CHAPTER 4

STRATEGY FORMULATION:
CORPORATE DIVERSIFICATION
STRATEGY
(CORPORATE, BUSINESS & FUNCTIONAL STRATEGY)

Strategic Management
 Concepts of strategy formulation

Strategy formulation stage is precede by the following questions:

 Where does the organization want to be?
 Where is the organization now?
 What is the desired end results to be achieved?
 How will we achieve desired results?

The answers for these sequential questions define an overall direction

for the organisation's grand strategy
 Levels of strategy

1. Corporate level strategy: concerned with the broad, long-term

questions of “what businesses are we in, and what do we want to do with
these businesses?” The corporate strategy sets the overall direction the
organization will follow

2. Business level strategy: involves deciding how the company will

compete within each strategic business unit. Formulating a specific competitive
strategy requires understanding of the five competitive forces.

3. Functional Level: is firm’s operational strategies developed at

functional level to enhance efficiency and productivity
 1. Corporate strategy

 Corporate strategy helps to exercise the choice of direction that an

organization adopts.

 Every corporation must decide its orientation toward growth

by asking the following three questions:
 Should we expand, cut back, or continue our operations unchanged?
 Should we concentrate our activities within our current industry, or should we
diversify into other industries?
 If we want to grow and expand nationally and/or globally, should we do so
through internal development or through external acquisitions, mergers, or
strategic alliances?
 Types of corporate strategy

 Corporate strategy can be examined in terms of:

 directional strategy (orientation toward growth),

 portfolio analysis (coordination of cash flow among units)

 corporate parenting (the building of corporate synergies through
resource sharing and development)
 A) Directional strategy

 A corporation’s directional strategy (also called grand strategies)

is composed of three general orientations:

 Growth strategies- expand the company’s activities

 Stability strategies- make no change to the current activities

 Retrenchment strategies(defensive)- reduce the company’s level

of activities
 Corporate-Level Strategies

Valuable
strengths
Concentration

Concentric Diversification (Economies

of Scope)
Corporate
growth Corporate
Firm strategies stability
Status Conglomerate strategies
Diversification
(Risk Mgt.)
Corporate
retrenchment
strategies
Critical
Can still go for business-level
weaknesses growth (economies of scale)
Abundant Critical
environmental environmental
opportunities
Environmental Status threats
 Cont’d

Vertical growth
concentration
Intensificatio Horizontal growth
Growth
n
diversificatio concentric
n
Directional conglomerate
stability
strategy Pause/proceed with caution
No change
 Profit strategy

turnaround
Retrenchmen Captive company
t
Sellout/divestment
Bankruptcy/
liquidation
 a) Growth strategy

 Is most widely pursued corporate directional strategies

 Firms choose this strategy if their perceptions of resource

availability and past financial performance are both high

 The most common growth strategies are:

 Concentration-
 Intensification
 Diversification (at the corporate level) into other product lines in
other industries
 Cont’d

i) Integration(concentration) growth Strategy

 Growing firms in a growing industry tend to choose these strategies
before they try diversification
 Cont’d

Types of concentration strategy

a) vertical growth:
I. back ward integration: grows by making its own supplies

II. forward integration: grows by making its own distribution

 Vertical integration is logical for firms having strong competitive position in

a highly attractive industry

b) horizontal growth: results when a firm adds a new unrelated products to

existing market or enter in a new market for existing product

 Horizontal growth is increasingly being achieved in today’s world through

international expansion by using many different strategies
 Cont’d

Concentration may be done in order to:

 reduce costs

 gain control over a scarce resource

 guarantee quality of a key input

 obtain access to potential customers

Growth via concentration can be achieved:

 internally by expanding current operations or

 externally through acquisitions and strategic alliance with other
firms in the same industry
 Cont’d

ii) Intensive growth Strategy

 Market penetration, market development, and product development are sometimes
referred to as an intensive strategies
 It is appropriate if a company’s current product lines have real growth potential

