How Can a Firm Determine Where to Initiate New Business? Use Gross Domestic Product (GDP) as a Guide.
Country
GDP Percent
2017 2018
United States 2.1 2.5
United Kingdom 1.5 1.4
Mexico 2.3 2.3
Japan 1.5 0.9
Germany 2.1 1.6
Canada 3.0 1.9
China 6.8 6.4
India 7.1 7.0
Thousands of companies and organizations desire to grow globally, but they are not sure where among the two-hundred-plus countries in the world. A key barometer for examining how to determine where to begin or expand company operations is gross domestic product (GDP) of various countries. GDP is a quanti- tative measure of a nation’s total economic output, growth, or activity over a specified period of time. According to a recent issue of Bloomberg Businessweek, the 2018 GDP will
be a bit less than 2017 for most countries, and the magical 4 per- cent number is expected only in India and China for the sample countries.
Caveat: GPD is important, but consumption habits are more im- portant. Does the foreign market value your product? If not, who cares about GDP? Market development allows for good risk/reward compared to other strategy types if consumption habits are similar in the targeted markets because the firm continues to focus on its core competency rather than entering businesses it knows less about.
Also, brand recognition can likely transfer to a new market more eas- ily when consumption habits are similar.
Source: Based on Peter Coy, “The World Economy Should Grow Nicely Again in 2018. (Unless Someone Does Something Dumb.)” Bloomberg Businessweek (November 6, 2017 to January 8, 2018):17.
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Automobile companies use product development extensively. Some old truck brands are making a comeback as Americans buy more pickups and SUVs. For example, the follow- ing brands are being reintroduced in the respective years given: Jeep Scrambler (2019), Jeep Wagoneer (2019), Chevy Blazer (2019), Ford Bronco (2020), Ford Ranger (2019), and Land Rover Defender (2019). The bulk of profits earned at Ford, GM, and Fiat Chrysler today come from pickups and SUVs.
Product development overall is an excellent option because a firm does not stray far from what it does best. The following five guidelines indicate when product development may be an especially effective strategy to pursue:10
1. An organization has successful products that are in the maturity stage of the product life cycle; the idea here is to attract satisfied customers to try new (improved) products as a re- sult of their positive experience with the organization’s present products or services.
2. An organization competes in an industry that is characterized by rapid technological developments.
3. Major competitors offer better-quality products at comparable prices.
4. An organization competes in a high-growth industry.
5. An organization has especially strong research and development capabilities.
Diversification Strategies
The two general types of diversification strategies are related diversification and unrelated diversification. Businesses are said to be related when their value chains possess competitively valuable cross-business strategic fits; businesses are said to be unrelated when their value chains are so dissimilar that few competitively valuable cross-business relationships exist.11 Most com- panies favor related diversification strategies to capitalize on synergies such as follows:
• Transferring competitively valuable expertise, technological know-how, or other capabili- ties from one business to another
• Combining related activities of separate businesses into a single operation to achieve lower costs
• Exploiting common use of a well-known brand name
• Cross-business collaboration to create competitively valuable resource strengths and capabilities12
Diversification strategies are becoming less popular because organizations are finding it more difficult to manage diverse business activities. In the 1960s and 1970s, the trend was to diversify to avoid being dependent on any single industry, but the 1980s saw a general reversal of that thinking. Diversification is still on the retreat. Michael Porter, of the Harvard Business School, commented, “Management found it couldn’t manage the beast.” Businesses are still selling, clos- ing, or spinning off less profitable or “different” divisions to focus on their core businesses. For example, ITT recently divided itself into three separate, specialized companies. At one time, ITT owned everything from Sheraton Hotels and Hartford Insurance to the maker of Wonder Bread and Hostess Twinkies. About the ITT breakup, analyst Barry Knap said, “Companies generally are not very efficient diversifiers; investors usually can do a better job of that by purchasing stock in a variety of companies.” Rapidly appearing new technologies, new products, and fast-shifting buyer preferences make diversification difficult. Another highly diversified company, General Electric, is selling off many of its diversified parts.
