Vertical Integration Case Study

7

Strategic
Position

Business

Corporate

Strategic
Choices

Innovation

International

Strategy in Action

Acquisitions
& Alliances

CORPORATE STRATEGY AND
DIVERSIFICATION

Learning objectives
After reading this chapter, you should be able to:

Key terms

●

Identify alternative strategy options, including market penetration, product development, market development and diversification. ●

Distinguish between different diversification strategies (related and conglomerate diversification) and evaluate diversification drivers. ●

Assess the relative benefits of vertical integration and outsourcing. ●

Analyse the ways in which a corporate parent can add or destroy value for its portfolio of business units.

●

Analyse …show more content…
portfolios of business units and judge which to invest in and which to divest.

Backward integration p. 240
BCG matrix p. 249
Cash cow p. 250
Conglomerate (unrelated) diversification p. 233
Diversification p. 232
Dogs p. 250
Dominant logic p. 238
Economies of scope p. 237
Forward integration p. 240
Market development p. 235
Market penetration p. 234
Outsourcing p. 241
Parental developer p. 248
Portfolio manager p. 247
Product development p. 234
Question mark p. 250

MyStrategyLab is designed to help you make the most of your studies.

Related diversification p. 232
Scope p. 231

Visit www.pearsoned.co.uk/mystrategylab to discover a wide range of resources speciﬁc to this chapter, including:

Star p. 250

• A personalised Study plan that will help you understand core concepts

Synergy p. 238

• Audio and video clips that put the spotlight on strategy in the real world Synergy manager p. 248
Vertical integration p. 240

• Online glossaries and flashcards that provide helpful reminders when you’re looking for some quick revision.

INTRODUCTION

7.1 INTRODUCTION hapter 6 was concerned with choices at the level of single business or organisational units, for instance through pricing strategies or differentiation. This chapter is about choices of products and markets for an organisation to enter or exit (see the ﬁgure in the Part II introduction). Organisations often choose to enter many new product and market areas. For example, the Virgin Group started out in the music business, but is now highly diverse, operating in the holiday, cinema, retail, air-travel and rail markets. Sony began by making small radios, but now produces games, music and movies, as well as a host of electronic products. As organisations add new units, their strategies are no longer concerned just with the business-level, but with the corporate-level choices involved in having many different businesses or markets.
Figure 7.1 indicates the basic themes of this chapter. First of all, there are questions to do with the scope, or breadth, of the corporate whole. Scope is concerned with how far an organisation should be diversiﬁed in terms of products and markets. Here a basic framework is provided by Ansoff’s two axes, indicating different diversiﬁcation strategies according to novelty of products or markets. Another way of increasing the scope of an organisation is through vertical integration, where the organisation acts as an internal supplier or a customer to itself (as for example an oil company supplies its petrol to its own petrol stations). Here we also consider the possibility of outsourcing, where an organisation ‘dis-integrates’ by subcontracting an internal activity to an external supplier.
Scope raises the two other key themes of the chapter. First, given that an organisation has decided to operate in different areas of activity, what should be the role of the ‘corporate-level’
(head-ofﬁce) executives that act as ‘parents’ to the individual business units that make up their organisation’s portfolio? How do corporate-level activities, decisions and resources add value to the actual businesses? As will be seen in the Key Debate at the end of this chapter, there is considerable scepticism about the value-adding role of corporate-level strategy. The second theme is, within an overall diversiﬁcation strategy, which speciﬁc business units should be included in the corporate portfolio, and how should they be managed ﬁnancially? Here portfolio matrices help structure corporate-level choices about which businesses to invest in and which to divest.

C

Figure 7.1 Strategic directions and corporate-level strategy

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ned. co.uk /myst rso 7.2 STRATEGY DIRECTIONS

ab egyl rat

www.p ea This chapter is not just about large commercial businesses. Even small businesses may consist of a number of business units. For example, a local builder may be undertaking contract work for local government, work for industrial buyers and for local homeowners. Not only are these different market segments, but the mode of operation and capabilities required for competitive success are also likely to be different. Moreover, the owner of that business has to take decisions about the extent of investment and activity in each segment. Public-sector organisations such as local government or health services also provide different services, which correspond to business units in commercial organisations. Corporate-level strategy is highly relevant to the appropriate drawing of organisational boundaries in the public sector, and privatisation and outsourcing decisions can be considered as responses to the failure of public-sector organisations to add sufﬁcient value by their parenting.

KEY
CONCEPT
Strategy directions The Ansoff product/market growth matrix1 provides a simple way of generating four basic directions for corporate strategy: see Figure 7.2 for an adapted version. An organisation typically starts in the zone around point A, the top left-hand corner of Figure 7.2. According to Ansoff, the organisation basically has a choice between penetrating still further within its existing sphere (staying in zone A) or increasing its diversity along the two axes of increasing novelty of markets or increasing novelty of products. Diversification involves increasing the range of products or markets served by an organisation. Related diversification involves diversifying into products or services with relationships to the existing business. Thus on
Ansoff’s axes the organisation has two related diversiﬁcation strategies available: moving rightwards by developing new products for its existing markets (zone B) or moving downwards

Figure 7.2 Corporate strategy directions

Source: Adapted from H.I. Ansoff, Corporate Strategy, Penguin, 1988, Chapter 6.
Ansoff originally had a matrix with four separate boxes, but in practice strategic directions involve more continuous axes. The Ansoff matrix itself was later developed – see Reference 1.

STRATEGY DIRECTIONS

233

ILLUSTRATION 7.1

Corporate strategy choices for Axel Springer
This German publishing company has many opportunities, and the money to pursue them.

In 2007, Mathias Döpfner, chairman and chief executive of Axel Springer publishers, had about a2bn
($2.8bn) to invest in new opportunities. The previous year, the competition authorities had prohibited his take-over of Germany’s largest television broadcaster,
ProSiebenSat.1 . . . Now Döpfner was looking for alternative directions.
Founded in 1946 by Axel Springer himself, by 2007 the company was already Germany’s largest publisher of newspapers and magazines, with more than
10,000 employees and over 150 titles. Famous print titles included Die Welt, the Berliner Morgenpost,
Bild and Hörzu. Outside Germany, Axel Springer was strongest in Eastern Europe. The company also had a scattering of mostly small investments in German radio and television companies. Axel Springer described its strategic objectives as market leadership in the
German language core business, internationalisation and digitalisation of the core business.
Döpfner had opportunities for further penetration with his existing markets and products. Increased digitalisation of the core newspapers and magazines business was clearly important and would require substantial funding. There were also opportunities for the launch of new print magazine titles in the
German market.
However, Döpfner was considering expanding also into new markets and new products. Such moves

would likely involve acquisitions: ‘it goes without saying’, he told the Financial Times, ‘that whenever a large international media company comes on to the market (i.e. is up for sale), we will examine it very closely – whether in print, TV or the online sector’.
Döpfner mentioned several specific kinds of acquisition opportunity. For example, he was still interested in buying a large European television broadcaster, even if it would probably have to be outside Germany.
He was also attracted by the possibility of buying under-valued assets in the old media (i.e. print), and turning them around in the style of a private-equity investor: ‘I would love to buy businesses in need of restructuring, where we can add value by introducing our management and sector expertise’. However,
Döpfner reassured his shareholders by affirming that he felt no need ‘to do a big thing in order to do a big thing’.
Main source: Financial Times Deutschland, 2 April 2007.

Questions
1 Referring to Figure 7.2, classify the various strategic directions Mattias Döpfner is considering for Axel Springer.
2 Using the Ansoff axes, what other options could Döpfner pursue?

by bringing its existing products into new markets (zone C). In each case, the further along the two axes, the more diversiﬁed is the strategy. Alternatively, the organisation can move in both directions at once, following a conglomerate diversiﬁcation strategy with altogether new markets and new products (zone D). Thus conglomerate (unrelated) diversification involves diversifying into products or services with no relationships to the existing businesses.
Ansoff’s axes can be used effectively in brainstorming strategic options, checking that options in all four zones have been properly considered. This section will consider each of
Ansoff’s four main directions in some detail. Section 7.5 will examine the additional option of vertical integration.

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7.2.1 Market penetration
For a simple, 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. This strategy builds on established strategic capabilities and does not require the organisation to venture into uncharted territory. The organisation’s scope is exactly the same. Moreover, greater market share implies increased power vis-à-vis buyers and suppliers (in terms of Porter’s ﬁve forces), greater economies of scale and experience curve beneﬁts.
However, organisations seeking greater market penetration may face two constraints:
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Retaliation from competitors. In terms of the ﬁve forces (section 2.3.1), increasing market penetration is likely to exacerbate industry rivalry as other competitors in the market defend their share. Increased rivalry might involve price wars or expensive marketing battles, which may cost more than any market-share gains are actually worth. The dangers of provoking ﬁerce retaliation are greater in low-growth markets, as any gains in volume will be much more at the expense of other players. Where retaliation is a danger, organisations seeking market penetration need strategic capabilities that give a clear competitive advantage.
In low-growth or declining markets, it can be more effective simply to acquire competitors.
Some companies have grown quickly in this way. For example, in the steel industry the
Indian company LNM (Mittal) moved rapidly in the 2000s to become the largest steel producer in the world by acquiring struggling steel companies around the world. Acquisitions can actually reduce rivalry, by taking out independent players and controlling them under one umbrella.

