Cambridge Unive rsit y Pre ss Phanish Puranam and Bart

CORPORATE STRATEGY

Tools for Analysis and Decision-Making

Many companies are not single businesses but a collection of businesseswith one or more levels of corporate management. Corporate strategyrefers to how they compete. Written for managers, advisors, and studentsaspiring to these roles, this book is a guide to decision making in thedomain of corporate strategy. It arms readers with research-based toolsneeded to make good corporate strategy decisions and to assess thesoundness of the corporate strategy decisions of others. Readers willlearn how to do the analysis for answering questions such as “Shouldwe pursue an alliance or an acquisition to grow?”, “How much should weintegrate this acquisition?” and “Should we divest this business?”. Thebook draws on the authors’ wealth of research and teaching experience atINSEAD, London Business School, and University College London. Arange of learning aids, including easy-to-comprehend examples, decisiontemplates, and FAQs, are provided in the book and on a rich companionwebsite.

phanish puranam is the Roland Berger Chair Professor of Strategy andOrganization Design, and Academic Director of the PhD programme atINSEAD. He was previously Chair of the PhD programme at LondonBusiness School. A leading researcher, teacher, and advisor in the areasof corporate strategy and organization design, Phanish has won severalhonours for his work. He received his PhD at the Wharton School(University of Pennsylvania).

bart vanneste is Associate Professor of Strategy at the UCL School ofManagement. He researches and teaches corporate strategy, with a focus onthe design and management of inter-organizational relationships. Hereceived his PhD at the London Business School.

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Cambridge University Press978-1-107-12091-4 - Corporate Strategy: Tools for Analysis and Decision-MakingPhanish Puranam and Bart VannesteFrontmatterMore information

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“Puranam and Vanneste will change how you think about corporate strat-egy. They offer rigorous principles, frameworks and exercises to addresssome of the most crucial challenges of business leaders. . . A must-read forbusiness students, business development professionals and seniorexecutives.”

Laurence Capron, The Paul Desmarais Chaired Professor of Partnershipand Active Ownership, Professor of Strategy, INSEAD

“. . . There are no better guides than Puranam and Vanneste. CorporateStrategy combines analytical rigor and an academic foundation with easy-to-grasp real world application. Brilliant!”

Nirmalya Kumar, Member-Group Executive Council, Tata Sons

“Corporate Strategy is a wonderful book! Refreshingly clear and practi-cal. . .this book will change the way we teach and practice corporatestrategy.”

Costas Markides, Professor of Strategy and Entrepreneurship,Holder of the Robert P Bauman Chair in Strategic Leadership,

London Business School

“This book provides a unique guide to business students and practicingmanagers who seek a comprehensive understanding of the factors to con-sider when making strategic decisions for multi-business firms.”

Constance E. Helfat, J. Brian Quinn Professor inTechnology and Strategy Tuck School of Business at Dartmouth

“Puranam and Vanneste have provided a thought-provoking articulationof the key aspects of a strong Corporate Strategy. . .Well worth the read forany practicing strategy executive”.

Vishal Dixit, Head of Group Strategy at a FTSE-100 telecomsoperator and former McKinsey management consultant






CORPORATE STRATEGYTools for Analysis and Decision-Making

PHANISH PURANAM

AND

BART VANNESTE






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It furthers the University’s mission by disseminating knowledge in the pursuit of education, learning and research at the highest international levels of excellence.

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© Phanish Puranam and Bart Vanneste 2016

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permission of Cambridge University Press.

First published 2016

A catalogue record for this publication is available from the British Library

Library of Congress Cataloguing in Publication dataPuranam, Phanish.

