The growing importance of horizontal strategy of the firm

Horizontal strategy is something that few firms today can afford to ignore. Interrelationships among business units and the ability to exploit them have been increasing in the last decade, and powerful and interconnected forces are likely to accelerate the trend in the 1980s and 1990s.

Diversification philosophy is changing. The philosophy guiding many firm’s diversification strategies has shifted markedly since the early 1970s. Most now emphasize related diversification. This has led to more attention being paid to “fit,” and widespread pruning of corporate portfolios. Unrelated or marginally related business units added during earlier phases of diversification have been sold off, and many firms have boosted their stock price through this process, including Borden, Scoville, Trans World Corporation, and IU International. A significant fraction of today’s merger activity involves firms selling divisions to other firms where the fit is closer.

Emphasis is shifting from growth to performance. The environment in most of the developed world is one of relatively slow growth coupled with growing global competition, a dramatic change from the previous decades. The emphasis has thus shifted from growth to improving competitive advantage. While largely independent business units may have been an appropriate vehicle for pursuing growth, a more difficult environment has made it increasingly important to coordinate business unit strategies to exploit interrelationships. Buyers, themselves under pressure, are often a force for coordination. Increas- ingly sophisticated purchasing by hospitals, for example, is compelling firms such as Johnson & Johnson and American Hospital Supply to integrate the sales forces and distribution systems of business units serving hospitals in order to maintain competitive advantage. Both of these firms have been among the strongest advocates of decentralization.

Technological change is proliferating interrelationships and making them more achievable. Technology is breaking down barriers between industries and driving them together, particularly those based on elec- tronics/information technology. Microelectronics, low-cost computers, and communications technology are permeating many businesses and causing technologies to converge. As these technologies are assimilated into many products and production processes, the opportunities for shared technology development, procurement, and component fabrication are increasing. The rush of many large diversified firms such as Gould and United Technologies to acquire electronics firms is a manifestation of this trend.

These same technologies are changing the functions of products and making them parts of larger systems, sometimes controlled centrally with a common computer. Integrated aircraft cockpits, office automation, telecommunications, and lighting, heating, airconditioning, security, and elevator systems in buildings are just a few examples where historically distinct businesses are now becoming strongly related.

New technology is also making it possible to share activities across business unit lines where it was not feasible previously. So-called “flexible automation” is one important example, in which a computer-controlled machine can produce a variety of similar products with minimal setup time. While flexible automation is penetrating slowly and its limits have yet to be defined, it is enhancing the possibilities for sharing component fabrication and assembly facilities among business units with related products. Flexibility that allows sharing also holds promise in other areas such as automated testing and computer-aided design.

The growing sophistication of information systems is also a powerful force in opening up possibilities for interrelationships. With the increasing capacity to handle complex on-line data, information technology is allowing the development of automated order processing systems, automated materials handling systems, automated warehouses, and systems to automate other value activities outside of manufacturing. These systems can often be shared among related businesses.69 Information technology is also restructuring distribution channels and the selling process in industries such as banking and insurance, in ways that can facilitate sharing.

At the same time that technology is creating interrelationships, it is also reducing costs of exploiting them. The ease of communication has increased just as dramatically as its costs have fallen, reducing the costs of coordinating the activities of business units. Information processing technology has allowed management information systems to be established in areas such as logistics, inventory management, production scheduling, and sales force scheduling. Flexibility in activities has become increasingly possible. While sharing activities may have involved unmanageable complexity and unacceptable costs in the past, this is less often the case today.

Multipoint competition is increasing. A final compelling motivation for horizontal strategy is a logical outgrowth of the other three. As more and more firms seek out or are forced to pursue interrelationships among business units, there is an increasing presence of what I term multipoint competitors. Multipoint competitors are firms that compete with each other not only in one business unit but in a number of related business units. For example, Procter & Gamble, Kimberly- Clark, Scott Paper, and Johnson & Johnson compete with each other in varying combinations of consumer paper products industries including disposable diapers, paper towels, feminine napkins, toilet tissue, and facial tissue. General Electric, Westinghouse, Square D, and Emerson Electric similarly meet each other in a number of electrical products industries. Where a firm has multipoint competitors, it must view its competitors more broadly than at the business unit level because competitive advantage will be more broadly determined.

Many important industry sectors are being affected by these forces. Financial services are being revolutionized by interrelationships created by information technology and unleashed by regulatory changes. Such firms as American Express, Citicorp, Sears, Prudential-Bache, and Merrill Lynch are aggressively linking previously separate financial services industries together. In health care, I have already noted how producers of medical equipment and supplies are beginning to pursue interrelationships more aggressively. A few health care providers are also just beginning to see the possible interrelationships in operating facilities such as hospitals, nursing homes, retirement communities, and home care services, though these interrelationships are not yet being exploited. Entertainment firms have begun to recognize the possi-bilities for coordinated strategies in different media. Information companies such as McGraw-Hill and Dun and Bradstreet are moving to combine many data base products. Computers and telecommunications firms are combining together and/or invading each other’s turf, as evidenced by such recent moves as IBM’s link with Rolm and AT&T’s entry into computers. Automation of the factory and the office is connecting many industries and spawning broadly-based strategies by such firms as GE, Westinghouse, and Xerox. This list of industries being connected by interrelationships is by no means exhaustive.

The forces leading to increasing interrelationships are also illustrated in a study I conducted of business units in 75 diversified Fortune 500 firms in 1971 and 1981. These 75 firms had organized their thousands of business units into 300 groups in 1971 and 315 groups in 1981. The nature and strength of the interrelationships among business units in each group were examined for both time periods. The number and strength of potential interrelationships within the groups increased over the ten-year period, as portfolios were reconfigured. However, the firms’ success at exploiting the potential interrelationships was less clear. From examining how firms changed their organizational structure over the period, it does appear that firms became more prone to group related businesses together.

Many factors point to the growing importance of horizontal strategy, and imply that past experience with synergy is a poor guide for the future. At the same time, though, many firms have not converted potential interrelationships into sources of competitive advantage. The same firms that are assembling groups of related business units continue to manage them like a portfolio. Thus diversified firms must learn how to manage interrelationships at the same time as they will increasingly have to identify and build upon them.

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

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