 Embedded in a development of a strategy are many choices

 Which markets or segments to penetrate or develop
 Which new or related products & services to develop
 How best to exploit & lever existing capabilities and whether to develop new capabilities.
 Some of the options are clearly presented in the Ansoff (1965) product/ market matrix
shown below
Ansoff Matrix
This matrix consider options for strategy based on two
dimensions: the products/services the organization sells & the
markets it serves

PRODUCTS

PRESENT NEW

PRESENT
Market Product
MARKETS Penetration Development
NEW

Market Diversification
Development
 Cont’d

1) Penetration(current product to current market)

Guidelines when market penetration may be effective strategy;
 When current market are not saturated( go for aggressive advertisement, mass
production and intensive distribution )
 When market share of competitors declining & industry sales increasing
 When increasing economies of scale provide major competitive advantage.
2) Market development
 Here organization takes its existing products, services and ventures in to new markets.
However, this may be a high-risk strategy
3) product/ services development
 This can be a strategic route to growth in established markets where existing products
ranges don’t fully exploit the available opportunities.
 Product development is a strategy that seeks increased sales by improving present
products/services.
 Cont’d

iii) Diversification Strategies

 The process of adding new businesses to the company that are
distinct from its established operations

 This often occurs when the firm has strong competitive position but
the industry growth is slow.

 Its main aim is to create value or wealth in excess of what firms

would enjoy without diversification.

 Diversification is part of the four main marketing strategies defined

by the Product/Market Ansoff matrix
 cont’d

Diversification can be concentric or conglomerate

i) Concentric(related) diversification
 A firm is said to have pursued concentric diversification strategy when it

enters into new product/service area belonging to different industry but

the new product/service is similar to the existing one with respect to
technology or production or marketing channels or customers.

 Thus, it create a situation in which the existing and new lines of business
share and gain special advantages from commonalities such as
technology, customers, distribution, location, product or manufacturing similarities
E.g. Tomato ketchup and sauce to the existing ‘Maggi’
NB: Concentric diversification can be market related, technology related, market & technology related
 Cont’d

 Appropriate for:
-Firms having strong competitive position but industry attractiveness is low.
 How could it be done?

-Internal development through product and market expansion utilizing the

existing resources and capabilities, and/or
-Through external(e.g. acquisitions) operating in the same market space

 Purpose
 Concentric diversification search for synergy. Synergy is the concept that two
businesses will generate more profits together than they could separately
Exercise: discuss with your classmates and give examples of concentric diversification in Ethiopia
 Cont’d

ii) Conglomerate (Unrelated) Diversification:

 Company that consists of a grouping of businesses from unrelated
streams is called a conglomerate

 Conglomerate diversification is a growth strategy in which a company

add new, entirely unrelated products/services and joining unrelated
industry

 The emphasis in conglomerate diversification is on sound investment and

value oriented management rather than on the product-market synergy
common to concentric diversification

Exercise: discuss with your classmates &give examples of conglomerate

diversification in Ethiopia
 Cont’d

Diversification strategy is appropriate if:

 the present industry is unattractive

 The firm seek more attractive opportunities for growth

 Managers want to spread the risk across different industries

 Managers want to exit an existing line of business

 the company lacks outstanding competencies for concentric strategy

NB: If two products did not differentiated clearly cannibalization resulted. It is the
process in which a company new launched brand start competing with its own
previous brand.

 Diversification can be done both internally or externally (e.g. M&A)

 Merger and acquisition as a means of diversification

 Merger:
-Is essentially a combination of the assets and liabilities of two firms to form a single business entity
 Mergers often occur between firms of somewhat similar size
 Most mergers are “friendly”—that is, both parties believe it is in their best interests to combine their
companies.
 Acquisition:
 100% purchase of another company
 In some cases, the company continues to operate as an independent entity and in others it is
completely absorbed as an operating subsidiary or division of the acquiring corporation
 Acquisitions is Marriage of unequal partners as it usually occur between firms of different sizes
& can be friendly or hostile
 Hostile acquisitions are often called takeovers
Why Merger and Acquisitions?