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Legal constraints. Greater market penetration can raise concerns from ofﬁcial competition regulators concerning excessive market power. Most countries have regulators with the powers to restrain powerful companies or prevent mergers and acquisitions that would create such excessive power. In the United Kingdom, 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. For example, when the German T-Mobile and French Orange companies proposed to merge their UK mobile phone operations in 2010, the European
Commission insisted that the merged companies should divest a quarter of their combined share of the key mobile phone 1800 MHz spectrum.2

Market penetration may not be an option too where economic constraints are severe, for instance during a market downturn or public-sector funding crisis. Here organisations will need to consider the strategic option of retrenchment, withdrawal from marginal activities in order to concentrate on the most valuable segments and products within their existing business. However, where growth is still sought after, the Ansoff axes suggest further directions, as follows. 7.2.2 Product development
Product development is where organisations deliver modiﬁed or new products (or services) to existing markets. This can involve varying degrees of diversiﬁcation along the rightward axis of Figure 7.2. For Sony, developing its Walkman products from the original tape-based

STRATEGY DIRECTIONS

product, through CDs and recently to MP3s involved little diversiﬁcation: although the technologies differed, Sony was targeting the same customers and using very similar production processes and distribution channels. A more radical form of product development would be
Axel Springer’s move into the online media businesses: effectively the same consumer markets are involved as for its existing newspaper and magazine businesses, but the production technologies and distribution channels are radically different (see Illustration 7.1). This form of product diversiﬁcation would typically be described as related diversiﬁcation, as Axel Springer’s online business would be related through similar customers to its existing newspaper and magazine customers.
Despite the potential for relatedness, product development can be an expensive and highrisk activity for at least two reasons:
●

New strategic capabilities. Product development strategies typically involve mastering new processes or technologies that are unfamiliar to the organisation. For example, many banks entered online banking at the beginning of this century, but suffered many setbacks with technologies so radically different from their traditional high-street branch means of delivering banking services. Success frequently depended on a willingness to acquire new technological and marketing capabilities, often with the help of specialised information technology and e-commerce consultancy ﬁrms. Thus product development typically involves heavy investments and high risk of project failures.

●

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. An extreme example is Boeing’s Dreamliner 787 plane: making innovative use of carbon-ﬁbre composites, the Dreamliner had incurred two and a half years of delay by launch in 2010, and required $2.5bn (~x1.75bn) write-offs due to cancelled orders.

Strategies for product development are considered further in Chapter 9.

7.2.3 Market development
If product development is risky and expensive, an alternative strategy is market development.
Market development involves offering existing products to new markets. Again, the degree of diversiﬁcation varies along Figure 7.2’s downward axis. Typically, of course, market development entails some product development as well, if only in terms of packaging or service.
Nonetheless, market development remains a form of related diversiﬁcation given its origins in similar products. Market development takes two basic forms:
●

New users. Here an example would be aluminium, whose original users, packaging and cutlery manufacturers, are now supplemented by users in aerospace and automobiles.

●

New geographies. The prime example of this is internationalisation, but the spread of a small retailer into new towns would also be a case.

In all cases, 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 2.4.3). Strategies based on simply off-loading traditional products or services in new markets are likely to fail.
Moreover, market development faces similar problems to product development. In terms of strategic capabilities, market developers often lack the right marketing skills and brands to

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ILLUSTRATION 7.2

Zodiac deflates: diversification and de-diversification
The Zodiac Group has managed a portfolio of related business for the best part of a century, with both diversification and de-diversification.

The Zodiac Group is probably best known for its Zodiac inflatable boats, used by Jacques Cousteau and seen in harbours around the world. But in 2007, Zodiac sold all its marine and leisure businesses and concentrated on aerospace.
The Zodiac company was founded in 1896 by Maurice
Mallet just after his first hot-air balloon ascent. For
40 years, Zodiac manufactured only dirigible airships.
In 1937, the German Zeppelin Hindenburg crashed near New York, which abruptly stopped the development of the market for airships. Because of the extinction of its traditional activity, Zodiac decided to leverage its technical expertise and moved from dirigible airships to inflatable boats. This diversification proved to be very successful: by 2004, over one million Zodiac rubber inflatables had sold worldwide.
However, because of increasing competition, especially from Italian manufacturers, Zodiac had been diversifying its business interests. In 1978, it took over Aerazur, a company specialising in parachutes, but also in life vests and inflatable life rafts. These products had strong market and technical synergies with rubber boats and their main customers were aircraft manufacturers. Zodiac confirmed this move to a new market in 1987 by the takeover of Air
Cruisers, a manufacturer of inflatable escape slides for aeroplanes. As a consequence, Zodiac became a key supplier to Boeing, McDonnell Douglas and
Airbus. Zodiac strengthened this position through the takeover of the two leading manufacturers of aeroplane seats: Sicma Aero Seats from France and Weber Aircraft from the USA. In 1997, Zodiac also took over, for a150m (~$210m), MAG Aerospace, the world leader for aircraft vacuum waste systems.
In 1999, Zodiac took over Intertechnique, a leading player in active components for aircraft (fuel circulation, hydraulics, oxygen and life support, electrical power, flight-deck controls and displays, systems monitoring, etc.). By combining these competences with its traditional expertise in inflatable products,
Zodiac launched a new business unit: airbags for the automobile industry.

In parallel to these diversifications, Zodiac strengthened its position in inflatable boats by the takeover of several competitors: BombardL’Angevinière in 1980, Sevylor in 1981, Hurricane and Metzeler in 1987. The company also developed a swimming-pool business. The first product line, back in 1981, was based on inflatable structure technology, and Zodiac later moved – again through takeovers – to rigid above-ground pools, modular inground pools, pool cleaners and water purification systems, inflatable beach gear and air mattresses.
However, by 2007, aircraft products accounted for
80 per cent of the total turnover of the group. Zodiac held a 40 per cent market share of the world market for some airline equipment: for instance, the electrical power systems of the new Airbus A380 and Boeing
787 were Zodiac products. Zodiac had even reached
Mars: NASA Mars probes Spirit and Opportunity were equipped with Zodiac equipment, developed by its US subsidiary Pioneer Aerospace.
Chief Executive Jean-Louis Gérondeau explained the sale of the marine and leisure businesses thus:
‘The proposed transaction . . . would allow the Zodiac
Group . . . to reinforce its acquisition capabilities in the aerospace sector’. However, the sale was also a response to pressure from financial analysts, who considered Zodiac too diversified. The sale was rapidly followed in 2008 by three further acquisitions of aircraft cabin equipment companies: Driessen,
Adder and TIA.
Source: Based on an illustration by Frédéric Fréry, ESCP Europe
Business School.

Questions
1 Explain the ways in which relatedness informed Zodiac’s diversification strategy over time.
2 What are the advantages and potential dangers of its decision to focus on the aircraft products market?

DIVERSIFICATION DRIVERS

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.
International market development strategy is considered in Chapter 8.

7.2.4 Conglomerate diversification
Conglomerate (or unrelated) diversiﬁcation takes the organisation beyond both its existing markets and its existing products (i.e. zone D in Figure 7.2). In this sense, it radically increases the organisation’s scope. Conglomerate diversiﬁcation strategies are not trusted by many observers, because there are no obvious ways in which the businesses are better off for being together, while there is a clear cost in the managers at headquarters who control them. For this reason, conglomerate companies’ share prices often suffer from what is called the ‘conglomerate discount’ – in other words, a lower valuation than the individual constituent businesses would have if stand-alone. In 2009, the French conglomerate Vivendi, with wide interests in mobile telephony and media, was trading at an estimated discount of 24 per cent on the value of its constituent assets. Naturally, shareholders were pressurising management to sell off its more highly valued parts on the open market.
However, it is important to recognise that the distinction between related and unrelated conglomerate diversiﬁcation is often a matter of degree. Also relationships might turn out not to be so valuable as expected. Thus the large accounting ﬁrms have often struggled in translating their skills and client contacts developed in auditing into effective consulting practices.
Similarly, relationships may change in importance over time, as the nature of technologies or customers change: see for example the decision by Zodiac to divest itself of its iconic boat business (Illustration 7.2).

7.3 DIVERSIFICATION DRIVERS
Diversiﬁcation might be chosen for a variety of reasons, some more value-creating than others.3 Growth in organisational size is rarely a good enough reason for diversiﬁcation on its own: growth must be proﬁtable. Indeed, growth can often be merely a form of ‘empire building’, especially in the public sector. Diversiﬁcation decisions need to be approached sceptically.
Four potentially value-creating drivers for diversiﬁcation are as follows.
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Exploiting economies of scope. Economies of scope refers to efﬁciency gains through applying the organisation’s existing resources or competences to new markets or services.4 If an organisation has under-utilised 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. In other words, there are economies to be gained by extending the scope of the organisation’s activities. For example, many universities have large resources in terms of halls of residence, which they must have for their students but which are under-utilised out of term-time. These halls of residence are more efﬁciently used if the universities expand the scope of their activities into conferencing and tourism during vacation 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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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

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managers (referred to as ‘corporate parenting skills’ in section 7.6) to new businesses. The dominant logic is the set of corporate-level managerial competences applied across the portfolio of businesses.5 Corporate-level managers may have competences that can be applied even to businesses which do not share resources at the operating-unit level. Thus the French luxury-goods conglomerate LVMH includes a wide range of businesses – from champagne, through fashion and perfumes, to ﬁnancial media – that share very few operational resources or business-level competences. However, LVMH creates value for these specialised companies by applying corporate-level competences in developing classic brands and nurturing highly creative people that are relevant to all its individual businesses. See also the discussion of dominant logic at Berkshire Hathaway in Illustration 7.4 later.
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Exploiting superior internal processes. Internal processes within a diversiﬁed corporation can often be more efﬁcient than external processes in the open market. This is especially the case where external capital and labour markets do not yet work well, as in many developing economies. In these circumstances, well-managed conglomerates can make sense, even if their constituent businesses do not have operating relationships with each other. For example, China has many conglomerates because they are able to mobilise investment, develop managers and exploit networks in a way that stand-alone Chinese companies, relying on imperfect markets, cannot. For example, China’s largest privately owned conglomerate, the Fosun Group, owns steel mills, pharmaceutical companies and China’s largest retailer, Yuyuan Tourist Mart.6

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Increasing market power.7 Being diversiﬁed in many businesses can increase power vis-à-vis competitors in at least two ways. First, having the same wide portfolio of products as a competitor increases the potential for mutual forbearance. The ability to retaliate across the whole range of the portfolio acts to discourage the competitor from making any aggressive moves at all. Two similarly diversiﬁed competitors are thus likely to forbear from competing aggressively with each other.
Second, having a diversiﬁed range of businesses increases the power to cross-subsidise one business from the proﬁts of the others. On the one hand, the ability to cross-subsidise can support aggressive bids to drive competitors out of a particular market. On the other hand, knowing this power to cross-subsidise a particular business, competitors without equivalent power will be reluctant to attack that business.

