165 CHAPTER OUTLINE CASE 1 Exxon Corporation CASE 2 Kao Corporation of Japan CASE 3 AT&T: Shifting Corporate Strategies in the 1990s Introduction The Concept of Resources in Corporate Strategy Alternate Routes of Corporate Strategy New Stages New Products and Industries Broad Types of Corporate Strategies Vertical Integration Related Diversification Building Synergy in Related Diversification Unrelated Diversification Corporate Strategies Compared More Attractive Terrain Growth Profitability Stability Access to Resources Physical Assets Technologies Expertise Sharing Activities Costs of Diversification Cost of Ignorance Cost of Neglect Cost of Cooperation Maximizing Benefits, Minimizing Costs Achieving Powerful Diversification Benefits Limiting Diversification Costs Alternatives to Diversification: Corporate Restructurings Selective Focus Divestitures and Spin-offs Corporate Application to Exxon, Kao, and AT&T Summary Exercises and Discussion Questions Corporate Strategy: Leveraging Resources to Extend Advantage WHAT YOU WILL LEARN • The concept of corporate strategy • The notion of a “resource-based view” of corporate strategy • How effective corporate strategy can be used to extend and leverage a firm’s distinctive competence • The broad types of corporate strategy, including vertical integration, related diversification, and unrelated diversification • Economic forces that motivate the pursuit of different corporate strategies • How to balance the benefits and costs of diversification • Benefits of sharing and leveraging resources among businesses or activities • Costs accompanying diversification and the limitations of sharing • Why companies undertake corporate restructuring • How spin-offs and divestitures represent a form of restructuring designed to regain focus 166 PART 2 Extending Competitive Advantage As the world’s largest petroleum refiner, Exxon Corporation currently has numerous oil-producing properties and interests around the world. Throughout the 1980s and 1990s, it has con- sistently rivaled General Motors and Ford for one of the top three positions on the Fortune 500 list of companies for sales. The company has a long history, starting in 1911 after the breakup of the Standard Oil Company. In its early years, it oper- ated solely as an oil refiner, buying raw petroleum from pro- ducers in Western Pennsylvania and selling refined products to dealers in major cities. However, the company has subsequently expanded its operation well beyond this initial base, entering new stages and segments of the oil industry, offering new prod- ucts, and moving into entirely new industries. It is this expan- sion that interests us here. Industry Segments Oil refining separates petroleum into various components, including lubricants, kerosene, gasoline, aviation fuel, motor oils, naphtha, asphalt, and feedstocks for use in the chemical and plastics industries. Many items we use daily are produced from plastics and chemical composites based on petroleum. Refining crude petroleum into various products occurs through a long series of processes. Petroleum molecules are reorganized to form new compounds. These compounds are used by differ- ent customers for their individual purposes. The oil industry thus consists of a number of distinct segments, each defined by a refining stage and the product’s use. Exxon was active in sev- eral segments such as heating oil, kerosene, naphtha, and lubri- cants right from its start. Over the years it has entered into spe- cial blend fuels, chemical feedstocks for plastics (e.g., ethylene), and industrial solvents, among others. It has also expanded geographically into more than 50 countries around the globe. Currently, Exxon is investing heavily in Latin Amer- ica, with marketing agreements in Argentina, Brazil, Mexico, and Venezuela. Production Stages The oil industry consists of five stages: (1) exploration—locat- ing oil beneath the earth’s surface, (2) production—bringing oil to the surface, (3) transportation—carrying oil to refiners, (4) refining—separating oil into its various components, and (5) marketing—selling refined products to users. Although Standard Oil (Exxon’s early predecessor) began operating at just one of these stages—refining—it eventually became active in all five. Exxon is therefore a fully integrated oil company today. Fully integrated means that Exxon has committed sub- stantial investments to all five activities that directly relate to convert petroleum from the ground into higher value-added products. Product Breadth Exxon has increased the range of products it offers traditional customers. During the 1980s and 1990s, it has begun supply- ing electric utilities with coal and uranium in addition to oil. Mining has become important to Exxon to protect its per- formance from wild oil price swings. Exxon’s mining opera- tions extend its technical expertise in developing new resources. The potential to use shale oil for petroleum, for example, demands expertise in geology. The frequent coexis- tence of natural gas with oil means that Exxon must be pre- pared to position itself in the liquefied natural gas (LNG) market as well. Many experts predict surging demand for cleaner natural gas fuels as new environmental regulations and alternative applications surface. Exxon’s continuous invest- ment in alternative forms of energy, such as LNG, shale oil, and renewable resources (wind and solar technologies) enables it to acquire new forms of knowledge and expertise from different but related energy sectors. New Industry Positions Several of Exxon’s diversification moves have carried the company into entirely new industries. Its ventures into copper, gold, and zinc mining are examples of this form of natural resource-based diversification. Resource mining allows Exxon to use its existing geology and extraction skills to enter these mineral and ore markets. On the other hand, Exxon’s 1979 acquisition of Reliance Electric Company, a major man- ufacturer of electric motors, involves diversification into an entirely new and different industry. The manufacture of elec- tric motors has only indirect benefits to helping Exxon improve its operations and financial performance, since another set of skills and capabilities are needed. Exxon also entered the office automation and equipment market during the 1970s and 1980s, but subsequently retreated because it lost money. Its most memorable product from its foray into the office automation industry was the Qyx typewriter that attempted to compete with IBM’s Selectric-brand