Corporate strategy: tools for analysis and decision-making / PhanishPuranam and Bart Vanneste.

pages cmIncludes index.

isbn 978-1-107-12091-41. Strategic planning. 2. Decision making. 3. Industrial

management. I. Vanneste, Bart. II. Title.hd30.28.p856 2016

658.4´012–dc232015026751

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Contents

List of figures page viList of tables ixList of boxes xiAcknowledgments xiiIntroduction: what this book is about and how to use it xiv

part i Foundations 11 Corporate advantage 32 Synergies: benefits to collaboration 293 Governance costs: impediments to collaboration 70

part ii Decisions about portfolio Composition: increasingthe scope of the corporation 834 Diversification 855 Ally or acquire? 1006 Organic or inorganic growth? 120

part iii Decisions about portfolio Composition: reducingthe scope of the corporation 1337 Divestiture: stay or exit 1358 Outsourcing: make or buy 153

part iv Decisions about portfolio organization 1739 Designing the multi-business corporation 17510 Designing the corporate HQ 19911 Managing the M&A process 22712 Managing the alliance process 256

Index 288

v






Figures

1.1 Willingness-to-pay and willingness-to-sell page 51.2 Different types of competitive advantage 61.3 Investors can jointly own business, corporate

strategists can additionally jointly operate them 131.4 Corporate advantage involves a comparison between

what is and what could have been 172.1 Value chain of a toy maker 332.2 A value chain and the resources underlying value 342.3 Consolidation (similar resources and high

modification) 382.4 Combination (similar resources and low

modification) 392.5 Customization (dissimilar resources and high

modification) 412.6 Connection (dissimilar resources and low

modification) 432.7 Value chain overview 502.8 Investors can jointly own business, corporate

strategists can additionally jointly operate them 543.1 Governance costs and collaboration 723.2 Governance structure and synergy characteristics 783.3 Corporate advantage, synergies, and governance

costs 794.1 Corporate diversification 864.2 Growth tree: organic and inorganic growth 865.1 A continuum of governance structures 1025.2 Possible organizational integration across governance

structures 1046.1 Growth tree: organic and inorganic growth 1216.2 Key trade-offs in accessing resources 124

vi






7.1 The difference between divestiture and outsourcing 1367.2 Ownership after divestiture 1397.3 Choosing a divestiture mode 1418.1 Outsourcing and offshoring 1548.2 The company remains in the footwear business after

outsourcing manufacturing 1558.3 Why a specialist vendor can create more value after

taking over parts of your value chain 1588.4 When to outsource 1598.5 Indicators of transaction costs in outsourcing and

offshoring 1659.1 Corporations as value chain bundles along three

dimensions 1779.2 Elements of organizational structures 1789.3 Prototypes of organizational structures 1819.4 The functional form 1819.5 The multi-divisional form 1829.6 The customer-centric form 1829.7 Performance implications of intra- vs.

inter-functional integration 1849.8 The product–function matrix 1859.9 A technology–customer hybrid 1869.10 MultiDevice’s re-organization from a functional

structure to a matrix structure of products andcustomers 189

9.11 Typical ownership structure of a business group 192A9.1 A single-product MNC 195A9.2 MNC structures 19610.1 HQ influence has two dimensions 20310.2 Synergistic portfolio framework 21110.3 The cost of omission and commission errors

influences the threshold of acceptance 21410.4 Synergistic portfolio framework for A2G 218

vii • List of figures






11.1 Stages and people in an M&A process 22811.2 Valuation sets the lower and upper bound for

negotiation 23011.3 The fundamental trade-off in PMI between

collaboration and disruption 23611.4 Grouping and linking 23811.5 Grouping and linking choices in PMI 23911.6 Grouping choices constrain linking choices 24111.7 PMI matrix 24211.8 PMI matrix for TechnoSystems and LittleCo. 24412.1 A continuum of governance forms 25712.2 Stages and stakeholders in an alliance process 25812.3 Determining the attractiveness of each scenario 26312.4 Four alliance situations 26512.5 Grouping and linking 27512.6 Linking choices in alliance integration 27512.7 Alliance integration matrix 27812.8 Non-equity and equity alliances 284

viii • List of figures






Tables

0.1 How the chapters build on each other page xxi1.1 Useful corporate strategies in different contexts 131.2 SOTP valuation 141.3 Assumptions when using SOTP valuation to

infer corporate advantage 161.4 Does risk reduction lead to a lower discount rate