Where diversiﬁcation creates value, it is described as ‘synergistic’.8 Synergy refers to the 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). Thus a ﬁlm company and a music publisher would be synergistic if they were worth more together than separately.
However, synergies are often harder to identify and more costly to extract in practice than managers like to admit.9
Indeed, some drivers for diversiﬁcation involve negative synergies, in other words value destruction. Three potentially value-destroying diversiﬁcation drivers are:
●

Responding to market decline is one common but doubtful driver for diversiﬁcation.
Rather than let the managers of a declining business invest spare funds in a new business, conventional ﬁnance theory suggests it is usually best to let shareholders ﬁnd new growth investment opportunities for themselves. For example, it is arguable that Microsoft’s diversiﬁcation into electronic games such as the Xbox – whose launch cost $500m
(~x350m) in marketing alone – is a response to declining prospects in its core Windows operating systems business. But if future proﬁts in the core business are likely to be low,

DIVERSIFICATION AND PERFORMANCE

shareholders might prefer Microsoft simply to hand back the surplus directly to them, rather than spending it on attacking strong companies such as Sony and Nintendo. If shareholders had wanted to invest in the games business, they could have invested in the original dominant companies themselves.
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Spreading risk across a range of markets is another common justiﬁcation for diversiﬁcation.
Again, conventional ﬁnance theory is very sceptical about risk-spreading by diversiﬁcation.
Shareholders can easily spread their risk by taking small stakes in dozens of very different companies themselves. Diversiﬁcation strategies, on the other hand, are likely to involve a limited range of fairly related markets. While managers might like the security of having more than one market, shareholders typically do not need each of the companies they invest in to be diversiﬁed as well – they would prefer managers to concentrate on managing their core business as well as they can. However, conventional ﬁnance theory does not apply to private businesses, where the owners have a large proportion of their assets tied up in their company: here it can make sense to diversify risk across a number of distinct activities, so that if one part is in trouble, the whole business is not pulled down.

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Managerial ambition can sometimes drive inappropriate diversiﬁcation. It is argued that the managers of British banks such as Royal Bank of Scotland (at one point the ﬁfth largest bank in the world) and HBOS (Britain’s largest housing-lender) promoted strategies of excessive growth and diversiﬁcation into new markets during the ﬁrst decade of the 21st century.
Such growth and diversiﬁcation gave the managers short-term beneﬁts in terms of managerial bonuses and prestige. But going beyond their areas of true expertise soon brought ﬁnancial disaster, leading to the nationalisation of RBS and the takeover of HBOS by rival
Lloyds bank.

7.4 DIVERSIFICATION AND PERFORMANCE
Because most large corporations today are diversiﬁed, but also because diversiﬁcation can sometimes be in management’s self-interest, many scholars and policy-makers have been concerned to establish whether diversiﬁed companies really perform better than undiversiﬁed companies. After all, it would be deeply troubling if large corporations were diversifying simply to spread risk for managers, to save managerial jobs in declining businesses or to generate short-term growth, as in the case of RBS and HBOS.
Research studies of diversiﬁcation have particularly focused on the relative beneﬁts of related diversiﬁcation and conglomerate or unrelated diversiﬁcation. Researchers generally ﬁnd that related or limited diversiﬁers outperform both ﬁrms that remain specialised and those which have unrelated or extensively diversiﬁed strategies.10 In other words, the diversiﬁcation–performance relationship tends to follow an inverted (or upside-down) U-shape, as in Figure 7.3. The implication is that some diversiﬁcation is good – but not too much.
However, these performance studies produce statistical averages. Some related diversiﬁcation strategies fail – as in the case of some accounting ﬁrms’ ventures in consulting – while some conglomerates succeed – as in the case of LVMH. The case against unrelated diversiﬁcation is not solid, and effective dominant logics or particular national contexts can play in its favour. The conclusion from the performance studies is that, although on average related diversiﬁcation pays better than unrelated, any diversiﬁcation strategy needs rigorous questioning on its particular merits.

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Figure 7.3 Diversity and performance

7.5 VERTICAL INTEGRATION
As well as diversiﬁcation, another direction for corporate strategy can be vertical integration.
Vertical integration describes entering activities where the organisation is its own supplier or customer. Thus it involves operating at another stage of the value network (see section 3.4.2).
This section considers both vertical integration and vertical dis-integration, particularly in the form of outsourcing.

7.5.1 Forward and backward integration
Vertical integration can go in either of two directions:
●

Backward integration refers to development into activities concerned with the inputs into the company’s current business (i.e. they are further back in the value network). For example, the acquisition by a car manufacturer of a component supplier would be a backward integration move.

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Forward integration refers to development into activities concerned with the outputs of a company’s current business (i.e. are further forward in the value network). For a car manufacturer, forward integration would be into car retail, repairs and servicing.

Thus vertical integration is like diversiﬁcation in increasing corporate scope. The difference is that it brings together activities up and down the same value network, while diversiﬁcation typically involves more or less different value networks. However, because realising synergies involves bringing together different value networks, diversiﬁcation (especially related diversiﬁcation) is sometimes also described as horizontal integration. For example, a company diversiﬁed in cars, trucks and buses could ﬁnd beneﬁts in integrating aspects of the various design or component-sourcing processes. The relationship between horizontal integration and vertical integration is depicted in Figure 7.4.

VERTICAL INTEGRATION

Figure 7.4 Diversification and integration options: car manufacturer example

Vertical integration is often favoured because it seems to ‘capture’ more of the proﬁts in a value network. The car manufacturer gains the retailer’s proﬁts as well. However, it is important to be aware of two dangers. First, 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. Second, even if there is a degree of relatedness through the value network, vertical integration is likely to involve quite different strategic capabilities. Thus car manufacturers who forwardly integrate into car service and repair have found that managing networks of small service outlets is very different to managing large manufacturing plants.
Growing appreciation of both the risks of diluting overall returns on investment and the distinct capabilities involved at different stages of the value network has led many companies in recent years to vertically dis-integrate.

7.5.2 To integrate or to outsource?
As above, it is often proposed to replace vertically integrated operations by outsourcing or subcontracting. Outsourcing is the process by which activities previously carried out internally are subcontracted to external suppliers. Outsourcing can refer to the subcontracting of components in manufacturing, but is now particularly common for services such as information technology, customer call centres and human resource management. The argument for outsourcing to specialist suppliers is often based on strategic capabilities. Specialists in a particular activity are likely to have superior capabilities than an organisation for which that particular activity is not a central part of their business. A specialist IT contractor is usually better at IT than the IT department of a steel company.
However, Nobel prize-winning economist Oliver Williamson has argued that the decision to integrate or outsource involves more than just relative capabilities. His transaction cost

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ILLUSTRATION 7.3

Deadly outsourcing? The Ministry of Defence under pressure The UK’s Ministry of Defence faces a dilemma over whether to outsource more of its support services, possibly at the expense of the safety of its own personnel.
Under pressure from budget cuts, and still committed to an expensive war in Afghanistan, in November
2009 the United Kingdom’s Ministry of Defence (MoD) was planning to outsource more of its logistics and equipment support. This announcement came just one month after the publication of the official report on the 2006 Nimrod military aircraft crash, in which
14 personnel had died. The chairman of the inquiry,
Charles Haddon-Cave, had castigated the MoD for
‘lamentable’ safety procedures. But he had also criticised two private-sector contractors, BAE Systems and Qinetiq, who had been involved in the safety checks for the doomed Nimrod aircraft. HaddonSmith complained: ‘there has been a shift in culture and priorities at the MoD towards business and financial targets at the expense of. . . . safety and airworthiness’. But now the Ministry of Defence was launching its
Defence Support Review (DSR), where it announced:
‘past efficiencies have . . . been delivered from a range of increasingly innovative arrangements with industry. . . . The cost base has, and will continue to, migrate to industry.’ The Defence Support Review claimed its recommendations could save £474m
(~a521m; ~$711m) in the first four years of its plan, and up to £2.4bn over the subsequent six years. The
BAE Systems contract for the support of Tornado fighter aircraft had already delivered savings of £1.3bn.
The main MoD civil service union replied that it was
‘. . . concerned that the DSR is premature and will damage the MoD’s ability to support the front-line’.
The Royal Air Force is the most committed of the three armed services to outsourcing support work to contractors. Minor repairs on aircraft are done intheatre by RAF mechanics. However, more substantial maintenance is done by contractors such as BAE
Systems, Rolls-Royce and Qinetiq at main operating bases distributed around the world. Contracts typically guarantee that aircraft will be available to fly a certain number of hours over an agreed period.

The Royal Navy relies on BAE Systems and
Babcock for support of its submarine and surface fleets. It leases fishery protection vessels from BAE
Systems as well. Availability contracts work less well for ships than for aircraft because there are fewer of them, making it harder to keep a contracted number of ships in service over an agreed period. The Army is the most reluctant to outsource repair and maintenance work, relying more on the in-house Defence
Support Group. However, in 2008, it signed a contract with BAE Systems to sustain about 400 Panther command and liaison vehicles.
BAE Systems is the second largest defence contractor in the world, behind the American
Lockheed-Martin. It makes and supports aircraft, missiles, ships, submarines and armoured vehicles.
In 2009, BAE Systems employed over 30,000 people in the UK, about 10 per cent of all UK defence industry jobs. The 2006 Parliamentary Select Committee on Defence had established that about 5 per cent of all MoD defence contracts by value go to BAE Systems each year, while BAE Systems derived 28 per cent of their sales from the MoD. BAE Systems was effectively a monopoly supplier in the UK of air systems and aircraft support.
Sources: House of Commons Defence Committee, 7th Report, 2006;
J. Lerner, ‘MoD considers call for rise of outsourcing’, Financial
Times, 17 November 2009; ‘Learning from the Nimrod Disaster’,
Financial Times, 30 October 2009.