typewriters. The Qyx was an innovative machine at the time; it utilized a free-moving, ribbon cartridge that allowed for smoother and more fine-grained office printing. (Case 1) Exxon Corporation 1 CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 167 Kao Corporation is Japan’s largest producer of soaps, deter- gents, dishwashing liquids, personal care and health products, and other consumer goods. In many ways, it is Japan’s counter- part and answer to Procter and Gamble and is organized along similar lines. Its 1997 revenues topped $7.26 billion, and its net income was over $220 million, making it one of the world’s largest consumer nondurable and personal care products firms in the world. Kao is known throughout Japan and Asia and offers more than 600 different products with numerous brands. The company is also developing a strong position in other industries and technologies, such as (1) fats, oils, emulsifying agents, and thin-film coatings for use in its core lotions, health care, and personal care products, (2) specialty chemicals and polymer resins for use in the printing, plastics, and textile industries, and even (3) floppy disks and thermal paper for the personal computer industry. Kao is expanding its presence in the United States and Europe by operating R&D centers in these locations. Product Categories and Breadth Competitive advantage in consumer nondurable products, such as shampoos, detergents, and soaps, depends upon a company’s ability to customize them to local markets, while offering a new array of products continually. New product development and strong marketing capabilities (especially in distribution and market research) represent critical skills needed to compete in markets that often exhibit a high volatility and change. Global competitors such as Procter and Gamble, Colgate-Palmolive, Unilever, Henkel, and Kao, must develop and test new product concepts and ideas in rapid-fire succession. Many of these products are R&D and advertising-intensive. Considerable expertise in applied chemistry, blending, distribution, and mar- keting research is needed to design, develop, and produce new products for fast-changing markets. Thus, consumer non- durables encompass a broad range of products that require fre- quent market testing. Market research and testing are vital tasks for companies such as Kao, since competitors can imitate their products quickly. Kao spends heavily on R&D each year (up to 5 percent of sales per year) to develop advanced chemistry-driven tech- nologies and skills concerning surfactants, emulsifiers, coat- ings, adhesives, fatty acids, alcohols, and oils. Surfactants, for example, are used in detergents, dishwashing liquids, and cleaners, where they interact with water to remove grease and other oily substances. Emulsifiers are an important component of many personal, health care, and convenience products, since they help to keep oils and other substances in the proper level of balance and suspension with other ingredients. Kao’s expertise with surfactants and emulsifiers has also allowed the company to learn and invest in thin-film coatings technolo- gies. In the broadest sense, thin-film coatings are used in many consumer and commercial applications, in which chem- icals and other substrates are carefully applied (in extremely thin layers) to a given surface area to achieve some desired effect. For example, thin-film coatings are at the heart of new nicotine-suppressing drugs that are delivered through skin (epidermal) patches to help customers avoid cigarette use. The skin patch has an extremely thin layer of a drug that is deliv- ered steadily over time through the skin. Fatty acids, alcohols, and oils are used not only as ingredients for many personal care products but also as end products in their own right for the food processing and other chemical-based industries. Each year, Kao introduces a new range of products based on these skills and ingredients. This strategy of rapid product develop- ment, combined with investment in core chemistry and mar- keting skills, enables Kao to keep its competitors off balance, especially in its close Asian-based markets. Kao’s wide assort- ment of products and excellent marketing research capabili- ties also give the company significant market power with wholesalers and retailers. Extending Advantage Through New Skills Kao’s renowned strength in chemical and product-based inno- vation can be seen in numerous hit products that have reached Asian and U.S. markets. For example, in the early 1990s, Kao pioneered a reduced-fat cooking oil. This oil also can be used in salad dressings, baking, and stir-frying in half the amount needed with conventional oils—an important marketing factor for many increasingly health-conscious markets. During the late 1980s, Kao beat back a major challenge by Procter and Gamble in the Japanese disposable diaper market. Using its superior knowledge of the Japanese market, Kao was able to counter many of P&G’s inroads with its own version of the popular, disposable Pampers diapers. In a broader sense, many of Kao’s products closely follow and resemble those of Amer- ica’s Procter and Gamble and Europe’s Unilever. Both P&G and Unilever consider Kao a formidable competitor in its tech- nological and marketing prowess. Many of Kao’s highly suc- cessful product innovations have come from its ultra-modern and impressive R&D facilities. In fact, concentrated laundry (Case 2) Kao Corporation of Japan 2 168 PART 2 Extending Competitive Advantage detergents (powder and liquid) were discovered through aggressive research and marketing-based competition between Kao’s and Procter and Gamble’s research laboratories in Japan. The superconcentrated liquid Tide detergent that is found on the store shelves of many U.S. grocery and convenience stores, for example, resulted from the intense research efforts put forth by P&G to improve its product line relative to Kao and other domestic competitors in Japan. In summer 1997, Kao introduced a new product in the United States known as Biore Pore Perfect. Designed as a skin care and cleansing product, Biore is a patch-like product that customers apply to the nose, face, and other areas that attract a high concentration of hard-to-clean oils and residues. Kao is believed to have captured some $55 million in sales in the last half of 1997 from sales of this new hit product. Despite the high price of the product ($6.00 per box), some pharmacy chains were already running out of the product. Biore is an extremely