(and hence a higher NPV)? 19A1.1 NPV calculation with a discount rate of 7 percent 282.1 The four basic synergy operators 352.2 Synergy operators and their attributes 45

A2.1 Synergy operators and value drivers 57A2.2 Estimated impact on business A 59A2.3 Estimated impact on business B 60A2.4 Impact of synergies 61A2.5 Business A standalone 62A2.6 Business A with synergies 64A2.7 Business B standalone 66A2.8 Business B with synergies 685.1 Preferred equity level 1085.2 Identifying the best combination of inorganic

growth mode and candidate firm 1116.1 Deciding between inorganic and organic growth 1277.1 Modes of divestiture 1389.1 The benefits and costs of grouping similar vs.

different activities 18310.1 Prototypes of HQ influence 20610.2 Enterprise values before and after hypothetical

spin-off (in million dollars) 21610.3 Benefits from and to A2G for each division 217

ix






10.4 The link between organizational structureand influence model 223

11.1 Valuation of synergies (all in million dollars exceptwhere noted otherwise) 251

11.2 Division of synergies 25312.1 Differences between M&A and alliances 259

x • List of tables






Boxes

1.1 The corporate advantage test page 72.1 The synergy test 314.1 The diversification test 887.1 The divestiture test 1408.1 The outsourcing test 156

xi






Acknowledgments

We would like to acknowledge our teachers and co-authors,who have taught us a lot of what we know about corporatestrategy. They are Laurence Capron (INSEAD), Ravee Chittoor(Indian School of Business), Ranjay Gulati (Harvard University),Prashant Kale (Rice University), Tobias Kretschmer (LudwigMaximilian University of Munich), Marlo Raveendran (Universityof California), Harbir Singh (University of Pennsylvania), KannanSrikanth (Singapore Management University), and Maurizio Zollo(Bocconi University).We also acknowledge the invaluable input of our colleagues on

early drafts of the book: Markus Becker (University of SouthernDenmark), Laurence Capron (INSEAD), Ravee Chittoor(Indian School of Business), Felipe Csaszar (University ofMichigan), Donal Crilly (London Business School), EmilieFeldman (University of Pennsylvania), Nirmalya Kumar (TataSons), Zdenek Necas (Ivey), Caterina Moschieri (IE BusinessSchool), Urs Peyer (INSEAD), Marlo Raveendran (University ofCalifornia), Evan Rawley (Columbia University), Astrid Schornick(INSEAD), Metin Sengul (Boston University), Kannan Srikanth(Singapore Management University), and Brian Wu (University ofMichigan). We are grateful to our many MBA, EMBA, MSc, andexecutive students at INSEAD, London Business School, andUniversity College London, in particular Arnaud Bonnet(Imperial Innovations), Kimchi Hoang (INSEAD), SantoshKumar (Facebook), Viren Lall (ChangeSchool.org), Elise Lee(Merck), Zan Li (University College London), Edwin Meyers(Capitales Cuestamoras), Mateen Poonawala (McKinsey), andNiels Christian Wedell-Wedellsborg (London Business School),

xii






who very generously read drafts of our chapters and providedexcellent suggestions to improve them. We thank CarolineKoekkoek and Krithiga Sankaran for research assistance. We aregrateful to Jan Vanneste (HBMEO) for the cover’s artwork.

xiii • Acknowledgments






Introduction: what this book is aboutand how to use it

We wrote this book to help you make good corporate strategydecisions and perform sound analysis of the corporate strategy deci-sions of others, on the basis of knowledge obtained from research.Since this is the goal of the book, it is useful to be clear about the keyterms in the statement above.Corporate strategy refers to the strategy that multi-business

corporations use to compete as a collection of multiple businesses.These businesses may each constitute a division within the corpora-tion (or be bundled together with very similar businesses into adivision), or may each be a legally distinct company, whose sharesare held by a parent company. This book and its contents areapplicable to all of these types of firms.By good decisions we mean something quite specific. In the world