Questions
1 Compare the arguments for defence outsourcing from strategic capabilities and transaction costs points of view.
2 If you were outsourcing aircraft maintenance, what might you be concerned about and how might you design the contract and the tendering process to reduce those concerns?

VALUE CREATION AND THE CORPORATE PARENT

framework helps analyse the relative costs and beneﬁts of managing (‘transacting’) activities internally or externally (see also the Key Debate at the end of this chapter).11 In assessing whether to integrate or outsource an activity, he warns against underestimating the long-term costs of opportunism by external subcontractors (or indeed any other organisation in a market relationship). Subcontractors are liable over time to take advantage of their position, either to reduce their standards or to extract higher prices. 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 subcontractor knows will have little value if they withhold their product or service.

Both capabilities and transaction cost reasoning have inﬂuenced the outsourcing decisions of the Ministry of Defence, see Illustration 7.3.
This transaction cost framework suggests that the costs of opportunism can outweigh the beneﬁts of subcontracting to organisations with superior strategic capabilities. For example, mining companies in isolated parts of the Australian outback typically own and operate housing for their workers. 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 a hundred miles away). Consequently, there would be large risks to both partners if the mine subcontracted housing to an independent company specialising in worker accommodation, however strong its capabilities. 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.
In sum, the decision to integrate or subcontract rests on the balance between two distinct factors: ●

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?

7.6 VALUE CREATION AND THE CORPORATE PARENT
Given the doubt over diversiﬁcation and integration strategies, it is clear that sometimes corporate parents are not adding value to their constituent businesses. Where there is no added value, it is usually best to divest the relevant businesses from the corporate portfolio. Thus when Carphone Warehouse recognised that its businesses would be more valuable separate rather than together, it decided in 2010 to break itself up entirely, creating a specialised retail business (including Best Buy, Europe’s largest phone retailer) on the one hand, and a specialised home broadband service (TalkTalk) on the other. In the public sector too, units such as schools or hospitals are increasingly being given freedom from parenting authorities, because independence is seen as more effective. Some theorists even challenge the notion of corporate-level strategy altogether, the subject of the Key Debate at the end of this chapter.

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This section examines how corporate parents can both add and destroy value, and considers three different parenting approaches that can be effective.

7.6.1 Value-adding and value-destroying activities of

corporate parents12
Any corporate parent needs to demonstrate that they create more value than they cost. This applies to both commercial and public-sector organisations. For public-sector organisations, privatisation or outsourcing is likely to be the consequence of failure to demonstrate value.
Companies whose shares are traded freely on the stock markets face a further challenge. They must demonstrate they create more value than any other rival corporate parent could create.
Failure to do so is likely to lead to a hostile takeover or break-up. Rival companies that think they can create more value out of the business units can bid for the company’s shares, on the expectation of either running the businesses better or selling them off to other potential parents. If the rival’s bid is more attractive and credible than what the current parent can promise, shareholders will back them at the expense of incumbent management.
In this sense, competition takes place between different corporate parents for the right to own and control businesses. In the competitive market for the control of businesses, corporate parents must show that they have parenting advantage, on the same principle that business units must demonstrate competitive advantage. They must demonstrate that they are the best possible parent for the businesses they control. Parents therefore must have a very clear approach to how they create value. In practice, however, many of their activities can be value-destroying as well as value-creating.

Value-adding activities13
There are four main types of activity by which a corporate parent can add value.
●

Envisioning. The corporate parent can provide a clear overall vision or strategic intent for its business units.14 This vision should guide and motivate the business unit managers in order to maximise corporation-wide performance through commitment to a common purpose.
The vision should also provide stakeholders with a clear external image about what the organisation as a whole is about: this can reassure shareholders about the rationale for having a diversiﬁed strategy in the ﬁrst place. Finally, a clear vision provides a discipline on the corporate parent to stop it wandering into inappropriate activities or taking on unnecessary costs. ●

Coaching and facilitating. The corporate parent can help business unit managers develop strategic capabilities, by coaching them to improve their skills and conﬁdence. They can also facilitate cooperation and sharing across the business units, so improving the synergies from being within the same corporate organisation. Corporate-wide management courses are one effective means of achieving these objectives, as bringing managers across the business to learn strategy skills also provides an opportunity for them to build relationships between each other and see opportunities for cooperation.

●

Providing central services and resources. The centre is obviously a provider of capital for investment. The centre can also provide central services such as treasury, tax and human resource advice, which if centralised can have sufﬁcient scale to be efﬁcient and to build up relevant expertise. Centralised services often have greater leverage: for example, combining the purchases of separate business units increases their bargaining power for shared inputs such as

VALUE CREATION AND THE CORPORATE PARENT

energy. This leverage can be helpful in brokering with external bodies, such as government regulators, or other companies in negotiating alliances. Finally, the centre can have an important role in managing expertise within the corporate whole, for instance by transferring managers across the business units or by creating shared knowledge management systems via corporate intranets.
●

Intervening. Finally, the corporate parent can also intervene within its business units in order to ensure appropriate performance. The corporate parent should be able to closely monitor business unit performance and improve performance either by replacing weak managers or by assisting them in turning around their businesses. The parent can also challenge and develop the strategic ambitions of business units, so that satisfactorily performing businesses are encouraged to perform even better.

Value-destroying activities
However, there are also three broad ways in which the corporate parent can inadvertently destroy value:
●

Adding management costs. Most simply, the staff and facilities of the corporate centre are expensive. The corporate centre typically has the best-paid managers and the most luxurious ofﬁces. It is the actual businesses that have to generate the revenues that pay for them.
If their costs are greater than the value they create, then the corporate centre’s managers are net value-destroying.

●

Adding bureaucratic complexity. As well as these direct ﬁnancial costs, there is the ‘bureaucratic fog’ created by an additional layer of management and the need to coordinate with sister businesses. These typically slow down managers’ responses to issues and lead to compromises between the interests of individual businesses.

●

Obscuring ﬁnancial performance. One danger in a large diversiﬁed company is that the underperformance of weak businesses can be obscured. Weak businesses might be crosssubsidised by the stronger ones. Internally, the possibility of hiding weak performance diminishes the incentives for business unit managers to strive as hard as they can for their businesses: they have a parental safety-net. Externally, shareholders and ﬁnancial analysts cannot easily judge the performance of individual units within the corporate whole.
Diversiﬁed companies’ share prices are often marked down, because shareholders prefer the
‘pure plays’ of stand-alone units, where weak performance cannot be hidden.15

These dangers suggest clear paths for corporate parents that wish to avoid value destruction.
They should keep a close eye on centre costs, both ﬁnancial and bureaucratic, ensuring that they are no more than required by their corporate strategy. They should also do all they can to promote ﬁnancial transparency, so that business units remain under pressure to perform and shareholders are conﬁdent that there are no hidden disasters.
Overall, there are many ways in which corporate parents can add value. It is, of course, difﬁcult to pursue them all and some are hard to mix with others. For example, a corporate parent that does a great deal of top-down intervening is less likely to be seen by its managers as a helpful coach and facilitator. Business unit managers will concentrate on maximising their own individual performance rather than looking out for ways to cooperate with other business unit managers for the greater good of the whole. For this reason, corporate parenting roles tend to fall into three main types, each coherent within itself but distinct from the others.16 These three types of corporate parenting role are summarised in Figure 7.5.

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ILLUSTRATION 7.4

Eating its own cooking: Berkshire Hathaway’s parenting
A portfolio manager may seek to manage a highly diverse set of business units on behalf of its shareholders.

Berkshire Hathaway’s chairman and CEO is Warren
Buffett, one of the world’s richest men – and also one of the most plain-spoken about how to run a business.
With annual sales now over $100bn (a70bn), Buffet founded this conglomerate with a small textile business in the early 1960s. Berkshire Hathaway’s businesses now are highly diverse. They include large insurance businesses (GEICO, General Re, NRG), manufacturers of carpets, building products, clothing and footwear, retail companies and NetJets, the private jet service. The company also has significant long-term minority stakes in businesses such as
Coca-Cola and General Electric. Aged 79, Buffett remains highly active: in 2008, he took a 10 per cent stake in Goldman Sachs, the world’s leading investment bank, and in 2009 he completed the purchase of BNSF, the second largest railway company in the
United States. Since the mid-1960s, Berkshire has averaged a growth in book value of 20.3% each year.
The 2009 Berkshire Hathaway annual report explains how Buffet and his deputy chairman Charlie
Munger run the business. With regard to shareholders, Buffet writes:
Charlie Munger and I think of our shareholders as owner-partners, and of ourselves as managing partners. (Because of the size of our shareholdings we are also, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets. . . . In line with Berkshire’s owner-orientation, most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.
Berkshire has a clear ‘dominant logic’:
Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft
(in 1930) and television sets (in 1950). But the future then also included competitive dynamics

that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. Just because Charlie and
I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable.
Even then, we will make plenty of mistakes.
Buffett also explains how they manage their subsidiary businesses: Charlie and I are the managing partners of
Berkshire. But we subcontract all of the heavy lifting in this business to the managers of our subsidiaries. In fact, we delegate almost to the point of abdication: Though Berkshire has about
257,000 employees, only 21 of these are at headquarters. Charlie and I mainly attend to capital allocation and the care and feeding of our key managers. Most of these managers are happiest when they are left alone to run their businesses, and that is customarily just how we leave them. That puts them in charge of all operating decisions and of dispatching the excess cash they generate to headquarters. By sending it to us, they don’t get diverted by the various enticements that would come their way were they responsible for deploying the cash their businesses throw off. Furthermore,
Charlie and I are exposed to a much wider range of possibilities for investing these funds than any of our managers could find in his or her own industry.