 Securing or protecting sources of raw materials/components

 To gain access to distribution channels
 To make use of underutilized resources of the company
 To increase market power – horizontal, vertical & related
acquisitions
 To avoid excessive competition (intense rivalry)
 To enter a new market, offer new products & avoiding cost of new
product development (Acquisition as substitute for innovation)
 To overcome entry barriers etc. (Cross-boarder acquisitions)
 Class activity
23

 A typical commercial retail bank facing

with a choice as to how to grow its
business .
 Suppose it chooses all Ansoff’s strategies,
illustrate all the activities it has to do in
each of Ansoff’s six strategies.
 If we were to map these strategies onto Ansoff’s
matrix , the following would result
24
 b) Stability Strategies

 A firm following this strategy does not seek to invest in new

factories and capital assets, gain market share, or invade new
geographical territories.

1. A pause/proceed-with-caution strategy: make only incremental

improvements until a particular environmental situation changes.
 this strategy does entail changing the way the business is run,
however, the range of products offered and the markets served
remain unchanged
 often it is temporary strategy to be used until the environment
becomes more hospitable.
 Cont’d

 Appropriate when:
 the industry in which it operates or the country’s economy is in
turmoil
 The firm go through a period of rapid expansion and need to
consolidate their operations before going for another bout of
expansion
 Cont’d

2. No-change strategy: is a decision to do nothing new—a choice to

continue current operations and policies for the foreseeable future

Appropriate if:

 there are no obvious opportunities or threats, nor is there much in the

way of significant strengths or weaknesses
 the industry is in a mature stage with few or no growth prospects
 the company is doing well and wants to maintain the status quo
“if it works, don’t fix it
 Cont’d

3. A profit strategy: is a decision to do nothing new in a worsening

situation but instead to act as though the company’ problems are
only temporary

 The profit strategy is an attempt to artificially support profits by

reducing investment and short-term discretionary expenditures
while actually a company’s sales are declining

 The profit strategy is useful only to help a company get through a

temporary difficulty
 c) Retrenchment Strategies

 Many firms experience deteriorating financial performance

resulting from market erosion and wrong decisions by
management

 Managers respond by selecting different corporate strategies that

redirect their attempt to turnaround the company by improving
their firm’s competitive position or divest or wind up the business
if a turnaround is not possible.
 Cont’d

1. Turnaround strategy
 Emphasizes on improvement of operational efficiency when the state of
decline(problem) is not severe
 This may be brought about through restructuring of capital, changes in
management personnel and better control in functional areas

The two turnaround strategies are:

 Contraction: is the initial effort to quickly “stop the bleeding” with a
general, across-the board cutback in size and costs
 Consolidation: to streamline the company, plans are developed to
reduce unnecessary overhead and to make functional activities cost-
justified
 Cont’d

2. Captive company strategy: is a strategy involves giving up

independence in exchange for security
 Management desperately searches for an “angel” by offering to be a
captive company to one of its larger customers in order to guarantee the
company’s continued existence with a long-term contract

3. Sell-Out/Divestment Strategy: makes sense if management can still

obtain a good price for its shareholders and the employees can keep their
jobs by selling the entire company to another firm

 If the corporation has multiple business lines and it chooses to sell off a
division with low growth potential, this is called divestment
 Cont’d

4. Bankruptcy/Liquidation Strategy

 Because no one is interested in buying a weak company in an unattractive

industry, the firm must pursue a bankruptcy or liquidation strategy

 Bankruptcy involves: giving up management of the firm to the courts in

return for some settlement of the corporation’s obligations.
 Top management hopes that once the court decides the claims on the
company, the company will be stronger and better able to compete in a
more attractive industry
 Bankruptcy seeks to perpetuate the corporation
 Cont’d

 Liquidation: this strategy is generally used when a company has

become sick and can not be revived. It is used last resort and hence
liquidation is the termination of the firm
 When the industry is unattractive and the company too weak to be sold
as a going concern, management may choose to convert as many
saleable assets as possible to cash, which is then distributed to the
shareholders after all obligations are paid
 B) Portfolio Strategy

 Companies with multiple product lines or business units form

multi-business corporation (portfolio).