popular product because it enables customers to attain that ultra-clean feeling of clean pores in the skin that conventional means of washing cannot readily achieve. Although Biore currently represents a small (but rapidly grow- ing) portion of Kao’s consumer-oriented business, it is a telling demonstration of how Kao has been able to combine its knowl- edge of thin-film coatings with its formidable market research capabilities to create an entirely new product category. Biore’s cleansing patch (similar to the skin patches now used to trans- mit nicotine-suppressing drugs) is the byproduct of Kao’s investment in the area of thin-film coatings that are now used in very innovative ways. The chemicals layered along the Biore patch product include softening agents that are used in hair conditioners and shampoos as well. Kao competes with P&G and other domestic competitors in Japan’s and Asia’s complex distribution channels. With respect to innovating and managing its marketing and distri- bution channels, Kao utilizes strategies, techniques, and new programs similar to America’s Wal-Mart. All products are extensively bar-coded. Inventories are monitored daily through a centralized information system and distribution facility. This system keeps track of sales and spot pricing trends from data gathered at wholesalers and retailers with lit- tle time delay or lag between recorded sales and new orders entered into the system. Thus, Kao is closely tied in with its largest buyers in much the same way that Wal-Mart works with its major suppliers. This tight management and control of supply chain and distribution channels enables Kao to “pull” products through its wholesalers and retailers while minimiz- ing inventory and holding costs. To continue its domestic and global growth, Kao produces many of its products in local markets. It has quickly secured important market positions throughout Asia. New Market Entry Throughout the 1980s, Kao expanded deeply not only into Asia but also into Europe and the United States. It acquired several chemical companies in Europe. Kao also set up a German sub- sidiary, Guhl Ikebana, that distributes shampoos throughout Europe. Kao’s research facility in Paris is the center for its fra- grance development. A large R&D center in Darmstadt, Ger- many, forms the nexus of European operations in skin care and beauty product development. In the United States, it has an ongoing joint venture with Colgate-Palmolive. In 1988, Kao acquired the Andrew Jergens company, a company once best known for producing a smooth hand lotion. This move further accelerated Kao’s presence in the North American market. The Andrew Jergens Research Center in Ohio has become an impor- tant center of Kao’s expertise in lotion-based products. A key function of both European and U.S. R&D facilities is to modify proprietary Kao ingredients to create products for local mar- kets. Across Asia, Kao’s manufacturing and distribution facili- ties proliferate throughout Thailand, Indonesia, Hong Kong, Singapore, Taiwan, and more recently, China. New Businesses and Industries Kao defines its core skills and competences along the broad strategic concept of surface action science. Surface action sci- ence refers to the use of applied chemicals and even thin films to coat an open surface area. Kao uses this guiding concept as a tool to consider which new businesses to enter. Some of Kao’s most important skills are in applied chemistry and coatings. Expertise with thin films, fatty acids, lotions, oils, alcohols, and other chemicals forms the basis of Kao’s products. Most con- sumers do not think of these chemicals as the building blocks of soaps, shampoos, detergents, and such radically new products as the Biore skin-cleaning patch. Yet, they provide the basis for expansion into other industries that use a similar set of applied chemistry, coatings, and blending skills. Kao’s specialty chem- icals and surface agents divisions supply polymers, lubricating oils, and additives to firms in the plastics, ink, and computer industries. These industries represent an alternative application of surface action science. In the mid-1980s, Kao expanded its strategy of surface action science to include the development and manufacture of floppy disks for personal computers. Since that time, Kao’s floppy disk operations have accounted for a fast-growing share of the data storage market. To further extend its expertise, Kao acquired High Point Chemical Corporation of the United States in 1987. High Point produces textile chemi- cals, fiber lubricants, de-inking agents, and agricultural chemi- cals. In the 1990s, Kao has begun to apply the thin-film layer- ing skills learned from floppy disks to make ink ribbons, thermal paper, and digital audio tape. Most of these products are supplied to other companies under their brand name. CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 169 During the 1990s, AT&T Corporation, America’s leading telecommunications services firm, has undergone a series of major strategic shifts in its corporate strategy. Within a span of eight years, the company has moved from being a fully inte- grated provider of computers, communications equipment, semiconductors, consumer electronics, telephone services, and even financial services to a much more streamlined telecom- munications firm. At the beginning of the decade, AT&T’s for- midable R&D, manufacturing, and marketing capabilities gave it the resources and scope to compete against the likes of such huge competitors as Toshiba and NEC of Japan, IBM and Motorola of the United States, and Ericsson, Siemens, and Alcatel of Europe. AT&T’s enormous investments in a broad range of technologies enabled it to design, develop, and apply such leading-edge applications as video transmission, virtual reality, advanced voice recognition software, ultra-fast semi- conductors, multimedia standards, and new forms of wireless transmission. None of these technologies were commercially viable as recently as six years ago, but they are now widely used and expected in state-of-the-art telecommunications, Internet, and computer-networking equipment. Yet, in 1998, the current AT&T Corporation (1997 revenues of $53.2 billion, net income of $4.64 billion) bears little, if any, resemblance to the company that came close to becoming a major player in a variety of dif- ferent industries at the start of the 1990s. It is this shift in cor- porate focus and realignment that interests us here. Early 1990s: Multiple, Integrated Businesses Since the