Questions
1 In what ways does Berkshire Hathaway conform (and not conform) to the archetypal portfolio manager described in section 7.6.2?
2 Suggest some industries and businesses, or types of industries and businesses, that
Warren Buffett is likely never to invest in.

VALUE CREATION AND THE CORPORATE PARENT

Figure 7.5 Portfolio managers, synergy managers and parental developers

Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994.

7.6.2 The portfolio manager
The 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. In effect, 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. Its role is to identify and acquire under-valued assets or businesses and improve them. The portfolio manager might do this, for example, by acquiring another corporation, divesting low-performing businesses within it and intervening to improve the performance of those with potential. Such corporations may not be much concerned about the relatedness (see section 7.2) of the business units in their portfolio, typically adopting a conglomerate strategy. Their role is not to get closely involved in the routine management of the businesses, only to act over short periods of time to improve performance. In terms of the value-creating activities identiﬁed earlier, the portfolio manager concentrates on intervening and the provision (or withdrawal) of investment.
Portfolio managers seek to keep the cost of the centre low, for example by having a small corporate staff with few central services, leaving the business units alone so that their chief executives have a high degree of autonomy. They set clear ﬁnancial targets for those chief executives, offering high rewards if they achieve them and likely loss of position if they do not.
Such corporate parents can, of course, manage quite a large number of such businesses because they are not directly managing the everyday strategies of those businesses. Rather they are acting from above, setting ﬁnancial targets, making central evaluations about the well-being and future prospects of such businesses, and investing, intervening or divesting accordingly. 247

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

Some argue that the days of the portfolio manager are gone. Improving ﬁnancial markets mean that the scope for ﬁnding and investing cheaply in under-performing companies is much reduced. However, some portfolio managers remain and are successful. Private equity ﬁrms such as Apax Partners or Blackstone are a new way of operating a portfolio management style, typically investing in, improving and then divesting companies in loosely knit portfolios.
For example, in 2010, Blackstone owned companies ranging from Hilton Hotels to the China
BlueStar chemicals company, totalling more than 990,000 employees around the world.
Illustration 7.4 includes a description of the portfolio parenting approach of Warren Buffet at
Berkshire Hathaway.

7.6.3 The synergy manager
Obtaining synergy is often seen as the prime rationale for the corporate parent.17 The 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 in the case of related diversiﬁcation. In terms of value-creating activities, the focus is threefold: envisioning to build a common purpose; facilitating cooperation across businesses; and providing central services and resources. For example, at Apple, Steve Jobs’s vision of his personal computers being the digital hub of the new digital lifestyle guides managers across the iMac computer, iPod, iPhone and iPad businesses to ensure seamless connections between the fast-developing offerings. The result is enhanced value through better customer experience. A metals company diversiﬁed into both steel and aluminium might centralise its energy procurement, gaining synergy beneﬁts through increased bargaining power over suppliers.
However, achieving such synergistic beneﬁts involves at least three challenges:
●

Excessive costs. The beneﬁts in sharing and cooperation need to outweigh the costs of undertaking such integration, both direct ﬁnancial costs and opportunity costs. Managing synergistic relationships tends to involve expensive investments in management time.

●

Overcoming self-interest. Managers in the business units have to want to cooperate.
Especially where managers are rewarded largely according to the performance of their own particular business unit, they are likely to be unwilling to sacriﬁce their time and resources for the common good.

●

Illusory synergies. It is easy to overestimate the value of skills or resources to other businesses. This is particularly common when the corporate centre needs to justify a new venture or the acquisition of a new company. Claimed synergies often prove illusory when managers actually have to put them into practice.

The failure of many companies to extract expected synergies from their businesses has led to growing scepticism about the notion of synergy. Synergistic beneﬁts are not as easy to achieve as would appear. For example, in 2007 Daimler sold most of its stake in mass-market car manufacturer Chrysler after ten years of trying to extract synergies with its luxury
Mercedes business. However, synergy continues to be a common theme in corporate-level strategy, as Illustration 7.2 on Zodiac exempliﬁes.

7.6.4 The parental developer18
The parental developer seeks to employ its own central capabilities to add value to its businesses. This is not so much about how the parent can develop beneﬁts across business units or

PORTFOLIO MATRICES

transfer capabilities between business units, as in the case of managing synergy. Rather 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 example, a parent could have a valuable brand or specialist skills in ﬁnancial management or product development.
If such parenting capabilities exist, corporate managers then need to identify a ‘parenting opportunity’: a business which is not fulﬁlling its potential but which could be improved by applying the parenting capability, such as branding or product development. Such parenting opportunities are therefore 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 example, a consumer products company might offer substantial guidance on branding and distribution from the centre; a technology company might run a large central R&D laboratory.
There are two crucial challenges to managing a parental developer:
●

Parental focus. Corporate parents need to be rigorous and focused in identifying their unique value-adding capabilities. They should always be asking what others can do better than them, and focus their energy and time on activities where they really do add value. Other central services should typically be outsourced to specialist companies that can do it better.

●

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. These can become
‘crown jewels’, to which corporate parents become excessively attached. The logic of the parental development approach is if the centre 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. Funds raised by selling a proﬁtable business can be reinvested in businesses where the parent can add value.

7.7 PORTFOLIO MATRICES
Section 7.6 discussed rationales for corporate parents of multi-business organisations. This section introduces models by which managers can determine ﬁnancial investment and divestment within their portfolios of business. Each model gives more or less attention to one of three criteria: ●

the balance of the portfolio, e.g. in relation to its markets and the needs of the corporation;

●

the attractiveness of the business units in terms of how strong they are individually and how proﬁtable their markets or industries are likely to be; and

●

the ‘ﬁt’ that the business units have with each other in terms of potential synergies or the extent to which the corporate parent will be good at looking after them.

ned. co.uk /myst rso ab egyl rat

One of the most common and long-standing ways of conceiving of the balance of a portfolio of businesses is the Boston Consulting Group (BCG) matrix (see Figure 7.6). The BCG matrix uses market share and market growth criteria for determining the attractiveness and balance of a business portfolio. High market share and high growth are, of course, attractive. However, the

www.p ea 7.7.1 The BCG (or growth/share) matrix19
KEY
CONCEPT
BCG matrix

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

Figure 7.6 The growth share (or BCG) matrix

BCG matrix also warns that high growth demands heavy investment, for instance to expand capacity or develop brands. There needs to be a balance within the portfolio, so that there are some low-growth businesses that are making sufﬁcient surplus to fund the investment needs of higher-growth businesses.
The growth/share axes of the BCG matrix deﬁne four sorts of business:
●

A star is a business unit within a portfolio which has a high market share in a growing market. The business unit may be spending heavily to keep up with growth, but high market share should yield sufﬁcient proﬁts to make it more or less self-sufﬁcient in terms of investment needs.

●

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. Developing question marks into stars, with high market share, takes heavy investment. Many question marks fail to develop, so the BCG advises corporate parents to nurture several at a time. It is important to make sure that some question marks develop into stars, as existing stars eventually become cash cows and cash cows may decline into dogs.

●

A cash cow is a business unit within a portfolio that has a high market share in a mature market. However, because growth is low, investments needs are less, while high market share means that the business unit should be proﬁtable. 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 and are thus the worst of all combinations. They may be a cash drain and use up a disproportionate amount of managerial time and company resources. The BCG usually recommends divestment or closure.

The BCG matrix has several advantages. It provides a good way of visualising the different needs and potential of all the diverse businesses within the corporate portfolio. It warns corporate parents of the ﬁnancial demands of what might otherwise look like a desirable portfolio of high-growth businesses. It also reminds corporate parents that stars are likely eventually to wane. Finally, it provides a useful discipline to business unit managers, underlining the fact

PORTFOLIO MATRICES

251

ILLUSTRATION 7.5

ITC’s diverse portfolio: smelling sweeter
What was once the Imperial Tobacco Company of India now has a portfolio stretching from cigarettes to fragrances.

ITC is one of India’s largest consumer good com-

started in the food business, with Kitchens-of-India

panies, with an increasingly diversified portfolio of

ready-to-eat gourmet foods, the Aashirvaad wheat-

products. Its chairman, Y.C. Deveshwar describes its

flour business, Sunfeast biscuits and Bingo snacks.

strategy thus: ‘It is ITC’s endeavour to continuously

ITC’s own agri-businesses were an important source

explore opportunites for growth by synergising and

of supply for these initiatives. Aashirvaad reached

blending its multiple core competences to create

over 50 per cent Indian market share, while Sunfeast

new epicentres of growth. The employees of ITC are

gained 12 per cent market share and Bingo 11 per

inspired by the vision of growing ITC into one of India’s

cent by 2008. At the same time, ITC took advantage

premier institutions and are willing to go the extra

of the strong brand values of its Wills cigarettes to

mile to generate value for the economy, in the pro-

launch Wills Lifestyle, a range of upmarket clothing

cess creating growing value for the shareholders.’

stores, with its own designs. In 2009, Wills Lifestyle

ITC was founded in 1910 as the Imperial Tobacco

was recognised as India’s ‘Most Admired Fashion

Company of India, with brands such as Wills, Gold

Brand of the Year’. In 2005, ITC launched its personal

Cut and John Players. ITC now holds about two thirds

care business, again using its cigarette brandnames:

of the market for cigarettes in India, with Philip

for example, ‘Essenza Di Wills’ (fragrances) and

Morris and BAT affiliated companies distant seconds

‘Fiama Di Wills’ (hair and skin care).

with about 13 per cent each. However, cigarettes in
India are highly discouraged by the Indian government, and increasingly heavily taxed.
ITC has a long diversification history. The com-

ITC segmental sales and profits (Rs in Crores)
Segment

2005 sales 2005 profits 2009 sales 2009 profits Cigarettes

10,002

2,288

15,115

4,184

Other FMCG

563

(195)

3,010

(483)

developed into a range of agricultural businesses

Hotels

577

141

1,014

316

within India, including edible oils, fruit pulp, spices

Agribusiness

1,780

2,284

256

and frozen foods. ITC had set up a packaging and

Paperboard, paper and packaging

1,565

1,719

509

pany’s original activities in the growth of leaf tobacco

printing business in the 1920s, originally to supply its cigarette business. By 2009, this was India’s largest packaging solutions provider. In 1975, ITC had entered the hotel business, becoming the country’s second largest operator with over 100 hotels by 2009, rang-

96.4
280

5 Rs in Crores ~ US $1,000,000 ~a700,000. Profits are before interest and tax. Figures in brackets are losses.
Sources: ITC annual reports; M. Balaji, 2006, ITC: Adding Shareholder
Value through Diversifications, IBSCDC; B. Gopal and S. Kora, 2009,
Indian Conglomerate ITC, IBS Research Center.

ing from de luxe to economy. In 1979, the company also entered the paperboard industry, and three decades later was the country’s largest producer, accounting for 29% of the market by value.
The early 21st century had seen many new diversification initiatives, especially in the booming Fast
Moving Consumer Goods (FMCG) sector. Initially it

Questions
1 How well does ITC’s portfolio fit in terms of the BCG matrix?
2 Identify and evaluate the various synergies in
ITC’s business.