of management, it is tempting but incorrect to define good decisionssolely in terms of good outcomes. Because decisions are made withlimited information and are not easy to reverse even after betterinformation comes along, it is better to think about good decisions asthose that (1) are the best given current information (and alsofeature a recognition that current information may not be com-plete), and (2) can be explained and defended to others. The firstcriterion is a straightforward one and requires little explanation. Thesecond comes from the organizational context in which corporatestrategy decisions are made. They must ultimately be evaluatedand implemented by others who must be convinced and motivatedby them.Relatedly, this book is about decisions, not topics. It is written to

provide an active guide for decision-making. This goes beyond apassive understanding of what corporate strategy is (which is the

xiv






focus of a typical textbook). Rather, our goal is to help a reader withlimited prior knowledge to (a) make a good decision on a concretecorporate strategy issue (e.g., should we pursue organic or inorganicgrowth, should we acquire or ally with this firm, or should we keep ordivest this business) and (b) offer a well-reasoned justification for thisdecision, that is rigorous and clear. Thus, the emphasis is on conceptsand how to use them to reach a decision, not on description.Finally, this book is designed to provide tools for analyses

and decisions about corporate strategy that are based on research.This means that the concepts, heuristics, ideas, and frameworksthat together make up these tools are either directly or indirectlybased on ideas and evidence that have passed the test of academicpeer review. The linkage in some cases will be very proximateand we will give references to relevant research where this isthe case.At the same time, we also recognize the limits to exclusive

reliance on the existing research base. We therefore also includeideas in this book whose connection to the research (and to rigor-ously validated ideas and evidence) is less proximate. While westrive to make these ideas always internally consistent, the evidencebase may not always exist yet. The reader is warned to recognizethese ideas by the absence of direct references (and is advised toexercise appropriate caution in adopting them).The reasons we rely on the research base (even when we do

so indirectly) in developing this material can be traced to ourexperiences teaching corporate strategy concepts to thousands ofMBA, EMBA, and MSc students as well as senior managers andCEOs for over a decade at INSEAD, London Business School, andUniversity College London. Through these experiences, we havecome to realize two things. First, corporate strategy is an extremelycomplex topic. As we will explain, a lot of the complexity comesfrom the difficulty of separating out the components of a decision.Second, it is precisely in such situations of complexity that

xv • Introduction






abstraction is valuable. In particular, our experience suggests thatthe abstractions and simplifications that researchers typicallyemploy to study the complexities of corporate strategy can in factbe useful to practitioners, too. We believe that it should not beany more difficult for practicing managers to explain and defenddecisions based on research, as it is to do so based on judgmentand received wisdom. Of course, this book does not aim to be acomprehensive summary of the academic literature in corporatestrategy; we are quite selective in picking what we need and knowbest (which, unsurprisingly, is often our own research) for theparticular decisions we are interested in.A final caveat to note is that the corporate strategy tools and

frameworks we present, like all strategy frameworks, try to provideinternally consistent representations that abstract from detail,assume some structure even for ill-defined problems, and simplifyambiguity into uncertainty, while still aspiring to be useful. We arekeenly aware of the trade-offs on each of these dimensions.1 Ananalogy may be useful here: a map, to be of any use at all, cannotpossibly be of a scale of 1:1! It necessarily ignores, reduces, andsimplifies and that’s what makes it useful, both on individualjourneys as well as in team efforts where all must agree and under-stand how to get to a destination. However, no one should or wouldmake the mistake of confusing the map with the real thing. In muchthe same way, the frameworks and models we present are simplifica-tions, which aim to be useful. They do not pretend to be “real.”Theyoffer a way to comprehend reality, and a basis for discussion. Thusthe reader is forewarned that the ideas in this book must becomplemented with a healthy dose of industry and company specificknowledge, and perhaps even skepticism about the ideas themselves,to be used in a creative and insightful manner.In particular, we believe that the frameworks we propose can

anchor useful debates around important decisions. A good way inwhich to use the frameworks in this book to make decisions is to

