The ability to organize is our most valuable social technology. Organizing affects an enterprise’s efficiency, effectiveness, and ability to adapt. Modern organizations operate in increasingly complex, dynamic environments, which puts a premium on adaptation. Compared to traditional organizations, modern organizations are flatter and more open to their environment. Their processes are more generative and interactive – actors themselves generate and coordinate solutions rather than follow hierarchically devised plans and directives. Modern organizations search outside their boundaries for resources wherever they may exist. They coproduce products and services with suppliers, customers, and partners. They collaborate, both internally and externally, to learn and become more capable. In this book, leading voices in the field of organization design articulate and exemplify how a combination of agile processes, artificial intelligence, and digital platforms powers adaptive, sustainable, and healthy organizations.

This chapter provides a framework to analyze the corporate diversification decision: a firm trying to enter a new business starting from an existing one. “New” here means new to the firm, not necessarily new to the world. For example, a company that only made footballs may diversify and start producing and selling footwear (see Figure 4.1 for the value chains before and after diversification). In Chapter 1 we defined a business in terms of the “who” (customer), “what” (product or service), and “how” (value chain). Two businesses are different if they differ on at least one of these dimensions. Therefore, diversification implies a new choice on at least one of these dimensions. For example, a bank that traditionally only provided services to businesses starts targeting consumers (who), an accountancy that begins to offer consultancy advice to existing clients (what), or a university that starts selling courses online (how) are all diversifying. Internationalization – a company that begins selling in another country – is an instance of diversification in terms of the “who,” e.g., a French champagne producer exporting to Russian clients.

“Entering” a business implies owning at least some of the resources and capabilities in the value chain underlying the new business, and accessing the rest, possibly through partners. It thus entails the process by which a firm accesses the resources and capabilities necessary to operate in a new business, through ownership and/or partnerships.

Choosing between modes of diversification

The basic modes available for a company to expand into a new business are captured in what we call the “Growth tree” (see Figure 4.2). At the first branch of the growth tree lies the choice between internal and external development. This has also been referred to as organic vs. inorganic growth. Organic growth is the process by which a company enters a new business on its own, including hiring, creation of a new project or business unit, or repurposing an existing business unit. If we think of the new business as possessing its own value chain, the goal of organic growth is to build up the resources and capabilities that this value chain entails on its own, without recourse to other firms.

Under inorganic growth we distinguish among three broad categories: non-equity alliances, equity alliances, and mergers and acquisitions (M&As).

We wrote this book to help you make good corporate strategy decisions and perform sound analysis of the corporate strategy decisions of others, on the basis of knowledge obtained from research. Since this is the goal of the book, it is useful to be clear about the key terms in the statement above.

Corporate strategy refers to the strategy that multi-business corporations use to compete as a collection of multiple businesses. These businesses may each constitute a division within the corporation (or be bundled together with very similar businesses into a division), or may each be a legally distinct company, whose shares are held by a parent company. This book and its contents are applicable to all of these types of firms.

By good decisions we mean something quite specific. In the world of management, it is tempting but incorrect to define good decisions solely in terms of good outcomes. Because decisions are made with limited information and are not easy to reverse even after better information comes along, it is better to think about good decisions as those that (1) are the best given current information (and also feature a recognition that current information may not be complete), and (2) can be explained and defended to others. The first criterion is a straightforward one and requires little explanation. The second comes from the organizational context in which corporate strategy decisions are made. They must ultimately be evaluated and implemented by others who must be convinced and motivated by them.

Relatedly, this book is about decisions, not topics. It is written to provide an active guide for decision-making. This goes beyond a passive understanding of what corporate strategy is (which is the focus of a typical textbook). Rather, our goal is to help a reader with limited prior knowledge to (a) make a good decision on a concrete corporate strategy issue (e.g., should we pursue organic or inorganic growth, should we acquire or ally with this firm, or should we keep or divest this business) and (b) offer a well-reasoned justification for this decision, that is rigorous and clear. Thus, the emphasis is on concepts and how to use them to reach a decision, not on description.

Outsourcing occurs when an organization hands over part of the value chain it owns to a different firm, while maintaining the number of business it is active in. In contrast, a divestiture occurs when the firm reduces the number of businesses it is active in by completely pulling out of a value chain and ceasing to offer the products from that value chain to the relevant customers. In other words, in outsourcing, the firm continues to offer the products and services based on inputs from the outsourced value chain activities to the relevant customers, but these parts of the value chain are no longer done in-house.

Offshoring occurs when part of a value chain moves to another geography, usually one with lower cost. Offshoring may or may not involve outsourcing. The same firm could merely relocate operations to a new location (see Figure 8.1). Thus decisions on whether to move the process out of the firm's boundary as well as out of the current geographical boundary occur together, if only implicitly (i.e., we may be implicitly choosing not to offshore, when we outsource to a local vendor).

