by Phanish Puranam, Bart Vanneste, published 2016
What is corporate strategy and how is it any different from business strategy? That was actually a distinction I hadn’t made in my own mind when I picked this title up. I was generally interested in exploring “strategy” in an economic or business competition sense and this book was one of many I selected for further research. It was a happy accident then to realize there is a difference and this book is all about explaining what it is and why it’s different.
Business strategy aims at creating competitive advantage in a firm-against-firm struggle within a given industry. It flows outward from customer behavior through organizational structure and management practice to policies and processes surrounding marketing, sales, production, distribution and customer service.
Corporate strategy aims at realizing synergies from the joint ownership of different businesses. Synergies can be realized between businesses competing in the same industry but with common ownership (and perhaps diverse geographic territories), the case of a “corporate HQ” utilizing economies of scale in back-end or administrative functions to lower their cost or raise their quality across the individual customer-facing businesses. Synergies can also be realized between businesses operating in distinct industries but where coordination between actors in these industries allows for new products or services to be bundled, consider a bank and an insurance company owned by one corporate parent which can then offer a full range of financial services to customers.
One interesting takeaway from the book is that all public equity investors who do not have 100% of their investments in a single company (ie, they own a portfolio of stocks) are engaged in corporate strategy. However, as the book advises, passive investors are not able to realize synergies which those in control of these businesses can through exerting influence over their management. So, a passive equity investor could have an insight about the unique value of owning a complimentary basket of businesses representing corporate advantage, but they do not have the means to act upon it unless they are able to successfully agitate for M&A activity or have enough resources to get voting control over the companies in which they can sway management to extract the synergies they’ve spotted.
Another concept that was interesting to me was the irony that by bringing businesses under common ownership, a corporation destroys its own best benchmark for valuation (ie, the individual market prices of each business) and thus it is trapped in a perpetual game of trying to evaluate whether it’s coordination of economic activity within the corporation is synergistic and creating value, or wasteful and destroying it.
Warren Buffett as a conglomerator par excellence is an interesting case because, at least nominally, he does not provide managerial oversight to operations of the businesses he owns and has never claimed he has purchased a business for synergistic reasons for corporate strategy. Rather, he purchases businesses ONLY because he considers them to be available on a bargain basis, that is, he thinks they are available for less than their intrinsic value.
The entire point of corporate strategy, according to the book, is to be able to pay market or “fair” prices for assets and businesses, but still realize a profit from owning them, because of the ability to manage or exploit them differently under a joint ownership structure. So, Buffett is NOT a corporate strategist, although he is a really great investor.
And if you can realize synergies AND buy at bargain prices (AND apply leverage safely…) then you are really cooking with gas!
One of the great ironies of the (public) business world is that many managers (they are hardly ever significant shareholders themselves) think they can spot synergies all over the place, which either they or their investment bankers use to rationalize their acquisition activity. But the data demonstrate that few synergies ever appear to be realized– acquiring companies usually overpay, their stock falls on the announcement of an acquisition and the target company’s stock rises. Further, these acquisitions are often followed years later by goodwill writeoffs or divestitures of the previously acquired business or assets.
On average, a corporate parent that divests a business increases shareholder value.
In fact, one of the strategic suggestions of the authors is the always be on the look out for someone who is a better owner of a business or asset than you (ie, willing to pay you more than it’s worth to you to continue owning it) and selling things seems to be one of the most reliable ways for corporate strategists to create corporate advantage. It’s a pity, then, that most corporate strategists are buyers, not sellers!
If some other corporate parent has even stronger synergies with a business than you do, you should consider divesting.
Divesting when you can, and not when you have to is usually preferable.
Imagine that, starting today, the two businesses would be moved into separate ownership and would be operated completely independently, with no communication or exchange of any kind between the two. How would the value of the businesses be effected?
If one thinks one is smart enough to beat the odds, the authors suggest four places to look for synergies from joint ownership and operations for corporate strategists:
- Consolidation, creating value by rationalization across similar resources from similar value chain activities by eliminating redundancies, affects mostly costs and invested capital
- Combination, creating value by pooling similar resources from similar value chain activities, such as combining purchasing to obtain volume discounts or acquiring a competitor then raising prices for customers, impacts either costs or revenues
- Customization, creating value by co-specializing dissimilar resources in order to create greater joint value, results in improved value in production or consumption and involves modification of resources, the transfer of best practices can create unique value
- Connection, generates value by simply pooling the output of dissimilar value chain activities, for example customers may value being able to buy a bundle of different products and services together, the product development of one business is being connected to the distribution channel of another
Here are some other major strategy risks that are common:
One common negative synergy is brand dilution, ie, does the brand apply? Another is complexity. Another is market rivalry, this is a significant concern in the advertising industry, where when two firms who serve rivals merge, the chances of keeping both their clients is low.
Governance costs act as taxes that eat into the potential benefits from synergies when they are attempted to be extracted. [ie, the price you pay to operate an acquired business effectively.]
When an autonomous business becomes a division within another, the incentives of the owner and managers are necessarily diluted.
Synergies likely to generate significant transaction costs are less likely to be successfully realized in arms length relationships between independent firms than under common ownership.
I particularly appreciated the discussion about the corporate advantage that can be achieved through thoughtful design of the organization and its management.
One should be able to read the corporate strategy of a company in its organization chart: what kinds of activities does the top management feel are essential to integrate?
While all organizational structures represent a unique combination, there are three “pure form” ways to structure the corporation and its management structure: by activity, by output, by user/customer.
The authors recommend that corporate strategists “Think about the multi-business corporation as a collection of value chain activities” and look for synergies accordingly. But, being economic entities, there are necessary tradeoffs to beware of with each choice:
Grouping similar activities together emphasizes economies of scale at the expense of economies of scope, whereas grouping different activities together does exactly the opposite.
Every grouping arrangement emphasizes certain interactions but excludes others, which show up as opportunity costs and bottlenecks.
Further, if the innovation literature and hundreds of years of business history haven’t beat it into your head yet, things change. That means that the “right” structure (the synergistic one) is likely to change over time. “No structure is permanent.” Corporate strategists should always be considering the possibility that the ideal economic structure for managing the company has changed in reflection of new competitive dynamics, customer tastes and habits or advancements in technology, culture and society. A good rule of thumb might be that the appropriateness of the corporate structure needs to be reconsidered every time a major acquisition or divestiture occurs.
There were two other nuggets of corporate strategy wisdom that stood out to me. One was that most multi-business firms have capital allocation decision-making on auto-pilot. Either every request gets granted, or every request gets denied, or every business gets to keep whatever it generates. The corporate strategist can grab some low-hanging fruit by being thoughtful about capital allocation decisions within the portfolio and providing a critical voice about whether capital should be redistributed amongst divisions or even outside the company (ie, dividend or acquisition activity).
The other was in the author’s description of the typical M&A process (which includes not just execution of the acquisition transaction but also successful completion of the post-merger integration process). The most overlooked, and final, step in the process is Evaluation, which “refers to a post-transaction review of what went right and wrong” and analyzes the economic impact of the transaction on the entire firm. Were synergies realized? In the amounts predicted? Did costs materialize that were surprising? Did any other kind of disruption or distraction that was not anticipated earlier occur during the course of the merger? From my personal experience, it is difficult for management teams to take the time to look into the rear-view mirror like this, and even harder for them to be honest about what they see!!