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• Anubhav Aggarwal

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Porter, Michael E. (1987), “From competitive advantage to corporate strategy,” Vol. 59, Cambridge, MA: Harvard Business Review. Summarized by: Anubhav Aggarwal Many corporations choose to grow by acquiring other companies, but not all acquisitions turn out to be profitable. Such acquisitions need to be guided by a corporate strategy that seeks to maximize shareholder value. Corporate strategy is what makes the corporate whole add up to more than the sum of business unit parts. It guides the corporation in choosing the businesses it should be in and how the array of business units should be managed. There are four popular concepts of corporate strategy: portfolio management, restructuring, transferring skills, and sharing activities. The first two do not require the acquired business unit to be connected with the existing units; the second two depend on such a connection. Although the concepts are not always mutually exclusive, the way in which they generate value for the corporation is different for each. In order to increase shareholder value for the corporation, these strategies should pass:   

The attractiveness test. High ROI, high entry barriers, low customer and supplier bargaining power, and few substitute products. The cost-of-entry test. If the cost of entry is so high that it prejudices the potential return on investment, profitability is eroded before the game has started. The better-off test. How will the acquisition provide advantage to either the acquirer or the acquired?

Portfolio Management This corporate strategy is analogous to its namesake in the financial sector, where it refers to an investor’s collection of shares in different companies, purchased to spread investment risk. The corporation acquires sound, attractive companies with competent managers who agree to stay on. But unlike an individual investor, a corporation using a portfolio management strategy tries to maximize its return by improving the operations of the acquired companies. It does so by supplying capital on favorable terms and improving management techniques. The acquired units are autonomous and do not have to be in the same industries as the existing units. The top management provides objective and dispassionate review of business unit results and the teams that run them are compensated accordingly. Portfolio managers categorize units by potential and regularly transfer resources from units that generate cash to those with high potential and cash needs. In order to pass the attractiveness and cost-of-entry tests, a corporation must find truly undervalued companies. This has become increasingly difficult in well-developed capital markets where everybody is aware of such companies. To meet the better-off test, the corporation must provide a significant competitive advantage to the acquired firm or vice-versa.

Normally, no such advantage emerges as the business units are autonomous. But in the end, it is the sheer complexity of managing a growing set of unrelated businesses that defeats even the best portfolio management strategy. Restructuring Restructuring is similar to portfolio management, except that the corporation takes an active role in managing and restructuring the acquired business unit. First, it seeks out undeveloped, sick, or threatened organizations or industries on the threshold of significant change. Then it intervenes frequently, changing the management team, shifting strategy, or introducing new technologies until the unit is strengthened. Finally, the corporation sells off the invigorated unit as it is no longer adding value. The restructuring strategy passes the attractiveness and cost-of-entry tests as it deliberately seeks out companies with problems and lackluster images or industries with unforeseen potential. It also passes the better-off test as the purpose of the acquisition is to intervene and turn around the business unit. To work, the restructuring strategy requires a corporate management team with the insight to not only spot undervalued companies or industries ripe for transformation, but also to actually turn the units around even though they may be in unfamiliar businesses. But perhaps the most difficult part of this strategy is fighting the human instinct of not wanting to dispose of the units once they are performing well. Transferring Skills Unlike the previous two strategies, the last two concepts exploit the interrelationships between the acquired and the existing business units. Every business unit is a collection of discrete activities ranging from sales to accounting that together form a value chain. It is at this activity level, not the company as a whole, that a unit achieves competitive advantage. One way to do this is by transferring skills or expertise among similar value chains. In this strategy, knowledge about how to perform activities is transferred among the units. These opportunities arise when business units have similar buyers or channels, similar value activities like government relations or procurement, similarities in the broad configuration of the value chain, or the same strategic concept. Even though the units operate separately, such similarities allow the sharing of knowledge. Transferring skills is successful only if the activities involved in the businesses are similar enough that sharing expertise is meaningful, it involves activities that are key to competitive advantage, and the expertise or skills to be transferred are both advanced and proprietary enough to be beyond the capabilities of competitors. This concept of corporate strategy meets the tests of diversification if the company is able to share proprietary expertise across units. This makes certain the company can offset the acquisition premium or lower the cost of overcoming entry barriers.

Sharing Activities The last corporate strategy is also exploits the interrelationships between the value chains of the business units. But instead of just sharing expertise or skills with another unit, in this case the units share the activities themselves. The ability to share activities is a potent basis for corporate strategy because sharing often enhances competitive advantage by lowering cost or raising differentiation. Sharing can lower costs if it achieves economies of scale, boosts the efficiency of utilization, or helps a company move more rapidly down the learning curve. It can also enhance and reduce the cost of differentiation. For example, a shared order-processing system may have features from both the businesses and still cost less than two separate systems. Like in the case of transferring skills, sharing must also involve activities that are significant to competitive advantage. Also the benefits of sharing must outweigh its costs. One cost is the greater coordination required to manage a shared activity. More important is the need to compromise the design or performance of an activity so that it can be shared. If a compromise greatly erodes a unit’s effectiveness, then sharing may reduce rather than enhance competitive advantage. In terms of the diversification tests, sharing activities clearly meets the better-off tests, if implemented successfully, as it generated competitive advantage for all the units involved. It also meets the cost-of-entry test as other corporations that lack opportunities to share activities will have lower reservation prices. Critique In this article, the author advances the idea of corporate diversification from portfolio management to a more synergy-oriented view of a multi-business firm based on interrelationships between business units. He argues that a company will create shareholder value through diversification to a greater and greater extent as its strategy moves from portfolio management toward sharing activities. This is because strategies based on interrelationships do not rely on superior insight or other assumptions about an acquired company’s capabilities. Although, the ideas of synergy and competitive advantage were already popular at the time this article was written, the author goes beyond talking about the general concepts by trying to illustrate where such synergies can be realized in order to enhance competitive advantage. One issue that the author ignores is how to manage the organizational complexity that arises out of integration of new business units. Exactly how can skills be transferred and how can activities be shared are questions that remain unanswered. Another topic that needs more elaboration is how to operationalize the diversification tests. For example, in case of the better-off test, it may be difficult to determine in advance which relationships will actually add value.