Formulating horizontal strategy of the firm

Formulating horizontal strategy involves a number  of analytical steps that flow from the framework described in Chapter 9:

  1. Identify all tangible The starting point in formulating horizontal  strategy is   to   identify   systematically   all   the tangible   interrelationships   that   are    actually    or   potentially    present among a firm’s business units. The first step in doing so is to examine value chains of each business unit for actual and possible opportunities for sharing. Initially, all interrelationships  that  seem to be present should be identified; illusory or insignificant interrelationships can be eliminated through  further analysis. In searching  for interrelationships, the specific characteristics  of value activities that  would   provide a basis for sharing  must be identified. For example, meaningful produc­ tion interrelationships must be based on similarities in specific produc­ tion equipment  or process steps rather  than  a generalized view that there are similar processes. Similarly, specific technologies and subtech­ nologies are the basis of technology interrelationships,  and common decision makers in buyers or channels are the basis of key market interrelationships.

Diagrams  like Figure  10-1   provide a   simple mechanism  to use in identifying interrelationships within a firm.

Figure 10-1.    Tangible Interrelationships in a Diversified Firm

Each cell of the interrelationship matrix displays the interrelation­ ships between a pair of business units, drawing from the types of interrelationships expressed in Table 9-1 in the previous chapter. If interrelationships are   extensive,   a   separate   matrix   can   be   prepared for each   type   of interrelationship.  The  linkage   diagram  is another way to display interrelationships that may be clearer if there are a manageable number of business units.   It allows the clustering of busi­ ness units that have strong interrelationships, and can facilitate the visualization   of groupings  of units   that  could be the basis for groups or sectors. W hatever graphical tool one uses, interrelationships should be divided into potential interrelationships and those that are actually being achieved.

There are often many different interrelationships within a diversi­ fied firm. Different groups of business units are frequently related in different ways. One group of business units may be related by their markets, while a different, but partially overlapping, group of business units is related in production.  The  interrelationship matrix  in Figure 10-1 illustrates one such   pattern,  where  business   units   1, 3, and 4 have a common component and common raw material, while business units 1, 2, and 3 have a common buyer.

In a diversified firm with many  business units,   a complex pattern of interrelationships  often   emerges.   To   simplify   the   analytical  task of identifying interrelationships, it may be possible to break up a diver­ sified firm into a number of clusters of business units that have many interrelationships among themselves, but relatively few with other clus­ ters. The  correspondence  of such clusters   to   the groups  or sectors that have been established is a subject to which I will return in Chapter 11. Where the interrelationships between two business units are perva­ sive and involve many significant value activities, the business unit definitions are probably The issues in drawing  business unit boundaries have been discussed in Chapter 7.

  1. Trace tangible interrelationships outside the boundaries o f the A firm will rarely compete in all the industries that are related to its current business units. Thus, it is necessary to identify interrela­ tionships between a firm’s existing business units and other  industries not currently in its portfolio. This requires that a firm examine impor­ tant value activities to look for related industries  where sharing or further sharing might be feasible. A firm with an effective sales force serving a particular buyer group, for example, should identify other products purchased by the same buyer group or products that fit the sales force’s expertise that might be sold to other  buyer  groups. Simi­ larly, each brand name, distribution channel, logistical system, techno­ logical development activity, and other im portant value activity should be probed for potential opportunities for sharing with other industries.

Identifying paths of interrelationship  outside a firm is a creative task, but one that will yield considerable  benefits in diversification planning and in the development  of defensive strategies   to anticipate and block potential entrants.  The  portfolios of diversified competitors can often provide im portant clues to industries with im portant interre­ lationships to the   firm’s. However,  detecting  new   interrelationships not exploited by any competitor can be even more valuable.