Diversification must do more than simply spread business risks across different industries;
after all, shareholders could accomplish this by simply purchasing equity in different firms across different industries or by investing in mutual funds. Diversification makes sense only to the ex- tent that the strategy adds more to shareholder value than what shareholders could accomplish acting individually. Any industry chosen for diversification must be attractive enough to yield consistently high returns on investment and offer potential synergies across the operating divi- sions that are greater than those entities could achieve alone. Many strategists contend that firms should “stick to the knitting” and not stray too far from the firms’ basic areas of competence.
A few companies today, however, pride themselves on being conglomerates, from small firms such as Pentair Inc. and Blount International to huge companies such as Textron, Berkshire Hathaway, Allied Signal, Emerson Electric, GE, Viacom, Amazon, Google, Disney, and Samsung.
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Conglomerates prove that focus and diversity are not always mutually exclusive. In an unattractive industry, diversification makes sense, such as for Philip Morris, because cigarette consumption is declining, product liability suits are a risk, and some investors reject tobacco stocks on principle.
Related Diversification
In a related diversification move, Walt Disney recently acquired 21st Century Fox’s film and TV stu- dios in a deal worth over $52 million. The deal included Fox-owned cable networks, including FX and National Geographic, and Fox’s stakes in international networks like Star TV, Sky, and Hulu.
Five guidelines reveal when related diversification may be an effective strategy to follow:13 1. An organization competes in a no-growth or a slow-growth industry.
2. Adding new, but related, products would significantly enhance the sale of current products.
3. New, but related, products could be offered at highly competitive prices.
4. New, but related, products have seasonal sales levels that counterbalance an organization’s existing peaks and valleys.
5. An organization has a strong management team.
Unrelated Diversification
An unrelated diversification strategy favors capitalizing on a portfolio of businesses that are capa- ble of delivering excellent financial performance in their respective industries, rather than striving to capitalize on strategic fit among the businesses. Firms that employ unrelated diversification continually search across different industries for companies that can be acquired for a deal and yet have potential to provide a high return on investment. Pursuing unrelated diversification entails being on the hunt to acquire companies whose assets are undervalued, companies that are finan- cially distressed, or companies that have high-growth prospects but are short on investment capital.
In an unrelated diversification move, Amazon.com is planning to enter the $412 billion phar- macy business. Today, 9 out of 10 patients pick up their prescriptions at a retail pharmacy, but Amazon is betting that home delivery of pharmaceuticals are soon to be the rule rather than the exception. Partly because of this external threat, CVS recently acquired the huge insurance firm, Aetna, Inc., in an unrelated diversification move targeted to offset their reliance on the drugstore industry, which as a whole has been experiencing faltering revenues and profits.
Five guidelines reveal when unrelated diversification may be an especially effective strategy follow:14
1. Existing markets for an organization’s present products are saturated.
2. An organization competes in a highly competitive or a no-growth industry, as indicated by low industry profit margins and returns.
3. An organization’s present channels of distribution can be used to market new products to current customers.
4. New products have countercyclical sales patterns compared to an organization’s present products.
5. An organization has the capital and managerial talent needed to compete successfully in a new industry.
Defensive Strategies
In addition to integrative, intensive, and diversification strategies, organizations also could pur- sue defensive strategies such as retrenchment, divestiture, or liquidation. Retrenchment is a broad term that can include divestiture and liquidation.
Retrenchment
Retrenchment occurs when an organization regroups through cost and asset reduction to re- verse declining sales and profits. Sometimes called a turnaround strategy, retrenchment is de- signed to fortify an organization’s basic distinctive competence. During retrenchment, strategists LO 5.6
work with limited resources and face pressure from shareholders, employees, and the media.
Retrenchment can involve selling off land and buildings to raise needed cash, pruning product lines, closing marginal businesses, closing obsolete factories, automating processes, reducing the number of employees, and instituting expense control systems.
Eli Lilly is cutting 8 percent of its global workforce mostly centered on the production and mar- keting of existing drugs that are nearing patent expiration because competition from lower-priced generics is forecasted to be fierce. Eli Lilly is deploying much of the salary savings into R&D of new drugs.
The world’s largest seller of generic drugs, Teva Pharmaceutical Industries is laying off 25 percent of its workforce, or about 14,000 employees around the world, and closing facto- ries and research centers, and suspending its dividend to cut costs. Headquartered in Tel Aviv, Israel, Teva expects its retrenchment strategy to save $3 billion in costs in 2018–2019.
