activities previously carried out internally are

subcontracted to external suppliers → For ex: A specialist IT contractor is usually better at IT


than the IT department of a steel company
Nobel prize-winning economist Oliver Williamson’s transaction cost framework helps analyze

the relative costs and benefits of managing (‘transacting’) activities internally or externally.
Williamson warns against underestimating the long-term costs of opportunism by external

subcontractors
Subcontractors are liable over time to take advantage of their position, either to reduce their

standards or to extract higher prices

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To Integrate or Outsource
Market relationships tend to fail in controlling subcontractor opportunism where:
there are few alternatives to the subcontractor, and it is hard to shop around;

the product or service is complex and changing, and therefore impossible to

specify fully in a legally binding contract;


investments have been made in specific assets, which the subcontractors

know will have little value if they withhold their product or service. See
Illustration 8.3.

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To Integrate or Outsource
This transaction cost framework suggests that the costs of opportunism can outweigh

the benefits of subcontracting to organizations with superior strategic capabilities


For ex: For the mining company functioning in Australian outbreak will be profitable to own the

housing services to its employees rather than outsourcing it since the isolation creates specific
assets (the housing is worth nothing if the mine closes down) and a lack of alternatives (the
nearest town might be 100 miles away)
Transaction cost economics therefore offers the following advice: if there are few

alternative suppliers, if activities are complex and likely to change, and if there are significant
investments in specific assets, then it is likely to be better to vertically integrate rather than
outsource 38
To Integrate or Outsource
In sum, the decision to integrate or subcontract rests on the balance between:
Relative strategic capabilities. Does the subcontractor have the potential to

do the work significantly better?


 Risk of opportunism. Is the subcontractor likely to take advantage of the

relationship over time?

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Illustration 8.3 ‘Out of sight – out of mind’?
Outsourcing at Royal Bank of Scotland. Page 255
In terms of transaction and capability costs, why might outsourcing be

attractive to companies?
What might be the risks of ‘insourcing’?

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The Portfolio Manager
Portfolio manager operates as an active investor in a way that shareholders in the

stock market are either too dispersed or too inexpert to be able to do


The portfolio manager is acting as an agent on behalf of financial markets and

shareholders with a view to extracting more value from the various businesses
than they could achieve themselves → to identify and acquire under-valued
assets or businesses and improve them
For example, Portfolio Managers acquire another corporation, divest low-

performing businesses within it and intervene to improve the performance of those


with potential → usually implemented in conglomerates
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Illustration 8.4 Eating its own cooking: Berkshire
Hathaway’s parenting. Page 260

In what ways does Berkshire Hathaway fit the archetypal portfolio manager

(see Section 8.6.2 )?


Warren Buffet still had $73bn to invest. Suggest industries and businesses

he would be unlikely to invest in.

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The Synergy Manager
Synergy manager is a corporate parent seeking to enhance value for business units
by managing synergies across business units
Synergies are likely to be particularly rich when new activities are closely related to

the core business


3 main focuses in value creating activities:

1) envisioning building a common purpose

2) facilitating cooperation across businesses

3) providing central services and resources

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The Synergy Manager
For example, at Apple, Steve Jobs’ vision of his personal computers being

the digital hub of the new digital lifestyle guided managers across the iMac
computer, iPod, iPhone and iPad businesses and it enhanced value through
better customer experience
3 challenges of synergistic benefits:
Excessive costs - The benefits in sharing and cooperation need to outweigh

the costs of undertaking such integration, both direct financial costs and
opportunity costs
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The Synergy Manager
Overcoming self-interest – Well-rewarded managers are likely to be

unwilling to sacrifice their time and resources for the common good.
Illusory synergies - overestimating the value of skills or resources to other

businesses. This is particularly common when the corporate center needs to


justify a new venture or the acquisition of a new company

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The Parental Developer
The parental developer seeks to employ its own central capabilities to add

value to its businesses


Parental developers focus on the resources or capabilities they have as

parents which they can transfer downwards to enhance the potential of


business units. For ex: A parent could have a valuable brand or specialist
skills in financial management or product development → See Illustration 8.5.

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The Parental Developer
Parenting opportunities tend to be more common in the case of related

rather than unrelated diversified strategies and are likely to involve


exchanges of managers and other resources across the businesses
Key value-creating activities for the parent will be the provision of central

services and resources.


For ex: A consumer products company might offer substantial guidance on

branding and distribution from the center; A technology company might run a
large central R&D laboratory.
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The Parental Developer
Two crucial challenges in managing a parental developer:

1) Parental focus – Corporate parents should identify the unique value-adding


capabilities by always be asking what others can do better than them. Other central
services should typically be outsourced to specialist companies that can do it better

2) The ‘crown jewel’ problem - Some diversified companies have business units in their
portfolios which are performing well but to which the parent adds little value →
corporate parents get excessively attached to them. The logic of the parental development
approach is: if the center cannot add value, it is just a cost and therefore destroying
value. Parental developers should divest businesses they do not add value to, even
profitable ones and reinvest the money to businesses where they can add value
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Illustration 8.5 Chipotle: doing things differently. Page 262

What parenting advantages did McDonald’s perceive it might bring to

Chipotle?
Despite its success, why was Chipotle spun-off?

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The BCG (or growth/share) matrix
A star is a business unit within a portfolio that has a high market share in a growing market.