xvi • Introduction






have competing teams perform analyses to justify different alterna-tives. For instance, one group may perform the analysis about adiversification decision with the goal of minimizing the chance ofan error of commission (i.e., the mistake of diversifying when oneshould not have) whereas another group may do so to minimize thechance of an error of omission (i.e., the mistake of missing a gooddiversification opportunity). As long as both teams use the samestructured approach, such as that we describe in this book, theresulting debate will involve real communication and be enor-mously insightful, even when the teams reach opposing conclusions.We believe such an approach can be useful for almost any majorcorporate strategy decision – e.g., partner selection, valuation,and post-merger integration (PMI) in mergers and acquisitions(M&As).

How this book is organized: key decisionsin corporate strategy

To make this book as useful as possible to corporate strategists, wehave organized the material in terms of the critical decisions theyface, and these make up the bulk of the book. Before we tackle thesedecisions, Part I (Foundations) of the book (Chapters 1, 2, and 3)introduce three theoretical pillars for the analysis of corporate strat-egy: corporate advantage, synergies, and governance costs.

Part I: FoundationsChapter 1 (Corporate advantage) introduces and defines the conceptof corporate advantage, and explains how it is different fromcompetitive advantage, the key concept in business strategy. Thechapter also explains why synergies are critical to sustaining corpo-rate advantage when investors can easily replicate the same portfolioof investments as a corporation, albeit without the decision rightsthat the managers of a corporation enjoy.

xvii • Introduction






Chapter 2 (Synergies: benefits to collaboration) develops a novelapproach to analyze synergies between any two businesses at thelevel of their underlying value chain segments. If synergies are thepotential gains from collaboration across different businesses, gov-ernance costs are the “tax” that eats into these potential benefits.Chapter 3 (Governance costs: impediments to collaboration) intro-

duces heuristic frameworks to assess the conditions under whichthese costs are likely to be significant impediments to the realizationof synergy. A key insight for corporate strategists is that these costscan be controlled through the appropriate choice of a governancestructure (e.g., contract, equity–alliance, joint venture, or full own-ership). The optimal governance structure is thus one that takes intoaccount the benefits of as well as the impediments to collaboration.The frameworks in these three chapters lie at the heart of all

the corporate strategy decisions that we discuss in the rest ofthe book, including diversification, divestiture, valuation, PMI, selec-tion of strategic alliance partners, re-organizing the structure of thecorporation, outsourcing, and offshoring. They are thus essential read-ing for getting the most out of any part of the rest of the book.

Parts II and III: Decisions about portfolio compositionIn this part of the book, we examine decisions that pertain towhich businesses should be in the portfolio of the corporatestrategist, and how to assemble such a portfolio. The implicitassumption is that once these businesses are brought into theportfolio, synergies across businesses can be realized throughadministrative control. Chapters 4, 5, and 6 look at increasingthe scope of the organization. Chapters 7 and 8 consider decreas-ing the scope of the organization.

Part II: Increasing the scope of the organization Chapter 4(Diversification) introduces a basic test to consider when and wherediversification, the entry into a new business, is useful. This brings

xviii • Introduction






together ideas about corporate advantage (why should you diversifyrather than your shareholders), synergies (which business should youdiversify into), and governance costs (what is the best governancestructure to exploit synergies). We discuss vertical integration as aspecial case of diversification.Chapter 5 (Ally or acquire?) covers the choice between strategic

alliance and acquisition, two of the fundamental mechanisms ofinorganic growth. A key distinction is that in an alliance the partnersremain independent, whereas in anM&A one party gives up control.Because the associated benefits and costs differ, we discuss when analliance is to be preferred over an acquisition, and vice versa.Chapter 6 (Organic or inorganic growth?) considers whether

to enter a new business organically (do it on your own) or inorgani-cally (through alliances or acquisitions). We discuss the factors thatfavor organic growth and those that favor inorganic growth.

