The need for explicit horizontal strategy of the firm

Organizational structure in most firms works against achieving interrelationships. However, organizational impediments alone do not explain why related business units, proceeding independently, will rarely optimize the competitive position of the firm as a whole. Without a horizontal strategy, business units may well act in ways that reduce rather than enhance their ability to exploit interrelationships:

Business units will value interrelationships differently and not agree to pursue them. Business units will rarely reap equal benefits from an interrelationship because of differences in size, strategy, or industry. The costs of compromise required to pursue an interrelationship can differ among business units, as can the impact of sharing on their cost positions or differentiation. Some business units may rightly conclude that the costs of coordination and compromise outweigh the value of the interrelationship to them, and interrelationships of value to the firm as a whole will never be achieved. Large and currently successful business units often prove the most resistant to pursuing interrelationships, as do business units which are asked to transfer their know-how to others to gain intangible interrelationships.

Business unit strategies will evolve in ways that weaken interrela- tionships. Left to formulate strategies independently, business units may well proceed in inconsistent directions that can make interrelationships more difficult to achieve. For example, when two business units share a common buyer or channel, one may pursue a differentiation strategy while another evolves toward striving for a low-cost position. Though these strategies may well be appropriate for the business units in isolation, the potential interrelationships between the two units imply that the inconsistent strategies will confuse buyers or channels, blur the overall brand image of the firm in the related industries involved, and diminish opportunities to share a brand name and sales force. Another example is the case where two business units specify slightly different components even though they could use a common one. Independent business unit strategies will always undervalue benefits that accrue not to them, but to the firm as a whole.

Pricing and investment decisions taken independently may erode firm position. Interrelationships imply that profits should be taken in some business units and not other related ones. For example, lowering prices in one business unit to boost volume can lead to lower costs in another business unit through increasing the overall firm purchasing power in shared components or raw material. Yet this sort of action would never be contemplated by business units that develop strategies independently and are evaluated solely by their own results. This problem cannot be solved through transfer pricing, because it arises even though business units do not buy or sell from each other.

There is also a risk of suboptimal investment decisions if related business units proceed independently. For example, one business unit sharing a component may have buyers which are extremely price- sensitive while the buyers served by other business unit are not. The second business unit will attach little value to investments that reduce the cost of the common component and will allocate its resources elsewhere. The business unit benefiting greatly from cost reduction may not be able to justify the investment on its own.

Business units will have a tendency to go outside to form alliances to achieve interrelationships available internally. Business units acting independently may not fully appreciate the benefits of internal projects in areas such as shared marketing, production, technology development, and sourcing compared to alliances with outside firms. Achieving interrelationships internally implies that all the benefits accrue to the firm. Interrelationships achieved through coalitions with outside firms must share some of the benefits with coalition partners. Outside alliances can also strengthen coalition partners that eventually emerge as competitors, and can lead to the diffusion of the firm’s proprietary technology. These arguments imply that in many instances business units should accept greater costs of compromise to work with sister units on an interrelationship. However, managers rarely see it this way. In fact, they often take the opposite view; they undervalue the benefits to the firm as a whole and prefer to deal with independent firms where they have full control over the relationship. Some of the organizational problems that reinforce these tendencies are described in Chapter 11.

Business units may ignore key potential competitors or the true significance of existing competitors. As described earlier, competitor analyses by business units will often fail to uncover potential competitors or the interrelationships that are vital to their existing competitors’ relative positions. This narrow perspective of competitors also obscures the way in which competitors view an industry within their broader strategies, an important determinant of competitor behavior. Business units proceeding independently will rarely consider the ways in which their actions might trigger competitive response that affects sister business units.

Transfer of know-how among genetically similar business units will not occur. The transfer of know-how that underpins intangible interrelationships does not occur naturally. Business units will want to develop their own strategies, and believe that they know their industries the best. They can rarely be expected to seek out know-how elsewhere in the firm. Business units with the know-how will have little incentive to transfer it, particularly if it involves the time of some of their best people or involves proprietary technology that might leak out.

Without an explicit horizontal strategy, there will be no systematic mechanism to identify, reinforce, and extend interrelationships. Business units acting independently simply do not have the same incentives to propose and advocate strategies based on interrelationship as do higher level managers with a broader perspective.

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

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