A question mark (or problem child) is a business unit within a portfolio that is in a growing

market but does not yet have high market share → needs heavy investments. Many
question marks fail to develop, so the BCG advises corporate parents to nurture several
at a time
A cash cow is a business unit within a portfolio that has a high market share in a mature

market. The cash cow should then be a cash provider, helping to fund investments in
question marks.
Dogs are business units within a portfolio that have low share in static or declining markets.

The BCG usually recommends divestment or closure


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4 potential problems with The BCG matrix
Definitional vagueness - It can be hard to decide what high and low growth or

share mean in particular situations → by ignoring relevant international markets


Capital market assumptions - The notion that a corporate parent needs a

balanced portfolio to finance investment from internal sources (cash cows)


assumes that capital cannot be raised in external markets, for instance by
issuing shares or raising loans → more relevant in countries where capital
markets are under-developed or in private companies that wish to minimize
dependence on external shareholders or banks.

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4 potential problems with The BCG matrix
Unkind to animals - Both cash cows and dogs receive ungenerous treatment,

the first being simply ‘milked’, the second terminated or cast out of the
corporate home. Can cause to motivation problems as managers in these
units see little point in working hard for the sake of other businesses. Also, can
cause to self-fulfilling prophecy. Moreover, cash cows can very quickly turn
into dogs as they are simply ‘milked’ and additional investment is denied
Ignores commercial linkages - The matrix assumes there are no commercial

ties to other business units in the portfolio. For instance, a business unit in the
portfolio may depend upon keeping a dog alive 54
The directional policy (GE–McKinsey) matrix
Categorizes business units into those with good prospects and those with

less good prospects.


Originally developed by McKinsey & Co. consultants in order to help the

American conglomerate General Electric manage its portfolio of business


units
Finds answers to the following questions:

(i) how attractive the relevant market is in which they are operating

(ii) the competitive strength of the SBU in that market


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The directional policy (GE–McKinsey) matrix
Attractiveness can be identified by PESTEL or five forces analyses; business

unit strength can be defined by competitor analysis (for instance, the strategy
canvas) (see Section 3.4.3)
Some analysts also choose to show graphically how large the market is for a

given business units activity, and even the market share of that business unit
For ex: A firm with the portfolio shown in Figure 8.7 will have relatively low shares

in the largest and most attractive market, whereas their greatest strength is in a
market with only medium attractiveness and smaller markets with little long-
term attractiveness 56
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The directional policy (GE–McKinsey) matrix
Two advantages of Directional Policy Matrix:
1) Unlike the simpler four-box BCG matrix, the nine cells of the directional policy
matrix acknowledge the possibility of a difficult middle ground
2) The two axes of the directional policy matrix are not based on single measures
(i.e. market share and market growth)
But the directional policy matrix shares some problems with the BCG matrix,

particularly about vague definitions, capital market assumptions, motivation and self-
fulfilling prophecy and ignoring commercial linkages

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The Parenting Matrix
The parenting matrix (or Ashridge Portfolio Display) developed by

consultants Michael Goold and Andrew Campbell introduces parental fit


as an important criterion for including businesses in the portfolio
Businesses may be attractive in terms of the BCG or directional policy

matrices, but if the parent cannot add value, then the parent ought
to be cautious about acquiring or retaining them

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The Parenting Matrix
There are two key dimensions of fit in the parenting matrix (see Figure 8.8):

1) ‘Feel’ - This is a measure of the fit between each business unit’s critical success
factors (see Section 3.4.3) and the capabilities (in terms of competences and
resources) of the corporate parent.
2) ‘Benefit’ - This measures the fit between the parenting opportunities, or needs,
of business units and the capabilities of the parent. For the benefit to be
realized, of course, the parent must have the right capabilities to match the
parenting opportunities (for instance, by bringing marketing expertise)
Businesses for which a corporate parent has high feel but can add little benefit

should either be run with a very light touch or be divested 60


The Parenting Matrix
Heartland business units are ones that the parent understands well

and can continue to add value to. They should be at the core of
future strategy
Ballast business units are ones the parent understands well but can

do little for. They would probably be at least as successful as


independent companies

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The Parenting Matrix
Value trap business units are dangerous. They appear attractive because there

are opportunities to add value (for instance, marketing could be improved). But
they are deceptively attractive, because the parent’s lack of feel will result in
more harm than good (i.e. the parent lacks the right marketing skills). The parent
will need to acquire new capabilities in order to move the business into the
heartland. Divesting to another corporate parent that could add value
Alien business units are clear misfits. They offer little opportunity to add value

and the parent does not understand them anyway. Exit is definitely the best
strategy.
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The Parenting Matrix
The parenting matrix can therefore assist hard decision where either high-feel

or high-parenting opportunities tempt the corporate parent to acquire or retain


businesses.
Parents should concentrate on actual or potential heartland businesses,

where there is both high feel and high benefit


Public- sector managers should control directly only those services and

activities for which they have special managerial expertise. Other services
should be outsourced or set up as independent agencies
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Virgin – is the brand more than Richard Branson?
by Marianne Sweet. Pages: 271-274
What directions of strategic development have been followed by Virgin over the

period of the case (use Figure 8.2 as a guide)?


Which type of corporate parenting role (as per Figure 8.5) best describes the

Virgin Group? Justify your choice.


How does the Virgin Group as a corporate parent add value to its businesses? To

what extent are these parenting skills relevant to the differing business units?
What should the future corporate strategy be? (And how essential is Richard

Branson himself to that strategy?)


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