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 con­ clude 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 interrelation­ ships 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. Inde­ pendent 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, lower­ ing prices in one business unit  to boost  volume  can   lead   to lower costs in another business unit through increasing the overall firm pur­ chasing power in shared components or raw m aterial.1 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  develop­ ment, 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  alli­ ances 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 o f existing competitors. As described earlier, competitor analyses by business units will often fail to uncover potential competi­ tors 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 im portant determinant of competitor behavior. Business units proceeding independently  will rarely consider the ways in which their actions might trigger competitive  response that affects sister busi­ ness units.

Transfer o f know-how among  generically 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 indus­ tries 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.

W ithout an explicit horizontal strategy, there will be no systematic mechanism to identify, reinforce, and  extend interrelationships.  Busi­ ness 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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