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

that the corporate parent ultimately owns the surplus resources they generate and can allocate them according to what is best for the corporate whole. Cash cows should not hoard their proﬁts.
However, there are at least three 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. Managers are often keen to deﬁne themselves as ‘high-share’ by deﬁning their market in a particularly narrow way (for example, 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. The notion of a balanced portfolio may be more relevant in countries where capital markets are under-developed or in private companies that wish to minimise dependence on external shareholders or banks.

●

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. This treatment can cause motivation problems, as managers in these units see little point in working hard for the sake of other businesses. There is also the danger of the self-fulﬁlling prophecy. Cash cows will become dogs even more quickly than the model expects if they are simply milked and denied adequate investment. Finally, the notion that a dog can be simply sold or closed down also assumes that there are no ties to other business units in the portfolio, whose performance might depend in part on keeping the dog alive. This portfolio approach to dogs works better for conglomerate strategies, where divestments or closures are unlikely to have knock-on effects on other parts of the portfolio.

7.7.2 The directional policy (GE–McKinsey) matrix
Another way to consider a portfolio of businesses is by means of the directional policy matrix20 which categorises business units into those with good prospects and those with less good prospects. The matrix was originally developed by McKinsey & Co. consultants in order to help the American conglomerate General Electric manage its portfolio of business units.
Speciﬁcally, the directional policy matrix positions business units according to (a) how attractive the relevant market is in which they are operating, and (b) the competitive strength of the
SBU in that market. 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 2.4.3. Some analysts also choose to show graphically how large the market is for a given business unit’s activity, and even the market share of that business unit, as shown in
Figure 7.7. For example, managers in a ﬁrm with the portfolio shown in Figure 7.7 will be concerned that they 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.
The matrix also offers strategy guidelines given the positioning of the business units, as shown in Figure 7.8. It suggests that the businesses with the highest growth potential and the greatest strength are those in which to invest for growth. Those that are the weakest and in the least attractive markets should be divested or ‘harvested’ (i.e. used to yield as much cash as possible before divesting).
The directional policy matrix is more complex than the BCG matrix. However, it can have two advantages. First, unlike the simpler four-box BCG matrix, the nine cells of the directional

PORTFOLIO MATRICES

Figure 7.7 Directional policy (GE–McKinsey) matrix

Figure 7.8 Strategy guidelines based on the directional policy matrix

policy matrix acknowledge the possibility of a difﬁcult middle ground. Here managers have to be carefully selective. In this sense, the directional policy matrix is less mechanistic than the
BCG matrix, encouraging open debate on less clear-cut cases. Second, the two axes of the directional policy matrix are not based on single measures (i.e. market share and market growth).

253

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

Business strength can derive from many other factors than market share, and industry attractiveness does not just boil down to industry growth rates. On the other hand, the directional policy matrix shares some problems with the BCG matrix, particularly about vague deﬁnitions, capital market assumptions, motivation and self-fulﬁlling prophecy. Overall, however, the value of the matrix is to help managers invest in the businesses which are most likely to pay off.
So far the discussion has been about the logic of portfolios in terms of balance and attractiveness. The third logic is to do with ‘ﬁt’ with the particular capabilities of the corporate parent. 7.7.3 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.21 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.
There are two key dimensions of ﬁt in the parenting matrix (see Figure 7.9):

Figure 7.9 The parenting matrix: the Ashridge Portfolio Display

Source: Adapted from M. Goold, A. Campbell and M. Alexander, Corporate Level Strategy, Wiley, 1994

PORTFOLIO MATRICES
●

‘Feel’. This is a measure of the ﬁt between each business unit’s critical success factors (see section 2.4.3) and the capabilities (in terms of competences and resources) of the corporate parent. In other words, does the corporate parent have the necessary ‘feel’, or understanding, for the businesses it will parent?

●

‘Beneﬁt’. This measures the ﬁt between the parenting opportunities, or needs, of business units and the capabilities of the parent. Parenting opportunities are about the upside, areas in which good parenting can beneﬁt the business (for instance, by bringing marketing expertise). For the beneﬁt to be realised, of course, the parent must have the right capabilities to match the parenting opportunities.

The power of using these two dimensions of ﬁt is as follows. It is easy to see that a corporate parent should avoid running businesses that it has no feel for. What is less clear is that parenting should be avoided if there is no beneﬁt. This challenges the corporate parenting of even businesses for which the parent has high feel. 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.
Figure 7.9 shows four kinds of business along these two dimensions of feel and beneﬁt:
●

Heartland business units are ones which 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. If not divested, they should be spared as much corporate bureaucracy as possible.

●

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 if it is to be able to move value-trap businesses into the heartland. It might be easier to divest to another corporate parent which could add value, and will pay well for the chance.

●

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.

This approach to considering corporate portfolios places the emphasis ﬁrmly on how the parent beneﬁts the business units. It requires careful analysis of both parenting capabilities and business-unit parenting needs. The parenting matrix can therefore assist hard decisions 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.
The concept of ﬁt has equal relevance in the public-sector. The implication is that publicsector 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 (see section 7.5).

255

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

KEY DEBATE

Why have corporate-level strategies anyway?
Do we really need diversified corporations?

The notion of corporate strategy assumes that corporations should own and control businesses in a range of markets or products. But ‘transaction cost’ economist Oliver Williamson believes that diversified corporations should only exist in the presence of
‘market failures’ (see also section 7.5.2). If markets worked well, there would be no need for business units to be coordinated through managerial structures. Business units could be independent, coordinating where necessary by simple transactions in the marketplace. The ‘invisible hand’ of the market could replace the ‘visible hand’ of managers at corporate headquarters. There would be no ‘corporate strategy’.
Market failures favouring the diversified corporation occur for two reasons:
●

●

‘Bounded rationality’: people cannot know everything that is going on in the market, so perfectly rational market transactions are impossible.
Information, for instance on quality and costs, can sometimes be better inside the corporate fold.
‘Opportunism’: independent businesses trading between each other may behave opportunistically, for example by cheating on delivery or quality promises. Cheating can sometimes be policed and punished more easily within a corporate hierarchy.

According to Williamson, activities should only be brought into the corporation when the ‘transaction costs’ of coping with bounded rationality (gaining information) and opportunism (guarding against cheats) are lower inside the corporate hierarchy than they would be if simply relying on transactions in the marketplace. This comparison of the transaction costs of markets and hierarchies has powerful implications for trends in product diversification:
●

Improving capital markets may reduce the relative information advantages of conglomerates in managing a set of unrelated businesses. As markets get better at capturing information there will be less need for conglomerates, something that may account for the recent decline in conglomerates in many economies.

●

Improving protection of intellectual property rights may increase the incentives for corporations to license out their technologies to companies, rather than trying to do everything themselves.
If the prospect of collecting royalties improves, there is less advantage for corporations keeping everything in-house.

Thus fewer market failures also means narrower product scope.
Williamson’s ‘transaction cost’ view puts a heavy burden on corporations to justify themselves. Two justifications are possible. First, knowledge is hard to trade in the market. Buyers can only know the value of new knowledge once they have already bought it.
Because they can trust each other, colleagues in sister business units within the same corporation are better at transferring knowledge than independent companies are in the open market. Second, corporations are not just about minimising the costs of information and cheating, but also about maximising the value of the combined resources. Bringing creative people together in a collective enterprise enhances knowledge exchange, innovation and motivation. Corporations are value creators as well as cost minimisers.
References:
1. O.E. Williamson, ‘Strategy Research: Governance and Competence Perspectives’, Strategic Management Journal, vol. 12, pp. 75–94 (1998).
2. B. Kogut and U. Zander, ‘What Firms Do? Coordination, Identity and Learning’, Organization Science, vol. 7, no. 5 (1996), 502–19.
3. S. Ghoshal, C. Bartlett and P. Moran, ‘A New Manifesto for
Management’, Sloan Management Review, Spring (1999), pp. 9–20.

Question
Consider a diversified corporation such as
Unilever (food, personal care and household): what kinds of hard-to-trade knowledge might it be able to transfer between product and country subsidiaries and is such knowledge likely to be of increasing or decreasing importance?

257

ned. co.uk/mys t rso ab egyl rat

SUMMARY

www.p ea VIDEO ASSIGNMENT

AUDIO
SUMMARY

●

Many corporations comprise several, sometimes many, business units. Decisions and activities above the level of business units are the concern of what in this chapter is called the corporate parent.

●

Organisational scope is often considered in terms of related and unrelated diversiﬁcation.

●

Corporate parents may seek to add value by adopting different parenting roles: the portfolio manager, the synergy manager or the parental developer.

