Corporate Strategy & Diversification Strategy: definitions (Antonio Ghezzi) - YouTube

Strategy, that is the quest towards a sustained performance higher than competitors,

is formulated and planned on distinct though intertwined levels.

More specifically, the level of Strategy are three:

a Corporate Strategy level, a Business Strategy level and a Functional or operational level.

Let’s focus on the Corporate level, so as to define Corporate Strategy.

The main goal of Corporate Strategy is to manage financial resources allocation

to the portfolio of different Strategic Business Units the overall company is made of.

At this level, strategy defines in which industries and markets the company is going to compete.

So the company is seen from an helicopter view as a bundle, or portfolio,

of different markets and Strategic Business Units.

The key issues to deal with at this level are:

first, to analyze and compare the competitive positioning of each business,

and of the overall business portfolio;

second, to suggest a generic strategic orientation to each business

(that will be further specified at a Business Strategy level);

and third, to define criteria and priorities for financial resources allocation to each business

(cash generating vs. cash absorbing SBUs), looking for an overall portfolio’s financial equilibrium.

In terms of scope, Corporate Strategy considers a Product Scope and a Geographical Scope.

About the Product scope, they key question to address is how focalized or specialized

should the company be in terms of the range of product it supplies.

For instance, a company like Coca-Cola is specialized in the beverages industry,

while General Electric is diversified and it operates in multiple industries.

Concerning the Geographical scope, the corporate management shall consider

what is the geographical spread of activities for the company:

on the one hand, we have global companies, such as Procter&Gamble or Toyota.

On the other hand, we may find some companies which have decided to focus on one country only.

Also, the definition of the level of vertical integration

may be achieved by adding or removing streamlined SBUs to or from the overall portfolio

is another scope decision taken at the Corporate level.

Here we find both highly integrated companies, such as Samsung,

and companies that outsource several activities of their value chain, like Apple.

So, as a whole, corporate strategy focuses on some fundamental topics that lead back

to product range, geographical coverage and level of vertical integration.

All of these corporate strategies that aim at changing the scope of a company’s portfolio

go under the name of “diversification strategies”.

Diversification is a Corporate level strategy aimed at entering new business areas

which the corporation is not currently serving (and creating new SBUs to serve such new business areas).

Considering the transaction costs theory, which compares the hierarchy vs market alternatives,

diversification is hence a choice of “hierarchy”,

that is, internalizing a new business within the corporate portfolio,

rather than externalizing or outsourcing the activity and related business to the market.

However, diversification is not the only option:

when should we decide to diversify rather than, for instance, go for brand franchising,

that is, selling our brand to third parties to receive royalties in return?

As we said, brand franchising is not a diversification strategy

since the company does not create an internal organization (that is, a SBU) to cover the industry.

So, this represent an example of the “market” option.

To investigate the issue, Robert Grant, in his book “Contemporary Strategy Analysis”,

makes the example of Harley Davidson.

That brand is not only associated to motorbikes, but also to a broad range of gadgets like T-shirts and so on.

However, Harley Davidson does not own the companies that produce and sell those gadgets,

it only rents its brand to them. Why?

To understand it, we should consider two parameters: scope economies, and transaction costs.

Scope economies are scale economies applied to a wider range or family of activities performed:

the higher the aggregated volume per year of the products range the company produces

(by adding up different products), the lower the average cost per unit.

Transaction costs are the costs to bear to set up an agreement with the “market”.

By combining the effects of scope economies and transaction costs,

we learn a fundamental rule about diversification.

Diversification is more favorable than other alternatives (e.g. brand franchising)

when the following criteria are met: scope economies are present, so aggregating the production

of more activities within the company’s boundaries lowers average cost per unit.

And transaction costs are high, so internally performing a new activity is more convenient

than outsourcing it to an external party.

This rule should guide Corporate management’s decision concerning diversification strategies.