The canonical outsourcing situation is one where before a company owned an entire value chain and, afterwards, only parts of it. For example, a company active in the footwear business can outsource manufacturing while continuing to do design and distribution, see Figure 8.2.

Corporations that comprise multiple businesses ultimately compete with actors in the capital markets who can put together similar portfolios of businesses through stock ownership. The central issues in corporate strategy therefore pertain to how managers can create the most value from the portfolio of businesses they can stitch together with organizational and governance linkages (in a way that investors and mutual fund managers cannot). The overlap between issues in corporate strategy and organization design is thus naturally very high.

In previous chapters we considered which businesses should be in the corporate portfolio (Parts II and III, Chapters 4–8). This chapter provides a framework for thinking about the choices we face in organizing this portfolio of businesses, their relative merits, and the circumstances for changing from one to another. Our focus here is on “organizational macro-structures,” by which we mean the stable pattern of interactions between groups of individuals specified at high levels of aggregation – for instance, as seen in organization charts. We will refer to these macro-structures simply as “structures.” This sets the stage for more fine grained decisions about organization design pertaining to how individuals within the same group or across groups interact (or the “micro-structure”).

Understanding the structure of the multi-business firm is critical for corporate strategists and those analyzing corporate strategies; in fact, we will show how to read the corporate strategy of the firm in its structure. Yet, it can seem hard to know where to begin, given the wide variations and complexities in organizational structures. Those complexities arise even within a single country. MNCs have added layers of complexity relative to one-country firms because they operate across geographies. With the simple ideas presented here, we hope to help you see why organizational structures are, to paraphrase the organizational economist Bob Gibbons, sometimes a mess, but seldom a mystery.

Strategic alliances are temporary, lateral forms of collaboration between organizations. They are temporary because the alliance typically has a finite life (after which it may or may not be renewed). They are lateral because neither partner has final authority over the other (unlike in an acquisition, when the acquirer's managers effectively have authority over the target firm's employees after the deal is completed). Alliances lie between simple arm's-length market relationships and a merger or acquisition. Unlike in M&As, in alliances the parties remain legally independent and both sides know that the relationship is not necessarily permanent. Unlike in simple market relationships, in alliances intensive collaboration between partners is essential, and a contract alone does not suffice. Something additional is needed in the form of organizational linkages between partners, which may be based on prior or expected interactions between the partners, or equity stakes of one (or both) in the other. The term “alliance” thus covers a wide spectrum of non-equity and equity based relationships (including joint ventures), as shown in Figure 12.1. This chapter covers the general principles that apply to all of them.

There are several stages in the process of setting up an alliance involving several people from within and outside the partner firms (see Figure 12.2). Much of the strategic thinking on diversification described in Chapters 4, 5, and 6 must be completed before and overlaps partly with Step 1 (partner selection) of the alliance process. In the remainder of the chapter we assume that this thinking has been done – i.e., there's an understanding of the potential synergies (Chapter 2) and transaction costs (Chapter 3), and an alliance is deemed a superior alternative to an M&A or organic growth (Chapters 4–6).

Corporate strategy refers to the strategy that multi-business corporations use to compete as a collection of multiple businesses. It is qualitatively different from strategy for a single business firm, or “business strategy.” The number of businesses, goals, the nature of competition, and, consequently, the concepts used in analysis, all differ between business and corporate strategy.

Difference 1: Single vs. multi-businesses

Business strategy involves a single business, whereas corporate strategy involves multiple businesses. For instance, a corporation could have multiple businesses that make appliances, software, mining instruments, turbines, jet engines, and healthcare products. Each business has its own business strategy. The corporate strategy of the corporation cuts across and affects all these businesses.

The questions “what is a business?” and “how do we distinguish businesses from each other?” are inescapable if we think of corporate strategy as the strategy of multi-business firms. We find it useful to think of a business as uniquely identified in terms of its business model. A business model comprises the set of choices about customers, products, and value chain activities that every business must make. These choices are also sometimes referred to as the “who/what/how” choices: who are the customers, what are we selling them, and how do we produce what we are selling and get it into the hands of the customers? Two businesses are different if their business models differ from each other on at least one of these dimensions. Thus, a business selling furniture out of local warehouses to customers in the UK is a different business than one selling to customers in India (different “who”). A business offering sushi for lunch from a small restaurant to busy professionals is a different business than one offering hamburgers (different “what”).