The action-camera company, GoPro Inc. in 2018 laid off one-fifth of its workforce and ex- ited the drone market as part of the firm’s retrenchment strategy. As smartphone cameras and videos have improved, GoPro’s camera business has suffered.
In some cases, declaring bankruptcy can be an effective retrenchment strategy. Bankruptcy can allow a firm to avoid major debt obligations and to void union contracts. Chapter 7 bankruptcy is a liquidation procedure used only when a corporation sees no hope of being able to operate successfully or to obtain the necessary creditor agreement. All the organization’s assets are sold in parts for their tangible worth. Several hundred thousand companies declare Chapter 7 bankruptcy annually with most of the firms being small.
Chapter 11 bankruptcy allows organizations to retrench, reorganize, and come back after filing a petition for protection. About 40 large U.S. retail companies declared bankruptcy in both 2017 and 2018, up from 18 in 2016. Firms declaring bankruptcy in 2017 included RadioShack, Payless Shoes, The Limited, HHGregg, Rue 21, Gander Mountain, and Toys R Us. Other retail com- panies closing stores rapidly and possibly heading for bankruptcy include Gymboree, Bebe, Crocs, Gamestop, Sears/Kmart, J. C. Penney, Michael Kors, Staples, Macy’s, and Chico’s. A key problem for retail firms is shoppers’ discount addiction spurred by Amazon’s prowess and also smartphone- shopping tools and apps prompting never-ending price-cutting, price matching, and price wars. The dramatic shift to online purchasing has also severely curtailed the need for brick-and-mortar stores of all kinds.
Three guidelines reveal when retrenchment may be an especially effective strategy to pursue follow:15
1. An organization is plagued by inefficiency, low profitability, poor employee morale, and pressure from stockholders to improve performance.
2. An organization has failed to capitalize on external opportunities, minimize external threats, take advantage of internal strengths, and overcome internal weaknesses over time;
that is, when the organization’s strategic managers have failed (and possibly will be re- placed by more competent individuals).
3. An organization has grown so large so quickly that major internal reorganization is needed.
Divestiture
Selling a division or part of an organization is called divestiture. It is often used to raise capital for further strategic acquisitions or investments. Divestiture can be part of an overall retrenchment strategy to rid an organization of businesses that are unprofitable, that require too much capital, or that do not fit well with the firm’s other activities. Divestiture has also become a popular strategy for firms to refocus on their core businesses and become less diversified.
Volkswagen AG recently divested upward of 20 percent of the company’s assets that are not part of the firm’s core business including the potential sale of Ducati, the motorcycle brand.
Commonwealth Bank of Australia recently divested all of its life insurance businesses in Australia and New Zealand totaling more than $3 billion, partly in response to pressure from regulators in
the countries. Nestlé SA recently divested its U.S. chocolate segment to the Italian firm Ferrero International SA for $2.8 billion, making the family-owned Ferrero company the third-largest chocolate seller in the United States.
A form of divestiture occurs when a corporation splits into two or more parts. Most often, divested segments become separate, publicly traded companies. Many large conglom- erate firms are employing this strategy. Sometimes this strategy is a prelude to the firm selling the separated part(s) to a rival firm. Corporations annually split off about $2 trillion worth of subsidiaries. Part of the reason for splitting diversified firms is that the homogenous parts are generally much more attractive to potential buyers. Most times, the acquiring firms desire to promote homogeneity to complement their own operations, rather than heteroge- neity, and are willing to pay for homogeneity. For example, Nacco Industries is divesting its Hamilton Beach Brands appliances and a kitchen-accessory store chain in an effort to refocus on its core coal and mining businesses. Nacco’s revenues are about $900 million annually with Hamilton Beach bringing in about $605 million and Kitchen Collection about
$144 million. Similarly, Britain’s GKN PLC in 2018 split into two companies, separating its aerospace and automotive businesses. Based in Redditch, England, GKN is one of Britain’s oldest companies (250 years) and today has about 58,000 employees.
