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. M ost now emphasize  related diversification. This  has led to more attention being paid to “ fit,” and widespread pruning of corpo­ rate 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  W orld   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  environ­ ment in most of the developed world is one of relatively slow growth coupled with   growing   global competition,  a dram atic   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 im portant to coor­ dinate 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 decentraliza­ tion.

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 fabrica­ tion are increasing. The  rush of many  large diversified firms such as Gould and United Technologies to acquire electronics firms is a mani­ festation of this trend.

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

New technology is also making it possible to share activities across business unit lines where it was not feasible previously. So-called “flexi­ ble autom ation” is one important example, in which a computer-con­ trolled 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 power­

ful force in opening up possibilities for interrelationships. With  the increasing capacity to handle complex on-line data, information  tech­ nology is allowing the development of autom ated order  processing systems, autom ated materials handling  systems, automated  ware­ houses, and systems to automate other value activities outside of manu­ facturing. These systems can often be shared among related businesses.5 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 activi­ ties has become increasingly   possible.   W hile   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 motiva­ tion for horizontal  strategy is a logical outgrowth  of the other  three. As more and more firms seek out or are forced to pursue interrelation­ ships   among  business   units,   there  is   an   increasing   presence   of what I term multipoint competitors. M ultipoint 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 includ­ ing disposable diapers,   paper  towels,   feminine   napkins,  toilet tissue, and facial tissue. General Electric, Westinghouse, Square D, and Emer­ son 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 im portant 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. Entertainm ent firms have begun to recognize the possi­bilities for coordinated strategies in different media. Information com­ panies such as McGraw-Hill and D un and Bradstreet are moving to combine many data base products. Computers and telecommunications firms are combining together an d /o r 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 illus­ trated in a study I conducted of business units in 75 diversified Fortune 500 firms in 1971 and 1981. These 75 firms had organized their thou­ sands 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 strat­ egy, 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 increas­ ingly 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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