deregulation of the long-distance telephone business in 1983, the nature of the telephone business has evolved to become more of a telecommunications business. In the broad- est sense, existing telephone lines (primarily copper) and new technologies (fiber-optic cable, packet switching, and wireless) once used primarily for transmitting voice signals can now be used to relay voice, video, and data signals in ways that greatly expand the flexibility and versatility of communications. The ability to transmit a number of different signals (voice, video, data) speedily and simultaneously along a network requires a tremendous increase in bandwidth. In its purest sense, band- width is the difference between the highest and lowest frequen- cies of a transmission signal. More broadly, increases in band- width refer to the number of different frequencies that a particular transmission media can provide. In popular parlance, an increase in bandwidth refers to an increase in the capacity of a given transmission medium to process voice, video, or data flows, often measured by how many bits per second can be transmitted or carried. With the rise of new ways to communi- cate across multiple mediums (wireline—copper, coax cable, and fiber optics; wireless—airwaves via radio frequencies; and Internet—data packets of any signal created through digitiza- tion), AT&T during the early 1990s invested large sums into becoming an important provider of voice, wireless, and data transmission equipment and services. AT&T’s entry into new technologies and products during the early 1990s emanated from a dual strategy of selected acquisitions and internal development efforts focused around a series of key technologies. Acquisition of other firms started aggressively in 1990 with AT&T’s buyout of computer giant NCR. This move gave the company access to a well-established mainframe computer business, as well as a big overseas pres- ence. AT&T envisioned that mainframe computers were a vital pillar to helping the firm develop new telecommunications serv- ices that were based on the merging of computers with com- munications. In 1993, AT&T initiated the purchase of two important businesses, Go Corporation and McCaw Cellular Communications. Go Corporation was a leading designer of personal hand-held computers that are the basis for today’s per- sonal digital assistants (PDAs). In 1994, Go Corporation was completely integrated into AT&T’s Microelectronics unit. The acquisition of McCaw Cellular enabled AT&T to develop more fully its national wireless network. The McCaw Cellular buy- out, followed later by the purchase of major stakes in Lin Broadcasting, further strengthened AT&T’s position in rolling out a more extensive cellular phone system coverage in key metropolitan areas. More important, entrance into the wireless segment enabled AT&T to compete indirectly with the local phone companies in providing cellular phone coverage. These acquisitions complemented the internally generated skills and technologies that originated from Bell Laboratories. A corporate resource vital to AT&T’s efforts to develop new technologies internally in the early 1990s was its world-renowned Bell Laboratories unit. Bell Labs remains one of America’s lead- ing research laboratories and holds numerous patents in many sci- entific and research areas involving high-energy physics, advanced electronics, mathematics, new materials, lasers, and computer programs and software. Bell Labs provided much of AT&T’s knowledge and talent that eventually made their way into new technologies and products sold by AT&T. In addition, AT&T (through its Western Electric unit) manufactured many vital elec- tronic components that have direct application to other related (Case 3) AT&T: Shifting Corporate Strategies in the 1990s 3 170 PART 2 Extending Competitive Advantage communication areas such as semiconductors, fiber optics, multi- plexing devices, computer-networking equipment, and advanced imaging technologies. These breakthroughs paved the way for more advanced forms of communications, networks, and even video game applications. Thus, by 1995,AT&T provided both the hardware and software used in many high-technology applica- tions for a number of different industries. By the mid-1990s, some of AT&T’s cutting-edge technolo- gies included the Hobbit microprocessor, which could compute 13 million instructions per second by using significantly less power than comparable Intel-made 486-based chips. AT&T Microelectronics, the developer of the Hobbit, has also designed video-compression technologies and chips that make it possible to transmit live video images over telephone lines and, later, through wireless techniques and platforms. This same Micro- electronics unit has helped Hewlett-Packard shrink a conven- tional computer hard-disk drive to the size of a credit card. Using its proprietary and cutting-edge technologies, AT&T entered the consumer electronics industry. For example, through its acquisi- tion of Go Corporation, AT&T pioneered one of the first pen- based, hand-held personal computer known as Eo, a technology that was the precursor to many of today’s personal digital assis- tants (PDAs) such as the PalmTop. Smaller and more efficient semiconductors and power supply devices from AT&T Micro- electronics are also making their way into new computers, cel- lular phones, and workstations—even in those devices manufac- tured by some of AT&T’s rivals. With its full range of R&D, technological capabilities, and manufacturing-based skills, AT&T thus became a major player in communications, comput- ers, semiconductors, and electronics by the mid-1990s. Mid-1990s: A Renewed Telecommunications Focus for AT&T By late 1995, however, AT&T’s senior management believed that the firm’s fully integrated and broad-based entry into com- puters, communications, semiconductors, consumer electron- ics, and telecommunications had become too cumbersome to manage. In September 1995, CEO Robert Allen expressed his concern that despite the company’s legendary development and implementation of many new technological breakthroughs, AT&T was increasingly at a disadvantage when it competed against more focused, nimbler, and agile competitors in the long-distance telephone and other telecommunications busi- nesses. CEO Allen believed that a number of environmental factors were beginning to complicate AT&T’s highly complex strategy to compete across a number of different businesses. First, companies such as MCI Communications (now MCI WorldCom), Sprint, and