 Portfolio strategy involves decisions to: increase or decrease the

breadth of diversification by closing out some lines of business, adding
others, and changing emphasis among the portfolio of businesses

 Portfolio analysis tends to primarily view financial matters

(manage business units for cash flow) and examine industry’s
attractiveness
 C) corporate parenting strategy

 Tries to capture valuable cross-business strategic fits in a portfolio

of business and turn them into competitive advantages, especially
transferring and sharing related technology, procurement leverage,
operating facilities, distribution channels, and/or customers
 Strategic partnering occurs when two or more organizations
establish a relationship to transfer/share resources , capabilities,
and core competencies to achieve some business objective.
 The major types of strategic partnerships: joint ventures, and
strategic alliances are discussed in this chapter
 2. Business-Level Strategy
 business level strategy deals how individual product lines and
business units can gain competitive advantage in the marketplace

 Just as corporate strategy asks what industry the company should be

in, business strategy asks how the company should compete or
cooperate in each industry

 Business strategy can be competitive (battling against all

competitors for advantage) and/or cooperative (working with one or
more companies to gain advantage against other competitors)
 a) Competitive strategy

Competitive strategy raises the following questions:

 Should we compete on the basis of lower cost (and thus price), or

should we differentiate our products or services on some basis

other than cost, such as quality or service?

 Should we compete head to head with our major competitors for

the biggest but most Sought-after share of the market, or should we
focus on a niche in which we can satisfy a less sought-after but
also profitable segment of the market?
 Why do strategies differ?

A firm’s competitive strategy deals exclusively with the specifics

of its efforts to position itself in the market-place, please
customers, ward off competitive threats, and achieve a particular
kind of competitive advantage.
Is the firm’s market target
broad or narrow?
Key factors that
distinguish one strategy
from another
Is the competitive advantage
pursued linked to low costs
or product differentiation?

Jump to Appendix 1 long image description

© McGraw-Hill Education.
 The Five Generic Competitive Strategies

Jump to Appendix 2 long image description

© McGraw-Hill Education.
THE FIVE GENERIC COMPETITIVE STRATEGIES

Low-cost Striving to achieve lower overall costs than rivals on products

provider that attract a broad spectrum of buyers

Broad Differentiating the firm’s product offering from rivals’ with

differentiation attributes that appeal to a broad spectrum of buyers

Focused low- Concentrating on a narrow price-sensitive buyer segment and on

cost costs to offer a lower-priced product

Focused Concentrating on a narrow buyer segment by meeting specific

differentiation tastes and requirements of niche members

Best-cost Giving customers more value for the money by offering upscale
provider product attributes at a lower cost than rivals
 i. Cost Leadership Strategy
 A low-cost provider’s basis for competitive advantage is lower overall costs than
competitors. To get Low-cost advantage, cumulative costs across the overall value chain
must be lower than competitors’ cumulative costs.
 A cost leadership strategy is an integrated set of actions designed to produce or deliver
goods or services:
 At lowest competitive price
 Features acceptable to many customers
 Products are relatively standard
 How to gain a low-cost advantage
 Perform value-chain activities more cost-effectively than rivals
 Revamp the firm’s overall value chain to eliminate or bypass cost-producing activities
 Use lower-cost inputs and hold minimal assets
 Offer only “essential” product features or services
 Offer only limited product lines
 Use low-cost distribution channels
 COST-CUTTING METHODS

1. Capturing all available economies of scale

2. Taking full advantage of experience and learning-curve effects
3. Operating facilities at full or near-full capacity
4. Improving supply chain efficiency
5. Substituting lower-cost inputs wherever there is little or no
sacrifice in product quality or performance
6. Using the firm’s bargaining power vis-à-vis suppliers or others
in the value chain system to gain concessions
7. Using online systems and sophisticated software to achieve
operating efficiencies