In Chapter 1, we stated that the goal of the corporate strategist is to pursue corporate advantage – to create more value from jointly owning a portfolio of businesses than the sum of their values when they are owned independently. When investors have equivalent investment opportunities, the threshold for the extent of corporate advantage that a corporate strategist must create is higher, and can only be met through synergies. In this chapter, we describe a systematic approach to analyzing synergies.

Despite their centrality to corporate strategy, synergies have remained hard to describe, value, and extract, and the word “synergy” itself is in great peril of becoming a mere buzzword. To a large extent, this is because we have lacked sophistication in being able to classify and distinguish different kinds of synergies, and their organizational implications. This chapter aims to rectify this.

What are synergies?

In its simplest form, an operational synergy potentially exists if two businesses operated jointly are more valuable than the two businesses operated independently. “Operated jointly” implies that decisions across the two businesses are coordinated with the aim of enhancing joint value. The degree of coordination required exceeds simple price-taking behavior such as in a market transaction.

In this book, when we say synergy, we will always mean operational synergy. Other forms of synergy that do not require joint operation (e.g., financial synergies or gains from trade) are also feasible. For instance, scale economies in financing may be a driver of alliances or acquisitions.

Recall that the basic modes available for a company to expand into a new business are captured in what we call the “growth tree” (see Chapter 4). At the first branch of the growth tree lies the choice between organic (internal) and inorganic (external) growth. Under inorganic growth the choice lies between non-equity alliances, equity alliances (including joint ventures), and acquisitions. These were the focus of Chapter 5. In this chapter we focus on comparing organic growth to these inorganic growth modes (see Figure 6.1).

What is organic growth?

We refer to organic growth as the process by which a company enters a new business on its own – hiring, creation of a new project or business unit, repurposing an existing business unit, etc. If we think of the new business as possessing its own value chain, the goal of organic growth is to build up the resources and capabilities that this value chain entails, without recourse to other firms.

The choice of organic vs. inorganic growth is distinct from the traditional “make or buy” analysis, which refers to a choice between making a product or service internally (and assumes that you have the capability to do this) or procuring it from an external supplier (who is also capable of producing the product or service, but at a different cost). This depends on a comparison of transaction costs and production cost differences (Chapter 9).

Divestiture refers to the process of reducing the portfolio of the businesses a firm owns. It is one of the two important ways in which a corporation reduces its scope. The other is outsourcing (the subject of Chapter 8). Divestiture occurs when the firm reduces the number of businesses it is active in by completely pulling out of the value chain and ceasing to offer the products from that value chain to the relevant customers. Consider ABC Sports, which is active in two businesses: footballs and footwear. If ABC Sports decides to divest the footwear business, this implies that it will no longer offer footwear. Alternatively, it may decide to outsource the manufacturing of the footwear, while still designing them and distributing them. The difference can be visualized as in Figure 7.1.

The two basic modes of divestiture are sell-offs and spin-offs. In a sell-off, the divested business is sold to another company. When the other company uses a significant amount of debt to finance its purchase, the transaction is called a leveraged buy-out (LBO). A special case of this is when the incumbent management of a business unit takes over the ownership of the business (again typically using debt finance); this is called a management buy-out (MBO). In a spin-off, the shares of the divested business B are distributed to the shareholders (of the parent business A) and business B is listed on the capital market. Thus, the shareholders can choose whether they want to hold both shares or sell their stakes in business B. The parent business A may also choose to hold some residual stake in business B. This can be a tax free event, if the parent divests a minimum threshold of shares.

Recall from Chapter 1 that the goal of the corporate strategist is to exploit synergies through administrative control that cannot be replicated by mere investors. The HQ, where the corporate strategists reside, is ultimately the custodian of corporate advantage. Its goal is to ask (and help answer) the question of why the collection of businesses they administer is worth more than what they would be worth if operated independently.

We will use “HQ” to refer not only to the corporate HQ in a multi-divisional corporation but in fact to any administrative unit making strategic decisions that cut across multiple businesses. These could be regional, national, or divisional HQ, or indeed the holding company of a portfolio of companies (as in a business group). To the extent that any of these entities is responsible for ensuring that the set of businesses they administer creates more value than what they would if operated independently, they are in effect pursuing corporate advantage. In addition, the HQ may also be the organizational or physical location of shared service units.

This chapter focuses on the mechanisms of influence, or the influence models, available to the HQ to achieve this objective, given a fixed portfolio composition. This focus is critical in order to understand each component of corporate advantage clearly; HQs create corporate advantage through the decisions they make about portfolio composition (the topics of Chapters 4–8), but also about how they manage the businesses that exist in the portfolio (this chapter and Chapter 9, which focuses on the organizational structures used to manage the portfolio), as well as how they manage the process of bringing businesses into the portfolio (Chapters 11 and 12).