Another example is the German company Daimler AG in 2018 consolidating its five busi- ness divisions into three separately registered, wholly-owned subsidiary companies. Analysts expect the Daimler restructuring is a prelude for Daimler divesting (spinning off) the three seg- ments into separate publicly listed companies: (1) Mercedes-Benz cars and vans, (2) Daimler trucks and buses, and (3) Daimler Financial Services. Pfizer Inc. and Honeywell International Inc. recently divested several of their major business units, spinning them off into separate pub- licly listed companies.
Here are some guidelines for when divestiture may be an especially effective strategy to pursue:16 1. An organization has pursued a retrenchment strategy and failed to accomplish needed
improvements.
2. A division is responsible for an organization’s overall poor performance.
3. A division is a misfit with the rest of an organization; this can result from radically differ- ent markets, customers, managers, employees, values, or needs.
4. A large amount of cash is needed quickly and cannot be obtained reasonably from other sources.
5. Government antitrust action threatens an organization.
Liquidation
Selling all of a company’s assets, in parts, for their tangible worth is called liquidation.
Liquidation is a recognition of defeat and consequently can be an emotionally difficult strat- egy. However, it may be better to cease operating than to continue losing large sums of money Chapter 7 bankruptcy is a liquidation procedure used only when a corporation sees no hope of being able to operate successfully or to obtain the necessary creditor agreement. All the organi- zation’s assets are sold in parts for their tangible worth. Several hundred thousand companies declare Chapter 7 bankruptcy annually with most of the firms being small.
The legendary, world famous, Ringling Bros. and Barnum & Bailey circus liquidated in 2017 after 146 years in business because of “declining tickets sales and high operating costs.”
The final circus performances were in Providence, Rhode Island, on May 7 and Uniondale, New York, on May 21, 2017. In May 2016, the circus had previously retired its elephant act, years after a suit by activists. The animal rights group PETA says “we herald the end of what has been the saddest show on earth for wild animals, and ask all other animal circuses to follow suit, as this is a sign of changing times.” PETA President Ingrid Newkirk says “our protests have awoken the world to the plight of animals in captivity.” The Ringling Bros. and Barnum &
Bailey circus went by the slogan: “The greatest show on earth,” a catchphrase so famous it was employed for the title of the 1952 Cecil B. DeMille best picture Oscar-winning film starring Charlton Heston and Betty Hutton. For more than 100 years, schools would close in towns and cities when Ringling Bros. and Barnum & Bailey came to town; those days are long gone.
The American iconic toy store chain Toys “R” Us Inc. in 2018 liquidated, selling or clos- ing all its 885 U.S. stores deleting about 33,000 jobs. The company is likely to liquidate also in France, Spain, Poland, and Australia. The company hopes to sell its operation in Canada, Central Europe, and Asia.
Two guidelines reveal when liquidation may be an especially effective strategy to pursue:17 1. An organization has pursued both a retrenchment strategy and a divestiture strategy, and
neither has been successful.
2. The stockholders of a firm can minimize their losses by selling the organization’s assets.
Value Chain Analysis and Benchmarking
Whenever a customer buys a product it is because that consumer feels the “value” to be derived from that product in terms of price paid versus benefits received is worthwhile. However, the ultimate price paid by a consumer for a product is determined from scores of activities that went into producing that product, from raw materials to suppliers, to production processes, to distribu- tors, etc. This collection of activities that leads to the ultimate price of a product is commonly referred to as a firm’s value chain.18 Firm’s seek competitive advantages anywhere they can up and down their value chain, to ultimately provide some product at some price and some level of quality that consumers will perceive to be of sufficient value to warrant the purchase. The value chain concept, as illustrated in Figure 5-3, is important in strategic management.
Value chain analysis (VCA) can be defined as the process whereby a firm determines the value (price minus cost) of each and all activities that went into producing and marketing a prod- uct, from purchasing raw materials to manufacturing, distributing, and marketing those products.
VCA is an excellent way to identify both external opportunities/threats and internal strengths/
weaknesses of a firm. Companies strive to gain competitive advantages wherever possible up and down their value chain, because such “value activities” are not easily duplicated or imitable by rival firms. In contrast, just lowering the price of an end product or hiring a celebrity to promote an end product is easily imitable; such actions do not represent a sustainable competitive advan- tage. In other words, at every step along a firm’s value chain, the firm strives to create value (price
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VALUE CHAIN Company
Supplier
Distribution Customer
FIGURE 5-3
A Value Chain Illustrated
minus cost) that can ultimately be transferred to the end user (customers), so customers will buy the product at some price to obtain the perceived value.