other new entrants were steadily eating away into AT&T’s share of the long-distance business (market share fell from 70 percent to 60 percent in six years). The long- distance business generated a large amount of cash from exist- ing operations, which was often diverted into other businesses (e.g., Microelectronics) or to fund large acquisitions of other companies (NCR, McCaw Cellular). Also, a big portion of this cash was used to fund cutting-edge R&D and products that often generated comparatively small returns on investment or languished in the laboratory. Over time, AT&T’s core long- distance business began to atrophy while other competitors were making steady inroads into its market with deep discounts and aggressive marketing promotions. Second, the Microelectronics and Western Electric businesses were unable to attain their full financial, technological, and sales potential within the AT&T umbrella, largely because these units faced significant obstacles to selling their state-of-the-art tech- nologies, products, and networks to other telecommunications and network customers. Firms in the long-distance (e.g., MCI, Sprint), local telephone (e.g., Ameritech, SBC Communications, Bell Atlantic, U.S. West), and wireless businesses (e.g., Sprint PCS) were increasingly reluctant to invest in new types of net- working and communications equipment made by AT&T Micro- electronics and Western Electric because they felt that their pur- chases would inevitably strengthen an already major competitor that demonstrated strong ambitions to enter new markets. In the meantime, AT&T’s competitors in the networking equipment industry such as Alcatel, Ericsson, Motorola, Northern Telecom (Nortel Networks), Fujitsu, and Siemens had begun cementing important sales agreements with the large Regional Bell Operat- ing Companies (RBOCs) for leading-edge equipment. Moreover, managers at both Microelectronics and Western Electric felt an internal obligation to always satisfy their internal customer first (AT&T long-distance), rather than to aggressively pursue other telecommunications customers. Thus, the difficulties in coordi- nating activities between AT&T’s long-distance business’ needs with that of Microelectronics’ and Western Electric’s needs slowed down the entire company. Finally, AT&T’s widely cherished belief that convergence between mainframe computers and communications to create an entirely new telecommunications platform never quite mate- rialized. The acquisition of NCR in 1990 to build a “third wave” of advanced communications capabilities failed to produce value and competitive advantage when innovative computer- networking technologies rapidly displaced mainframe comput- ers as the key pillar to support the integration of voice, video, and data. Instead, cutting-edge technologies such as advanced data hubs, switches, and routers are now the backbone of today’s Internet. New competitors such as Cisco Systems, Ascend Communications, 3Com Corporation, Fore Systems, Tellabs, and other networking firms have done much to design, develop, and build the equipment that is the backbone of today’s Internet and telecommunications network. CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 171 INTRODUCTION Thus far, most of our examination of competitive advantage has been from the stand- point of a firm operating a single business within an industry. We are now ready to broaden our view. A firm can develop new capabilities by expanding into other seg- ments, businesses, or industries. Such expansion is guided by corporate strategy. The Thus, in September 1995, AT&T broke itself into three dif- ferent companies by divesting the networking equipment and mainframe computer business. The original AT&T Corporation would concentrate on its core long-distance and emerging telecommunications and Internet-driven businesses. AT&T Microelectronics, Bell Laboratories, and the Western Electric manufacturing unit became an independent, new firm known as Lucent Technologies. Lucent’s share offerings were made to the public in April 1996. The mainframe computer business returned to its previous independence and namesake as NCR. Late 1990s: New Growth and Challenges As of June 1999, all three companies, AT&T, Lucent Tech- nologies, and NCR are much more focused entities. In partic- ular, Lucent Technologies has become a leading developer and provider of state-of-the-art telecommunications, photonics, computer-networking, and semiconductor (digital signal processors) technologies. At the end of 1997, Lucent Tech- nologies’ revenues were close to $26.5 billion with net income of $541 million. As of April 1999, however, Lucent boasted a market capitalization that topped $140 billion, even greater than that of its former parent AT&T ($130 billion), and has become one of the most potent competitors in the telecom and computer-networking equipment businesses. Most important, Lucent Technologies has aggressively moved away from many low-margin businesses to focus on data-networking products (hubs, switches, and routers) that compete directly with pow- erhouse Cisco Systems to build the infrastructure for the Inter- net. It has also won a series of important sales contracts from local telephone companies (e.g., SBC Communications) that would have been reluctant to purchase equipment from it as recently as three years ago. The new firm is also a major player in the semiconductor industry. Lucent now produces advanced digital signal processors (DSPs) that are at the heart of advanced digital cellular phones and other consumer electron- ics applications. After many early successes, Lucent is now in the curious position of deciding whether to continue its own strategy of internally developing new technologies through its Bell Labs unit or to acquire other smaller companies to quickly build market share and gain access to new technologies. So far, in the thirty-six months that it earned its independence, Lucent has also acquired a number of extremely innovative network- ing companies, such as Prominet, Livingston, Yurie, Triple C Communications, Ascend Communications, and Lannet. The original AT&T, now focused on its core long-distance and growing Internet businesses, has become more active in pursuing new acquisitions to penetrate the local telephone business. Since the Telecommunications Act of 1996, long-distance companies are now free to enter the local telephone business and vice versa (with government approval on a case-by-case basis). In January 1998, AT&T purchased Teleport Communications