Part III: Decreasing the scope of the organization Chapter 7(Divestiture: stay or exit) covers the divestiture decision, in particularthe choice between different modes of exit from a business.Divestiture can be seen as a horizontal scope decision, in whichthe organization reduces the number of businesses it is active in. Wefocus on divestiture through sell-off or spin-off.Chapter 8 (Outsourcing: make or buy) covers vertical scope

decisions where there is a reduction in the number of value chainsegments the corporation is active in while the number of businessesremains constant. We consider the conditions under whichoutsourcing is appropriate, and when to consider offshoring.

Part IV: Decisions about portfolio organizationIn this last part of the book, we take the portfolio composition asgiven. The focus is on managing the portfolio to extract synergiesacross the businesses through administrative control.

xix • Introduction






Chapter 9 (Designing the multi-business corporation) covers organi-zational structure decisions. We analyze when pure, hybrid, andmatrix structures are appropriate, and contrast the legal and organi-zational structure of multi-business corporations. We also discusswhen it is time to re-organize.Chapter 10 (Designing the corporate HQ) covers “corporate

parenting” decisions: how to select the appropriate role forthe headquarters (HQ) in a multi-business firm. We highlightthree key dimensions: standalone vs. linkage based approachesto synergy across businesses, directive vs. non-directive approachesto managing each business, and resource allocation across businessesto balance growth and profits while exploiting synergies.Chapter 11 (Managing the M&A process) examines the key

choices when conducting an M&A. Given that a decision to under-take an M&A has been made, several steps need to be taken tosuccessfully conduct it. We focus on the critical aspects: valuation,negotiations, and post-merger integration.Chapter 12 (Managing the alliance process) analyzes the key

choices when structuring an alliance. In an alliance, the goal isfor the partners to collaborate but without either side gaining fullcontrol over the other. We discuss how partner selection, valua-tion, negotiation, and integration can help you to succeed withan alliance.While Parts II and III separate the decisions around which

businesses belong in the portfolio from how they are managed oncethe portfolio decision is made, this is an analytical convenience and inpractice both aspects must be considered simultaneously. Therefore,the structure of the book is such that it allows the reader to selectivelycombine a set of chapters to get what she is after efficiently.For instance, those interested only in M&A should read Chapters

1, 2, and 3 (as these provide the foundations), and then go on toChapters 5 and 11. To consider the design of the corporate HQ,Chapters 1, 2, 3, and 10 would suffice. Table 0.1 illustrates how the

xx • Introduction






table

0.1

How

thechaptersbuild

oneach

other

Buildso

nChapter

Part

Chapter

12

34

56

78

910

1112

IFo

undation

s1

Corporate

advantage

2Synergies:benefitsto

collaboration

1

3Governancecosts:im

pedi-

mentsto

collaboration

12

IIPortfolio

composition

:4

Diversification

12

3

increasing

scope

5Ally

oracquire?

12

34

6Organicor

inorganicgrow

th?

12

34

5

III

Portfolio

composition

:7

Divestiture:stayor

exit

12

3

redu

cing

scope

8Outsourcing:m

akeor

buy

12

37

IVPortfolio

organization

9Designing

themulti-business

corporation

12

3

10Designing

thecorporateHQ

12

3

11ManagingtheM&A

process

12

35

12Managingtheallianceprocess

12

35






chapters are related. We do not have a separate chapter on interna-tional business because we view international aspects as increasinglybeing quite inter-mingled with corporate strategy decisions. Forinstance, foreign market entry is an instance of diversification, anda cross-border merger or joint venture is, first and foremost, anacquisition or an alliance, respectively.Where relevant, we mentionhow decisions may differ between a national and an internationalcontext.Each chapter ends with a list of Frequently asked questions

(FAQs) on aspects of corporate strategy, and some Further readingaround the topic of the chapter.

Note

1. See for instance the insightful discussion on these issues in Levinthal, D. A.(2011). A behavioral approach to strategy – what’s the alternative? StrategicManagement Journal, 32(13), 1517–1523.

xxii • Introduction






Documents

Cambridge Unive rsit y Pre ss Phanish Puranam and Bart