Substantial judgment may be required in performing a VCA because different items along the value chain may impact other items positively or negatively, at times creat- ing complex interrelationships. For example, exceptional customer service may be es- pecially expensive yet may reduce the costs of returns and increase revenues. Cost and price differences among rival firms can have their origins in activities performed by sup- pliers, distributors, creditors, or even shareholders.
The initial step in implementing VCA is to divide a firm’s operations into specific activities or business processes. Then the analyst attempts to attach a cost of each discrete activity versus the price to be paid; the costs could be in terms of both time and money.
Finally, the analyst converts the “value data” into information by looking for competitive oppotunities/threats and/or strengths/weaknesses that may yield competitive advantage or disadvantage. Conducting a VCA is supportive of the research-based view’s examina- tion of a firm’s assets and capabilities as sources of distinctive competence.
When a major competitor or new market entrant offers products or services at low prices, this may be because that firm has substantially lower value chain costs or perhaps the rival firm is just waging a desperate attempt to gain sales or market share. VCA en- ables a firm to examine and monitor the extent that its prices and costs are competitive throughout the value chain; those value segments lead cumulatively to the customers’
perceived value received by paying some price for some end product.
A value chain is illustrated in Figure 5-4. There can be more than a hundred particu- lar value-creating activities associated with the business of producing and marketing a product or service, and each one of the activities can represent a sustainable competitive advantage or disadvantage for the firm. The combined costs of all the various activities in a company’s value chain define the firm’s cost of doing business. Firms should deter- mine where cost advantages and disadvantages in their value chain occur relative to the value chain of rival firms.
Value chains differ immensely across industries and firms. Whereas a paper prod- ucts company, such as Stone Container, would include on its value chain timber farm- ing, logging, pulp mills, and papermaking, a company such as Hewlett-Packard would include programming, peripherals, mining of metals, licensing, software, hardware, and laptops. A motel would include food, housekeeping, check-in and check-out operations, website, reservations system where they order supplies and so on.
All firms should use VCA to develop and nurture a core competence and convert this competence into a distinctive competence. A core competence is any element of a firm's value chain that performs especially well (yields high value). When a core compe- tence evolves into a major competitive advantage, then it is called a distinctive compe- tence. Figure 5-5 illustrates this process.
More and more companies are using VCA to gain and sustain competitive advantage by becoming especially efficient and effective along various parts of the value chain. For example, Walmart has built powerful value advantages by focusing on exceptionally tight inventory control and volume purchasing of products. In contrast, computer companies compete aggressively along the distribution end of the value chain. Price competitive- ness is a key component of competitiveness for both mass retailers and computer firms.
To gain and sustain competitive advantage, a firm must create value for a product or service that exceeds the value offered by rivals.19 This is commonly done in one of two ways: (1) operating at the lowest cost, or (2) commanding a premium price. A few firms try to do both simultaneously. The bottom line, however, is that a business needs to be better than rivals on many points along its value chain because these points likely cannot be easily copied, thus they are sustainable. Rival firms ask, “How do they do it?” The answer for many successful firms is “through effective value chain analysis.”
VCA focuses on the quality differences in activities among rival firms. Not all firms in a given industry will place equal weights on various value chain items. For exam- ple, Rolex and Timex both produce watches, yet each value chain will differ substan- tially on key areas. Rolex creates value for the customer through prestige and elegance, whereas Timex creates value through price and utility. Each firm creates value so long
Supplier Costs
Production Costs
Distribution Costs
Sales and Marketing Costs
Customer Service Costs
Management Costs Raw materials Fuel Energy Transportation Truck drivers Truck maintenance Component parts Inspection Storing Warehouse Inventory system Receiving Plant layout Maintenance Plant location Computer R&D
Cost accounting Loading Shipping Budgeting Personnel Internet Trucking Railroads Fuel Maintenance Salespersons Website Internet Publicity Promotion Advertising Transportation Food and lodging Postage Phone Internet Warranty Human resources Administration Employee benefits Labor relations Managers Employees Finance and legal
FIGURE 5-4
An Example Value Chain for a Typical Manufacturing Company