Group, a local telephone company in the Northeast, for $11.3 billion from Com- cast Corp., Tele-Communications, Inc., and Cox Enterprises— three cable television companies that once had aspirations to enter the local phone business themselves. However, the cable compa- nies underestimated the amount of investment in new technology that was required to convert one-way cable lines into two-way communication systems. Teleport is an important acquisition for AT&T because it has over 250,000 direct communication lines to business customers that bypass the expensive Regional Bell oper- ating networks. With the Regional Bell companies potentially moving closer into the long-distance business, AT&T’s acquisi- tion of Teleport could be viewed as a first-mover strategy to fore- stall the local telephone companies’ future moves. In late June 1998,AT&T purchased Tele-Communications Inc. (also known as TCI) for $37.3 billion. The complicated deal enables AT&T to pursue faster entry into the local phone business and to put the Internet into every home that has cable, but there are numerous technical obstacles to implementing this strategy. Most important, converting cable’s one-way television lines into two-way conduits will cost additional billions. Also, local phone companies are competing with an alternative set of technologies (Digital Sub- scriber Line) that use existing copper lines to provide Internet access as well. By way of its TCI acquisition, AT&T also gains access to new Internet cable access technology through TCI’s AtHome affiliate. AT&T is now in the midst of looking for other acquisition candidates in the cable television and Internet arenas. On the other hand, NCR, the former giant in mainframe computers, has continued to languish as the industry faces ongoing challenges from personal computers, computer net- working systems, and single-digit growth. In 1997, NCR’s rev- enues were $6.58 billion with net income of $7 million. 172 PART 2 Extending Competitive Advantage issues surrounding corporate strategy are different and significantly more complex than those for a firm operating a single business in one industry. Corporate strategy requires managers to establish a coherent, well-defined direction that guides the allocation of resources into new areas of activity. Corporate strategy in this book refers to the iden- tification of opportunities and the allocation of resources to develop and extend the firm’s competitive advantage to other activities or lines of businesses. In its most pow- erful application, corporate strategy is more than the sum of the firm’s individual busi- ness unit strategies; it seeks to leverage the firm’s distinctive competence from one busi- ness to new areas of activity. Corporate strategy is an important but often misunderstood area of management. An overwhelming number of the Fortune 500 companies operate more than one line of busi- ness. In fact, recent research shows that the average Fortune 500 company has positioned itself in about ten different businesses. Such expansion, however, is not easy. One land- mark study found that more than half of all acquisitions made by 33 large corporations prior to 1975 were subsequently divested by 1985. 4 Moreover, many of the large Fortune 500 companies that have attempted to enter new lines of businesses (General Electric, IBM, General Mills, Sears, American Express, and AT&T) have encountered serious dif- ficulties in building and extending their competitive strengths even to businesses and industries that they knew well. The key issue of corporate expansion into new activities or businesses may be viewed as follows: Is a firm’s competitive advantage in one business or area of activity strengthened by the firm’s presence in another? Identifying activities or businesses that satisfy this requirement is the focus in this chapter. First, we examine the concept of what resources are important to formulating a coher- ent corporate strategy. Ideally, well-formulated corporate strategies are based on utilizing and leveraging resources that enable the firm to create distinctive sources of value and advantage over a long time period. Managers need to build their corporate strategies on those resources—assets, skills, and capabilities—that are hard for other firms to duplicate. Second, we consider the various routes to expanding the number of businesses a firm oper- ates. Third, we look at specific types of corporate strategies that enable firms to leverage their resources and skills to extend their competitive advantage to new areas of activity. We focus our attention on the issue of diversification in particular. Fourth, we then consider the chief benefits and costs associated with each type of expansion, especially as it con- cerns diversification. Finally, we offer guidelines to help firms achieve the benefits of expansion into new areas while avoiding its costs. THE CONCEPT OF RESOURCES IN CORPORATE STRATEGY Corporate success in extending sources of competitive advantage to new arenas—prod- ucts, businesses, and market segments—depends heavily on how well firms have devel- oped and cultivated those assets, skills, technologies, and capabilities to create a set of dis- tinctive competences and resources that are significantly different from those of its competitors. In many ways, the central issue that relates to building competitive advantage at the business-unit level—leveraging a distinctive competence to create a competitive advantage—is fundamentally no different an issue than that for companies trying to com- pete across multiple businesses. However, managing a diverse set of multiple business units, particularly those involving market positions among different industries, signifi- cantly adds to the complexity of operations. Building and leveraging sources of competitive advantage among multiple business units within a diversified firm thus calls for a different perspective that recognizes the inherent complexity of managing assets, skills, technologies, and capabilities across the corporate strategy: plans and actions that firms need to formulate and implement when managing a portfolio of businesses; an especially critical issue when firms seek to diversify from their initial activities or operations into new areas. Corporate strategy issues are key to extending the firm’s competitive advantage from one business to another. CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 173 firm’s different subunits. When considering the issue of corporate strategy, firms need to understand how their broader collection of resources contributes not only to leveraging their distinctive competences among internal businesses, but also to competing against other firms as well. In many ways, successful corporate strategy is based on identifying those resources that enable a firm to build systemwide advantage among its businesses in ways that other firms cannot readily imitate or duplicate. During the 1990s, this resource- based view of the firm is becoming more important to understanding corporate strategy. 