© McGraw-Hill Education.
 Cost Drivers: The followings are Keys to Driving Down
Company Costs
NB:A cost driver is a factor that has a strong influence on a firm’s costs

© McGraw-Hill Education. Jump to Appendix 3 long image description

Competitive advantage and risks of the cost-leadership strategy

 Competitive advantages
 Greater total profits and increased market share gained from
under pricing competitors
 Risk
 Low pricing may not attract enough new buyers
 Rival’s retaliatory price-cutting sets off a price war
 Processes used to produce & distribute goods or services may
become obsolete due to competitors’ innovations
 Focus on cost reductions may occur at expense of customers’
perceptions of differentiation
 Competitors may learn to successfully imitate the cost leader’s
strategy
 ii. Broad differentiation strategy

 The essence of a broad differentiation strategy is to offer

unique product attributes that a wide range of buyers find
appealing and worth paying for.

 Increase the ability of the firm to sell goods or services at a price

that substantially exceeds the cost of creating.

 Allowing the firm to outperform rivals & earn above-average

returns.
 Cont’d

 Effective Differentiation Approaches

 Carefully study buyer needs and behaviors, values, and
willingness to pay for a unique product or service
 Incorporate features that both appeal to buyers and create a
sustainably distinctive product offering
 Use higher prices to recoup differentiation costs
 Advantages of Differentiation
 Command premium prices for the firm’s products
 Increased unit sales due to attractive differentiation
 Brand loyalty that bonds buyers to the differentiating features of
the firm’s products
 Value Drivers: The Keys to Creating a Differentiation Advantage
NB:A uniqueness driver is a factor that can have a strong differentiating effect

Jump to Appendix 4 long image description

© McGraw-Hill Education.
Pitfalls to avoid in pursuing a differentiation strategy

 Relying on product attributes easily copied by rivals

 Introducing product attributes that do not evoke an enthusiastic
buyer response
 Eroding profitability by overspending on efforts to
differentiate the firm’s product offering
 Offering only trivial improvements in quality, service, or
performance features vis-à-vis the products of rivals
 Over-differentiating the product quality, features, or service
levels exceeds the needs of most buyers
 Charging too high a price premium
 Cont’d

 Porter's Five Forces Model – Effective differentiators can remain

profitable even when the five forces appear unattractive.
 Rivalry – Brand loyalty means that customers will be less sensitive
to price increases, as long as the firm can satisfy the needs of its
customers (audiofiles).
 Suppliers – Because differentiators charge a premium price they
can more afford to absorb higher costs and customers are willing to
pay extra too.
 Entrants – Loyalty provides a difficult barrier to overcome.
Substitutes (trans. 4-26) – Once again brand loyalty helps combat
substitute products.
 iii. Focus(Market niche) Strategy

 Companies use focus strategy to concentrate on a particular

competitive segment by understanding the dynamics of that market and
the unique need of customers with it
 This help the companies to develop uniquely low cost or well
specific(unique) product for the market
 They tend to build strong brand loyalty among their customers.

Focused Strategy
Approaches
Focused Focused
Low-Cost Differentiatio
Strategy n Strategy
 iv. Focused Low-Cost Strategy

 It concentrate selling product at a low cost to a narrow target

segment
 The main objective is to serve the niche buyers better than the
rivals
 The features of the product offered are tailored according to the
need and taste of the niche buyers
 v. Focused differentiation Strategy

 Pursuing strategic differentiation within a focused market

 In Focused Low-Cost Strategy, a company aims to differentiate

its product within a small number of target market segments

 Focused Low-Cost Strategy is most effective when consumers

have different preference or requirements and when rival firms
are not attempting to specialize in the same target market
 Cont’d