  1. Identify possible intangible After identifying tangible interrelationships, the next step is to seek out intangible inter­ relationships. This involves   the   isolation   of   value   activities   in   which a firm has valuable know-how  that might be useable in other business units or in new   industries.   It   also   requires   identifying   new   industries in which a presence would lead to know-how  that is valuable in the firm’s existing business units. Signals of potential intangible interrela­ tionships include similarities in generic strategy, buyer  type, or value chain configuration. While identifying intangible interrelationships  is subtle, it can be important. Many potential intangible interrelationships are usually present, which makes screening them to access their impor­ tance to competitive advantage an essential task.
  1. Identify competitor    A firm must  identify all its multipoint competitors, potential multipoint competitors, and com­ petitors pursuing  different patterns  of interrelationships.  A diagram such as that  in Figure  9 -4   above can   provide a structure  for doing so. The existence of multipoint competitors often provides clues about the presence of interrelationships, and can aid in their identification. Conversely, interrelationships  often are useful predictors  of potential new competitors, as described above. After the array of multipoint competitors has been identified from a firm wide perspective, the interre­ lationships within each im portant  competitor’s  portfolio must  be charted. Often competitors  have different interrelationships  that  in­ volve different sets of businesses.
  1. Assess the importance o f interrelationships to competitive advan­ The net competitive advantage  from a tangible interrelationship is a function of the advantage from sharing, the costs of sharing, and the difficulty of matching the interrelationship.  Shared  activities must  be measured  against the corresponding  activities of competitors on all three dimensions. The tangible interrelationships present in a diversified firm are often numerous.  However,  experience has shown that the number  with strategic importance  is likely to be relatively small. The challenge is to isolate the im portant  ones, including those that  involve industries  in which a   firm   has   no   presence   currently. The fact that an interrelationship is not being achieved is not a reliable sign that it is not important. The interrelationship may have been overlooked, or the costs of compromise  associated with it may be reduced by making business unit strategies more consistent.

Intangible interrelationships lead to competitive advantage if the benefits of transferring know-how exceed the cost of transferring it. Transferring know-how is beneficial if the similarities among  value activities are significant, the activities are im portant to competitive advantage in the industries involved, and the firm has know-how that can materially enhance competitive advantage if it is transferred. Expe­ rience suggests that skepticism is warranted in assessing intangible interrelationships to avoid pursuing  intellectually plausible but practi­ cally useless similarities among businesses.

  1. Develop a coordinated horizontal strategy to achieve and enhance the most important Im portant interrelationships can be achieved or enhanced  in a variety of ways.

Share Appropriate Value Activities. Value activities of related business units should  be shared  if the benefits exceed the costs. This may involve measures such as combining sales forces, rationalizing manufacturing facilities, coordinating procurement, and rebranding product lines. Sharing will always require some adjustments to current practices. Business unit strategies may need to be modified to gain maximum  advantage  from   sharing.   Similarly,   activities may   have to be redesigned to reduce the cost of compromise.

Coordinate Strategic Postures o f Related  Business Units. The strategies of related business units should  be coordinated  to   increase the competitive advantage  of interrelationships  and   reduce  the costs of compromise. This  can   involve everything  from   minor  adjustments of business unit  strategies to m ajor  repositionings, including acquisi­ tions and divestitures. The coordination of strategies requires that marketing programs and investment spending plans are consistent, and that business units are aware of each other’s plans in product development and other  im portant  areas.   Coordination  also   implies that actions toward competitors are part of an integrated group, sector, or corporate battle plan. M arket interrelationships  often create the greatest need for consistent  business unit  strategies,   in order  to gain the maximum  impact  with common  customers  or channels. However, a degree of consistency is required  for achieving and   exploiting any form of interrelationship. Coordinating business units can involve diffi­ cult tradeoffs   between   enhancing  interrelationships  and   the   position of individual business units. These tradeoffs are often difficult. However without a horizontal strategy they will rarely even be considered re­ gardless of the benefits to the firm.

Distinguish the Goals o f Business   Units.   The  goals of business units should be set to reflect the role of business units in interrelation­ ships. Some business units, for example, might be given more ambitious sales targets but lower profit goals because of the contribution of their volume to the position of other  business   units.   Asking  all business units to meet the   same goals may seem   to be the   “fairest”  solution, but it also threatens to undermine some im portant sources of competi­ tive advantage.