5 From this perspective, corporate strategy will be successful only to the extent that the firm possesses and leverages those resources (assets, skills, technologies, capabilities) that share a number of important characteristics. First, a firm’s resources should ideally be so distinctive that they are hard for competi- tors to imitate or duplicate. The more distinctive or hard-to-imitate the resource, the less likely there will be direct competition in that arena. If a resource (skill, technology, or capability) is hard to imitate, then any future profit stream and competitive advantage is likely to be more enduring and sustainable. Conversely, those resources that are easy-to- imitate will generate only temporary value, since other firms can readily copy that skill. Over the long term, however, few corporate resources will sustain their hard-to-imitate qualities unless firms continue to invest and upgrade them at a rate faster than what other competitors can do. As we noted in Chapter 4, it is difficult for the vast majority of firms in the semiconductor industry to sustain their distinctive resources and skills over a long period of time when new entrants and competitors come out with ever newer designs, man- ufacturing processes, and advanced materials as the product goes through its life cycle stages. On the other hand, an organizational capability for fast innovation such as that found at Hewlett-Packard or Procter and Gamble may be considered a valuable resource that is hard-to-imitate. Second, a firm’s resources should also be highly specialized and durable. This feature can often represent a double-edged sword. Highly specialized assets and skills can produce long- lasting value, but they can also be very rigid and hard to change when new technologies or demand patterns arise. Some of the most specialized and durable assets can also limit a firm’s ability to respond to environmental changes, as we have seen in the Eastman Kodak and Timex examples. On the other hand, some of the best examples of where highly specialized and durable resources have created sustainable advantage over long time periods include such assets as brand names and patents. Brand names such as Walt Disney, Procter and Gam- ble, AT&T, IBM, Frito Lay,American Express, Intel, and Microsoft provide these firms with a durable, lasting degree of staying power and freedom to maneuver, even when their respec- tive markets may be fast-moving. Patents, especially those in the pharmaceutical and chem- ical industries, are another way in which specialized and durable resources can be readily used and reused to build and leverage new sources of competitive advantage. Both brand names and patents may be significant resources in helping firms formulate and implement their corporate strategies, since they are enduring over an extended period of time. Third, firms need to monitor the environment so that their corporate resources do not suffer from easy substitution from other competitive providers of similar value-adding activities. In other words, even when a firm’s set of resources is hard-to-imitate and highly durable, senior managers need to remain aware of potential substitute threats from firms in other industries who may bring to bear an entirely different set of assets, skills, technolo- gies, and capabilities to the current industry or arena. Over the long term, however, emerg- ing products, services, or technologies that could serve as substitutes are likely to surface in any industry. Yet, many firms have invested in learning new sets of skills and capabili- ties that enable them not only to deal effectively with the emerging substitute threat but also to embrace the substitute as part of its own redefined strategy. For example, until resource-based view of the firm: an evolving set of strategic management ideas that place considerable emphasis on the firm’s ability to distinguish itself from its rivals by means of investing in hard-to-imitate and specific resources (e.g., technologies, skills, capabilities, assets, and management approaches). 174 PART 2 Extending Competitive Advantage 1994, Microsoft had not really developed a well-thought-out strategy for dealing with such pioneering upstarts as Netscape Communications and others who were riding the first wave of the Internet. By late 1995, realizing the potential threat that Netscape’s Web- browser products could eventually substitute for many of its existing stand-alone, desk top applications, Microsoft completely shifted its strategy and made the Internet a central part of its corporate strategy to extend its software design and applications skills to learning and building new businesses. Using many of these resource-based perspectives, we now begin to examine how firms can develop various types of corporate strategies for leveraging their sources of competi- tive advantage into new arenas. ALTERNATE ROUTES OF CORPORATE STRATEGY Firms usually begin their existence serving just one or a few niches. At some point during their evolution, many expand beyond their initial base or core business. 6 Such expansion increases the diversity of customers a firm serves, the number of products it produces, and the technologies it must learn and manage. This pattern is therefore broadly referred to as expanding the scope of operations. Scope of operations refers to the extent of a firm’s operations across different activities, products, and markets. Corporate strategy is con- cerned with selecting the products, markets, and industries in which to extend the firm’s distinctive competence. Expansion into other activity areas is considered successful when the firm’s distinctive competence is strengthened by moving into new areas. 