Competitive risks of focus strategies

 The focuser firm may be ‘out focused’ by its competitors. A firm

competing on an industry-wide basis decides to pursue the niche

market of the focuser firm
 Erosion of cost advantages within the narrow segment

 Highly focused products and services are still subject to

competition from new entrants & from imitation

 Focusers can become too focused to satisfy buyer needs

 Customer preferences in the niche market may change to more

closely resemble those of the broader market
 iv) Best Cost Provider

 Is hybrid of low cost and differentiation strategies that aim at

providing desired quality/feature/performance/service attributes
while beating rivals on price

 Is also called Integrated Cost Leadership & Differentiation

Strategy

 The integrated strategy is an appropriate choice for firms

possessing the core competencies to produce somewhat
differentiated products at relatively low prices
 Cont’d

 It strives to give customers more values for the money by combing

an emphasis on lower cost with an emphasis on upscale
differentiation

 The objective is to create superior value by meeting or beating

customers’ expectation on product attributes and beating their price
expectations
 Cont’d

 Key to success for Integrated Cost Leadership &

Differentiation Strategy

 Match close competitors on key product attributes and beat them

on cost
 Expertise at incorporating upscale product attributes at a lower
cost than competitors
 Contain costs by providing customers a better product
 Cont’d

Competitive risks of the integrated cost leadership/differentiation

strategy

 Integrated strategy often involves compromises

 Becoming neither the lowest cost nor the most differentiated
firm i.e. ‘stuck in the middle’
 Stuck in the middle refers organizations that are unable to
develop a cost or differentiation advantage

 A best-cost provider may get squeezed between strategies of

firms using low-cost and differentiation strategies
Improving Competitive Position vis-à-vis the Five Forces

An overall focus strategy

 Creates higher entry  Reduces buyer power

barriers due to cost because the firm
leadership or provides specialized
differentiation or both products or services
 Can provide higher  Focused niches are less
margins that enable the vulnerable to substitutes
firm to deal with supplier
power

5-58
 b) Cooperative Strategies

 Cooperative strategies
 used to gain a competitive advantage within an industry by working
with other firms
 The two general types of cooperative strategies are collusion and
strategic alliances

1. Collusion
 Is the active cooperation of firms within an industry that enable firms
to reduce output and raise prices (i.e. to avoid economic law of supply
and demand)
 Collusion may be explicit or tacit
 Cont’d

2) Strategic alliances
 Strategic alliance exists whenever two or more independent
organizations co-operate in the development, manufacture, or sale
of products or services
 It is a long-term cooperative arrangement between two or more
independent firms or business units that engage in business activities
for mutual economic gain
 Cooperative arrangements fall along a continuum from weak and
distant to strong and close.
 Types of Alliances

i) Joint ventures: Company A and company B setting up company C to achieve a commonly

agreed purpose, while preserving their separate identity/autonomy

ii) Collaboration(for mutual service)

 Flexible alliance/partnership of similar companies in similar industries that pool their resources to gain a
benefit(that is too expensive to develop alone, such as access to technology) without necessarily forming
new company

iii) Mutual service consortium: the collaboration made by more than two companies
Example the collaboration among IBM, Sony Electronics, and Toshiba to pool their resources is an
example of a mutual service consortium.
iv) Licensing arrangement
 agreement in which the licensing firm grants rights to another firm in another country or market
to produce and/or sell a product

v) Value-chain partnership
 a strong and close alliance in which one company or unit forms a long-term arrangement with a key supplier
or distributor for mutual advantage
Strategic Alliance Success Factors
 3. Functional-level strategies

 Functional strategy is the approach a functional area takes to achieve

corporate and business unit objectives and strategies by maximizing
resource productivity.
 Are the short-term (not more than one year), goal-directed decisions
and actions of the organization’s various functional departments
 Functional-level strategies support the business-level strategy
 i.e., Marketing, operation, human resources, research and
development, and finance all support the business-level strategy
 Problems occur when employees or customers don’t understand a
company’s strategy
NB: THE DETAILS OF THIS SECTION IS LEFT AS READING ASSIGNMENT