●

There are several portfolio models to help corporate parents manage their businesses, of which the most common are: the BCG matrix, the directional policy matrix and the parenting matrix.

●

Divestment and outsourcing should be considered as well as diversiﬁcation, particularly in the light of relative strategic capabilities and the transaction costs of opportunism.

WORK ASSIGNMENTS
✱ Denotes more advanced work assignments. * Refers to a case study in the Text and Cases edition.
7.1

Using the Ansoff axes (Figure 7.2), identify and explain corporate strategic directions for any one of these case organisations: CRH*, Ferrovial*, SAB Miller*.

7.2

Go to the website of any large multi-business organisation (for example, Google, Tata Group,
Siemens) and assess the degree to which its corporate-level strategy is characterised by
(a) related or unrelated diversification and (b) a coherent ‘dominant logic’ (see section 7.3).

7.3

For any large multi-business corporation (as in 7.2), explain how the corporate parent should best create value for its component businesses (as portfolio manager, synergy manager or parental developer: see section 7.6). Would all the businesses fit equally well?

7.4✱ For any large multi-business corporation (as in 7.2), plot the business units on a portfolio matrix
(for example, the BCG matrix: section 7.7.1). Justify any assumptions about the relative positions of businesses on the relevant axes of the matrix. What managerial conclusions do you draw from this analysis? Integrative assignment
7.5

Take a case of a recent merger or acquisition (see Chapter 10), and assess the extent to which it involved related or unrelated diversification (if either) and how far it was consistent with the company’s existing dominant logic. Using share price information (see www.bigcharts.com or similar), assess shareholders’ reaction to the merger or acquisition. How do you explain this reaction?

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CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

VIDEO ASSIGNMENT
Visit MyStrategyLab and watch the Fridays case study.
1 What are the benefits and disadvantages of Fridays’ relationship with the supermarkets? Relatively how strong is Fridays vis-à-vis other competitors in this relationship?
2 Explain Fridays’ diversification strategy in terms of the Ansoff axes and strategic relatedness
(Chapter 7: Figure 7.2).

RECOMMENDED KEY READINGS
●

●

An accessible discussion of corporate strategy is provided by A. Campbell and R. Park, The Growth Gamble:
When Leaders Should Bet on Big New Businesses, Nicholas
Brealey, 2005.
M. Goold and K. Luchs, ‘Why diversify: four decades of management thinking’ in D. Faulkner and A. Campbell
(eds), The Oxford Handbook of Strategy, vol. 2, Oxford

University Press, pp. 18–42, provides an authoritative overview of the diversiﬁcation option over time.
●

A summary of different portfolio analyses is provided in D. Faulkner, ‘Portfolio matrices’, in V. Ambrosini (ed.),
Exploring Techniques of Analysis and Evaluation in Strategic
Management, Prentice Hall, 1998.

REFERENCES
1. This ﬁgure is an extension of the product/market matrix: see I. Ansoff, Corporate Strategy, 1988, Chapter 6. The Ansoff matrix was later developed into the one shown below.

Source: H. Ansoff, The New Corporate Strategy, Wiley, 1988.

2. For the European Commission competition authority, http://ec.europa.eu/comm/competition; for the UK
Competition Commission, see http://www.competitioncommission.org.uk/.
3. For discussions of the challenge of sustained growth and diversiﬁcation, see A. Campbell and R. Parks, The Growth
Gamble, Nicholas Brearly (2005) and D. Laurie, Y. Doz and C. Sheer, ‘Creating new growth platforms’, Harvard
Business Review, vol. 84, no. 5, (2006), 80–90.

4. On economies of scope, see D.J. Teece, ‘Towards an economic theory of the multi-product ﬁrm’, Journal of Economic
Behavior and Organization, vol. 3 (1982), pp. 39–63.
5. See C.K. Prahalad and R. Bettis, ‘The dominant logic: a new link between diversity and performance’, Strategic
Management Journal, vol. 6, no. 1 (1986), pp. 485–501;
R. Bettis and C.K. Prahalad, ‘The dominant logic: retrospective and extension’, Strategic Management Journal, vol. 16, no. 1 (1995), pp. 5–15.
6. See C. Markides, ‘Corporate strategy: the role of the centre’ in A. Pettigrew, H. Thomas and R. Whittington (eds),
Handbook of Strategy and Management, Sage, 2002. For a discussion of recent Chinese diversiﬁcation patterns, see
A. Delios, N. Zhou and W.W. Xu, ‘Ownership structure and the diversiﬁcation and performance of publicly-listed companies in China’, Business Horizons, vol. 51, no. 6
(2008), pp. 802–21.
7. These beneﬁts are often discussed in terms of ‘multimarket’ or ‘multipoint’ competition: see J. Anand, L. Mesquita and R. Vassolo, ‘The dynamics of multimarket competition in exploration and exploitation activities’, Academy of
Management Journal, vol. 52, no. 4 (2009), pp. 802–21.
8. M. Goold and A. Campbell, ‘Desperately seeking synergy’,
Harvard Business Review, vol. 76, no. 2 (1998), pp. 131–45.
9. A. Pehrson, ‘Business relatedness and performance: a study of managerial perceptions’, Strategic Management Journal, vol. 27, no. 3 (2006), pp. 265–82.
10. L.E. Palich, L.B. Cardinal and C. Miller, ‘Curvilinearity in the diversiﬁcation-performance linkage: an examination of over three decades of research’, Strategic Management

REFERENCES

11.

12.

13.

14.

Journal, vol. 21 (2000), pp. 155–74. The inverted-U relationship is the research consensus, but studies often disagree, particularly ﬁnding variations over time and across countries. For recent context-sensitive studies, see
M. Mayer and R. Whittington, ‘Diversiﬁcation in context: a cross national and cross temporal extension’, Strategic
Management Journal, vol. 24 (2003), pp. 773–81 and
A. Chakrabarti, K. Singh and I. Mahmood, ‘Diversiﬁcation and performance: evidence from East Asian ﬁrms’,
Strategic Management Journal, vol. 28 (2007), pp. 101–20.
For a discussion and cases on the relative guidance of transaction cost and capabilities thinking, see R. McIvor,
‘How the transaction cost and resource-based theories of the ﬁrm inform outsourcing evaluation’, Journal of
Operations Management, vol. 27, no. 1 (2009), pp. 45–63.
See also T. Holcomb and M. Hitt, ‘Toward a model of strategic outsourcing’, Journal of Operations Management, vol. 25, no. 2 (2007), pp. 464–81.
For a good discussion of corporate parenting roles, see
Markides in reference 6 above. A recent empirical study of corporate headquarters is D. Collis, D. Young and
M. Goold, ‘The size, structure and performance of corporate headquarters’, Strategic Management Journal, vol. 28, no. 4 (2007), pp. 383–406.
M. Goold, A. Campbell and M. Alexander, Corporate Level
Strategy, Wiley, 1994, is concerned with both the valueadding and value-destroying capacity of corporate parents.
For a discussion of the role of a clarity of mission, see
A. Campbell, M. Devine and D. Young, A Sense of Mission,
Hutchinson Business, 1990.

259

15. E. Zuckerman, ‘Focusing the corporate product: securities analysts and de-diversiﬁcation’, Administrative Science
Quarterly, vol. 45, no. 3 (2000), pp. 591–619.
16. The ﬁrst two rationales discussed here are based on
M. Porter, ‘From competitive advantage to corporate strategy’, Harvard Business Review, vol. 65, no. 3 (1987), pp. 43–59.
17. See A. Campbell and K. Luchs, Strategic Synergy,
Butterworth/Heinemann, 1992.
18. The logic of parental development is explained extensively in Goold, Campbell and Alexander (see reference 13 above). 19. For a more extensive discussion of the use of the growth share matrix see A.C. Hax and N.S. Majluf in R.G. Dyson
(ed.), Strategic Planning: Models and Analytical Techniques,
Wiley, 1990; and D. Faulkner, ‘Portfolio matrices’, in
V. Ambrosini (ed.), Exploring Techniques of Analysis and Evaluation in Strategic Management, Prentice Hall,
1998; for source explanations of the BCG matrix see
B.D. Henderson, Henderson on Corporate Strategy, Abt
Books, 1979.
20. A. Hax and N. Majluf, ‘The use of the industry attractivenessbusiness strength matrix in strategic planning’, in
R. Dyson (ed.), Strategic Planning: Models and Analytical
Techniques, Wiley, 1990.
21. The discussion in this section draws on M. Goold,
A. Campbell and M. Alexander, Corporate Level Strategy,
Wiley, 1994, which provides an excellent basis for understanding issues of parenting.

CASE
EXAMPLE

Virgin: the global entrepreneur
John Treciokas

Introduction
Richard Branson founded Virgin in 1970 and has effectively used his personality to bring the Virgin brand to the attention of the consumer. Virgin’s businesses are portrayed in an exciting light with a personal touch and this gives the Virgin brand a softer feel than other large multinational companies. The Virgin Group has grown over the last 40 years to become one of the largest private companies in the UK. Virgin currently has more than 200 branded companies worldwide, employing in the region of 50,000 employees in 29 countries with revenues in excess of £11 billion (approx. a12bn; $16 bn) in
2008.
The largest and most celebrated business, Virgin
Atlantic celebrated 25 years of flying people across the
Atlantic in 2009 with a striking advertising campaign which portrayed the excitement and fun of flying with, or working at, Virgin. Branson believes in the value of careful brand enhancement and the benefits of transferring this brand image across a diverse portfolio.
Research has shown that the Virgin name is associated with words such as: ‘fun’, ‘innovative’, ‘daring’ and
‘successful’.
However, does such a portfolio of businesses make strategic sense and will Virgin’s conglomerate group of diverse companies survive after Richard Branson departs? These are the key questions facing the company in 2010, the start of a new decade.