7 Recall that a firm’s distinctive competence refers to what it can do particularly well vis-a-vis its competitors. Distinctive competence is rooted in such attributes as a central technology, resource, expertise, or skill that the firm uses to create and add value. From the perspective of corporate strategy, if a firm can successfully apply and extend its distinctive competence to new activities, prod- ucts, or markets, then it can develop competitive advantage across multiple businesses. The most common routes to enlarging the firm’s scope of operations are expansion into new stages of the industry value chain and expansion into new products and industries (see Exhibit 6-1). New Stages Firms may expand their scope of operations to include different stages or levels of value- adding activity within the same industry. Expansion into an earlier or later stage of a firm’s base industry is usually referred to as vertical integration. We briefly discussed vertical integration in previous chapters as a source of competitive advantage for a single-business firm. Yet, vertical integration is also a corporate strategy issue, since it involves enlarging the scope of what the firm does to include other value chain activities. It can take two basic forms: backward integration and forward integration. Backward integration moves the firm into an activity currently carried out by a supplier. Forward integration moves the exhibit(6-1) Common Avenues to Enlarging the Firm’s Scope of Operations • Entrance into new stages of activity (i.e., vertical integration) • Entrance into new businesses/industries (i.e., industry-based diversification) scope of operations: the extent of a firm’s involvement in different activities, products, and markets. vertical integration: the expansion of the firm’s value chain to include activities performed by suppliers and buyers; the degree of control that a firm exerts over the supply of its inputs and the purchase of its outputs. Vertical integration strategies and decisions enlarge the scope of the firm’s activities in one industry. backward integration: a strategy that moves the firm upstream into an activity currently conducted by a supplier (see vertical integration, forward integration). forward integration: a strategy that moves the firm downstream into an activity currently performed by a buyer (see vertical integration, backward integration). [...]... especially distinctive, perhaps even unique, to the firm possessing them Firms possessing such knowledge and expertise-based resources are well situated to extend their own distinctive competences into new areas of activity, since the uniqueness of such knowledge makes it hard for competitors to follow rapidly CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage In the pharmaceutical industry,... distinctive competence across a wide array of similar businesses CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage and activities Related diversification works to extend a firm’s distinctive competence by building a corporate- level, firm-specific, resource-based source of competitive advantage Corporate- level advantage occurs when value is created both in a firm’s individual business... CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage chips and other electronic devices from outside firms, it was dependent on these suppliers However, its Microelectronics unit’s capability to produce the chips and other electronic devices in-house enabled AT&T not only to reduce the uncertainty of future supply but also to learn and to extend chip-based technologies to new products... subsidiaries to Associates First Capital, a financial powerhouse that was recently part of Ford Motor Company Associates First Capital bought Avco Financial Ser- CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage vices because it represented a complementary fit to its own commercial and credit-card financial services businesses Textron’s current corporate strategy is to allocate... own camping expertise would be useful to CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 197 a RV manufacturer This expectation went largely unfulfilled, however Success in the RV business requires sophisticated assembly skills, which KOA, a service enterprise, totally lacked KOA possessed little expertise it could transfer to Gardner Unable to improve Gardner’s performance, KOA... Diversification A More attractive terrain • Faster growth • Higher profitability • Greater stability B Access to resources • Physical assets and access to markets • Technologies and skills • Expertise C Sharing of activities (any business system activity) CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage MORE ATTRACTIVE TERRAIN New terrain may be more attractive than that of a firm’s base business... Value creation at both business and corporate levels becomes easier when managers work jointly to develop ways to extend the firm’s distinctive competence across businesses Thus, related diversification strategies are designed to extend the firm’s distinctive competence and corporate resources to other products, businesses, and industries Related diversification aims to create synergy, whereby the firm... advise top management in diversification issues This effort takes time and can potentially distract attention from core businesses e x h i b i t (6-5) Costs of Diversification • • • Ignorance (about newly entered fields) Neglect (of core business) Coordination • communication • compromise • accountability CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage Once a decision to diversify... prices A manager’s CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 195 performance can then no longer be strictly equated with financial results of the business’s operations; instead, performance must be judged in part on other subjective factors Such evaluations complicate the job of senior managers by requiring them to consider these subjective factors when measuring a manager’s...CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 175 firm closer to its customers.8 Standard Oil (Exxon) integrated backward when it moved into oil production from its initial base in refining It integrated forward when it began retailing gasoline through its own service . or operations into new areas. Corporate strategy issues are key to extending the firm’s competitive advantage from one business to another. CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage. backward integration). CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 175 firm closer to its customers. 8 Standard Oil (Exxon) integrated backward when it moved into oil production from. value to the firm when managed as a single, unified entity. CHAPTER 6 Corporate Strategy: Leveraging Resources to Extend Advantage 179 and activities. Related diversification works to extend