Business unit goals that reflect interrelationships are broader than those prescribed in portfolio planning techniques, commonly involving mandates such as build, hold, or harvest. Portfolio   models   typically ignore interrelationships,  and set different goals for business units only in the sense that  some business units are expected to   generate cash while other are expected to use it. Interrelationships provide a broader perspective of corporate  strategy based on   competitive   advantage, within which cash flow considerations are subsumed.

Coordinate Offensive and Defensive Strategies Against Multipoint Competitors and  Competitors with Different Interrelationships.    There must be an overall firm game plan for dealing with each significant multipoint competitor  and each   competitor  with   a   different   pattern of interrelationships that could be threatening.  Ideally, a firm should seek to promote industry  evolution in directions that increase the value of its interrelationships and compromise the value of competitors. More specific options for offensive and defensive strategy are discussed in Chapters 14 and 15.

Exploit Important Intangible Interrelationships through Formal Programs for Exchanging Know-How. A firm must actively encour­ age the transfer of know-how among business units with potentially important generic similarities. Receiving business units may not  be receptive because of “ not invented here” problems, and business units asked to transfer expertise may resent the commitment  of time and people   involved.    Achieving   intangible   interrelationships   will   require a shared understanding  of their value, and organizational  mechanisms to facilitate the transference of know-how.

Diversify to Strengthen Important Interrelationships or Create New Ones.      Diversification strategy   should  focus on finding and entering new   businesses   that  reinforce   the   most  im portant  interrelationships or creating new interrelationships of high strategic importance. Diversi­ fication strategy will be treated in the next section.

Sell Business Units That Do Not Have Significant Interrelationships with Others or That Make the Achievement o f Important Interrelation­ ships More Difficult. Business units that have no im portant interrela­ tionships to others in a firm or are not  likely bases of further diversification are candidates  for sale in the   long term.  Even   if they are attractive and profitable, such business units will be worth  as much or even more to other owners, since being part  of the firm does not enhance their competitive advantage and being part  of another  firm might. A firm can thus  be in a position to recover the full value to it or more of such business   units by selling them.   The  proceeds can then be invested in business units where interrelationships can enhance competitive advantage. Practical considerations mean that such a strat­ egy may have to be implemented over the long-term, however. Buyers that  recognize the value of a business unit  may   not  be easy to find, and it may be hard  to replace a highly profitable, albeit unrelated business unit with   an   equally   attractive  one,   no   m atter  how   great the potential interrelationships might be.

The presence of some marginally  related business units may make it more difficult to achieve other, more  im portant  interrelationships. They, too, are candidates  for sale. A firm may be less able to build a shared distribution  channel, for example, if it has another business unit that uses a different and competing  channel  to reach the same buyer group. Similarly, a firm may be less able to exploit opportunities for sharing a sales force and m arketing  to reach a particular  buyer group if it has a business unit in the buyer  group’s industry  that competes with it. Interrelationships may create conflicts with buyers, suppliers, or channels. American Express has experienced this as it increasingly competes with banks which are also a key outlet  for its travelers checks. Unlocking  some interrelationships,  then, may require a firm to get out of some industries.

When there  are several patterns  of interrelationships  within a firm involving different groups  of business units, taking  some of the steps noted above may involve tradeoffs. Coordinating  strategic pos­ tures to facilitate one type of interrelationship  can   reduce  the   ability to achieve another. Distinguishing business unit goals can lead to the same sort of tradeoff.   Where  such  tradeoffs exist,   the   principle must be to reinforce those interrelationships  that  have the greatest  impact on competitive advantage, even at the expense of others. However, organizational mechanisms  described in the next  chapter  can often allow interrelationships  among  different   groups  of business   units   to be achieved  simultaneously.

  1. Create horizontal organizational mechanisms to assure imple­ Firms cannot successfully exploit interrelationships without a horizontal organizational structure that encourages coordination and transfers skills across business unit  lines. Such   tasks   as defining the right business units, clustering them into the proper groups and sectors, and establishing incentives for business unit managers to work together are vital to success. The principles of horizontal  organization  are the subject of Chapter 11.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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