Growth and strategy
Virgin began selling music records in 1970 when Branson was just twenty years old and its rapid growth led to an
Oxford Street shop a year later. Further expansion into the music industry followed with the Virgin record label in 1973. From an early stage in the business Virgin courted controversy by signing the Sex Pistols, a ‘punk rock group’ whose rude and anti-establishment behaviour quickly brought them and Virgin high public exposure. Risk-taking and courting publicity epitomised
Branson’s philosophy from the outset.

Source: Steve Bell/Rex Features.

Virgin Atlantic was founded in 1984 and a year after
Virgin Holidays began. These became the core of the
Virgin group. In 1987 Virgin Records America was established: Branson commented, ‘we were flying there a lot so it made sense to expand there too’. In 1988
Virgin Megastores (retail outlets with a huge selection of recorded music and related products) were opened in
Glasgow and Paris, followed by numerous other British,
European, American, Japanese and Pacific Basin cities.
Virgin was becoming an international company.
Virgin at this stage of its existence was involved largely in two industries: travel/holidays and music.
From the 1990s onwards there followed numerous acquisitions, divestments and joint ventures that resulted in a highly diversified group. Chief amongst these were:
●

●

●
●

In 1992 the sale of Virgin Records to EMI for £510m, mainly to raise funds for Branson to invest further in his favourite business (Virgin Atlantic).
The acquisition of the Our Price chain of shops in
1994, making Virgin Retail the UK’s largest music retailer. The launch of a low-cost airline, Virgin Express in 1996.
The acquisition in 1997 of the ailing West Coast rail franchise in the UK. Virgin Trains set about trying to improve its services and five years later introduced the tilting Pendolino trains, allowing faster services.

VIRGIN: THE GLOBAL ENTREPRENEUR
●

●

●

●

●

●

The start of Branson’s interest in the media business with the launch of Virgin One, a tabloid TV channel, in
1997.
In 1999 the launch of Virgin Mobile, using other providers’ networks via a joint venture with what is now T-mobile.
The launch of a network of health clubs in 1999 and, in 2006, the acquisition of the Holmes Place health chain to give it a significant market share in the UK.
The sale in 2000 Virgin of 49 per cent of Virgin
Atlantic to Singapore Airlines – perhaps accepting that this was a risky and expensive business.
Branson insisted, however, that Virgin would not lose its majority control in this core business.
In 2008 Virgin Mobile in India was launched, in partnership with the Tata group. Tata Teleservices provided the network service, though it is marketed under the
Virgin brand. The offering included music, entertainment and news on India’s film industry, sports and stock market. The target market was the younger population – some 51 per cent of the 1.1 billion people in India are under 25 and two-thirds are under 35.
In 2007, Virgin had tried a major move into the financial industry, with the attempted takeover of Northern
Rock, a troubled British mortgage bank. The move was resisted by the press and some politicians –
Branson has never quite been accepted by the establishment. However, at the beginning of 2010, Virgin continued this strategy with the purchase of a littleknown private bank (Church House Trust) which enabled it to apply for a full banking licence and to offer its own mortgages and current accounts. Will this be the next major plank in the Virgin empire?

A move to merge several of its offerings occurred in
2006, when four Virgin companies combined to become one media company providing television, broadband, telephone and mobile phone services in partnership with NTL-Telewest. This company, trading as Virgin
Media, had a total of nine million subscribers, giving it a strong position to compete with, and aggressively challenge, its major rival BSkyB. Virgin began to offer complete packages for the family, including a broad range of television packages, broadband at home and away, home telephone services and mobile phone services.
This package often included free hardware to lock customers in for up to two years on a contract.
Since 2000 Virgin has also set up a rather futuristic attempt to launch a passenger service into suborbital space (Virgin Galactic) as well as more down to earth businesses like Virgin Comics and Virgin Healthcare.

261

Table 1 Other strategic developments: 1990–2010
1993
1994
1995
1996
1997
1997
1997
2000

Virgin Radio commences broadcasting.
Launch of Virgin Vodka and Virgin Cola.
Launch of Virgin Direct, an investment product.
Launch of Virgin Net, an internet service provider.
Virgin Trains is founded to run a rail franchise in the UK.
Virgin Cosmetics launches with four flagship stores.
Virgin One commences operations in tabloid TV.
Nine new companies are launched, including a new low-cost airline and mobile phone service, both in
Australia.
2006 Virgin Express airline merged with SN Brussels Airline.
2006 Launch of airline in Nigeria.

The table also shows other strategic developments during this time.
Branson has also become increasingly interested in environmental issues, with the launch of the Virgin
Earth Challenge. In 2007, he announced this challenge to produce practical designs that can remove large amounts of carbon dioxide from the atmosphere and offered a $25m (about a17.5m) prize. This initiative was part of a number of initiatives brought together by Branson under the banner of ‘World Citizen’. These included ‘People & Planet,’ with the aim of ensuring that Virgin companies contribute to a sustainable society; Virgin Unite, a not-for-profit entrepreneurial foundation, with the aim of partnering to develop new ways to improve social and environmental issues; and the Virgin Green Fund to invest in companies in renewable energy and resource efficiency sectors in Europe and the US. Richard Branson also joined ‘The Elders’ – a group of leaders brought together by Nelson Mandela to promote peace and tackle humanitarian problems.
It seems that Branson, like Microsoft’s Bill Gates, was turning his attention to non-profit and CSR issues.

Corporate rationale
Branson’s 2008 book, Business Stripped Bare, had the subtitle: ‘the adventures of a global entrepreneur’. Virgin states on its own website that it is a ‘leading branded venture capital organisation’ and companies are part of a family rather than a hierarchy. It has minimal layers of management, no bureaucracy and a small global HQ.
Branson sees Virgin as adding value in three main ways in addition to the brand. These are: its public relations and marketing skills; its experience with
‘green-field’ start-ups; and its understanding of the opportunities presented by ‘institutionalised’ markets – by this he means those dominated by a few competitors who are not giving good value to customers because

262

CHAPTER 7 CORPORATE STRATEGY AND DIVERSIFICATION

they have become inefficient, complacent or preoccupied with rivals.
The key criterion for whether Virgin backs a new venture is ‘does an opportunity exist for restructuring a market and creating competitive advantage?’ Each business is ‘ring-fenced’, so that lenders to one company have no rights over the assets of another and financial results are not consolidated. Virgin has a mix of privately owned and public-listed companies, as well as a mix of start-up small businesses and very large corporate ventures. Each may have very different strategic reasoning: some may be an attempt to keep
Virgin in the public consciousness or possibly a method of training and developing managers. Some larger startups are serious strategic moves into new industries.
Increasingly large financial pockets and a proven track record in highly competitive industries have also enabled Virgin to enter into business opportunities with joint venture partners.

The future
Not all of Virgin’s companies are successful and not all meet the standards of customer service that Virgin would like to see – both Virgin Media and Virgin Rail have had many customer complaints. None the less,
Branson has created an image with the British public of a ‘cheeky entrepreneur’ who has battled the mighty
‘monopoly’ of British Airways and whose Virgin brand has grown into a business empire. The other lesserknown image – according to Branson-watcher and journalist Tom Bower – is one of a ruthless, crafty businessman always trying to get one over on his rivals.
It is difficult to discover the overall financial position of Virgin as it is made up of so many individual companies (many private) and there are no consolidated accounts. However, Bower states (2008) that the financial accounts show that the Virgin holding company lost
£3.9m, even as its mainstay air-travel subsidiary made a profit of £123m. Sir Richard has argued that he pursues

growth, not profits, and builds companies for the long term. With the aviation industry in crisis in 2009/10 and
Virgin’s dependence on airlines, this must raise concerns for the future of the organisation.
Richard Branson does not mention his departure in interviews but states that the company has been carefully groomed to continue without him, and that the brand is now globally well known, thus implying that his publicity stunts are no longer required. However, can
Virgin survive as an entity without Branson?

Notes
Some parts of this case are based on the previous cases on Virgin in earlier editions of this text, originally written by Urmilla Lawson and revised by Aidan McQuade.
References and sources www.Virgin.com. Bower, Tom Branson, Harper Perennial, 2008. www.businessweek.com/November 2007. www.reuters.com, 16 December 2009.
The Economist, ‘Virgin rebirth’, 12 September 2008.
The Economist, ‘Toyota slips up’, 12 December 2009.
Goff, Sharlene, Financial Times, 8 January 2010.

Questions
1 Describe Virgin’s various diversification moves in terms of Ansoff’s axes (Figure 7.2).
2 How does Virgin add value as a corporate parent? Is there anything more it should do to add value?
3 Assess whether moving further into the banking industry is the right strategic option for Virgin.
Does the continued pursuit of this industry suggest a more careful hidden strategic plan that is not revealed to outsiders?
4 What would be the challenges faced by a successor to Richard Branson, and what might he or she do?

8

Strategic
Position

Business

Corporate

Strategic
Choices

Innovation

International

Strategy in Action

Acquisitions
& Alliances

INTERNATIONAL STRATEGY

Learning outcomes
After reading this chapter, you should be able to:
●

Assess the internationalisation potential of different markets.

●

Identify sources of competitive advantage in international strategy, through both global sourcing and exploitation of local factors. ●

Distinguish between four main types of international strategy.

●

Rank markets for entry or expansion, taking into account attractiveness, cultural and other forms of distance and competitor retaliation threats.

●

Assess the relative merits of different market entry modes, including joint ventures, licensing and foreign direct investment.

Key terms
CAGE framework p. 278
Global–local dilemma p. 274
Global sourcing p. 272
Global strategy p. 266

MyStrategyLab is designed to help you make the most of your studies.

International strategy p. 266

Visit www.pearsoned.co.uk/mystrategylab to discover a wide range of resources speciﬁc to this chapter, including:

Porter’s Diamond p. 271

• A personalised Study plan that will help you understand core concepts

Staged international expansion model p. 282

• Audio and video clips that put the spotlight on strategy in the real world Yip’s globalisation framework
p. 268

• Online glossaries and flashcards that provide helpful reminders when you’re looking for some quick revision.

Vertical Integration Case Study

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