Fluent Essays

From Competitive Advantage to Corporate Strategy by Michael E. Porter Reprint 87307 Harvard Business Review HBR M AY– J U N E 1 9 8 7 From Competitive Advantage to Corporate Strategy Michael E. Porter Corporate strategy, the overall plan for a diver-sified company, is both the darling and thestepchild of contemporary management practice—the darling because CEOs have been ob- sessed with diversification since the early 1960s, the stepchild because almost no consensus exists about what corporate strategy is, much less about how a company should formulate it. A diversified company has two levels of strategy: business unit (or competitive) strategy and corporate (or companywide) strategy. Competitive strategy con- cerns how to create competitive advantage in each of the businesses in which a company competes. Cor- porate strategy concerns two different questions: what businesses the corporation should be in and how the corporate office should manage the array of business units. Corporate strategy is what makes the corporate whole add up to more than the sum of its business unit parts. The track record of corporate strategies has been dismal. I studied the diversification records of 33 large, prestigious U.S. companies over the 1950- 1986 period and found that most of them had divested many more acquisitions than they had kept. The corporate strategies of most companies have dissi- pated instead of created shareholder value. The need to rethink corporate strategy could hardly be more urgent. By taking over companies and break- ing them up, corporate raiders thrive on failed corpo- rate strategy. Fueled by junk bond financing and growing acceptability, raiders can expose any com- pany to takeover, no matter how large or blue chip. Recognizing past diversification mistakes, some companies have initiated large-scale restructuring programs. Others have done nothing at all. Whatever the response, the strategic questions persist. Those who have restructured must decide what to do next to avoid repeating the past; those who have done nothing must awake to their vulnerability. To sur- vive, companies must understand what good corpo- rate strategy is. A SOBER PICTURE While there is disquiet about the success of corporate strategies, none of the available evidence satisfacto- rily indicates the success or failure of corporate strat- egy. Most studies have approached the question by measuring the stock market valuation of mergers, captured in the movement of the stock prices of acquiring companies immediately before and after mergers are announced. Michael E. Porter is professor of business administration at the Harvard Business School and author of Competitive Advantage (Free Press, 1985) and Competitive Strategy (Free Press, 1980). Copyright © 1987 by the President and Fellows of Harvard College. All rights reserved. These studies show that the market values mergers as neutral or slightly negative, hardly cause for seri- ous concern.1 Yet the short-term market reaction is a highly imperfect measure of the long-term success of diversification, and no self-respecting executive would judge a corporate strategy this way. Studying the diversification programs of a com- pany over a long period of time is a much more telling way to determine whether a corporate strategy has succeeded or failed. My study of 33 companies, many of which have reputations for good management, is a unique look at the track record of major corporations. (For an explanation of the research, see the insert “Where the Data Come From.”) Each company en- tered an average of 80 new industries and 27 new fields. Just over 70% of the new entries were acquisi- tions, 22% were start-ups, and 8% were joint ven- tures. IBM, Exxon, Du Pont, and 3M, for example, focused on start-ups, while ALCO Standard, Beatrice, and Sara Lee diversified almost solely through acquisi- tions (Exhibit 1 has a complete rundown). My data paint a sobering picture of the success ratio of these moves (see Exhibit 2). I found that on average corporations divested more than half their acquisi- tions in new industries and more than 60% of their acquisitions in entirely new fields. Fourteen compa- nies left more than 70% of all the acquisitions they had made in new fields. The track record in unrelated acquisitions is even worse—the average divestment rate is a startling 74% (see Exhibit 3). Even a highly respected company like General Electric divested a very high percentage of its acquisitions, particularly those in new fields. Companies near the top of the list in Exhibit 2 achieved a remarkably low rate of divestment. Some bear witness to the success of well-thought-out corporate strategies. Others, how- ever, enjoy a lower rate simply because they have not faced up to their problem units and divested them. I calculated total shareholder returns (stock price appreciation plus dividends) over the period of the study for each company so that I could compare them with its divestment rate. While companies near the top of the list have above-average shareholder re- turns, returns are not a reliable measure of diversifi- cation success. Shareholder return often depends heavily on the inherent attractiveness of companies’ base industries. Companies like CBS and General Mills had extremely profitable base businesses that subsidized poor diversification track records. I would like to make one comment on the use of shareholder value to judge performance. Linking shareholder value quantitatively to diversification performance only works if you compare the share- holder value that is with the shareholder value that might have been without diversification. Because such a comparison is virtually impossible to make, measuring diversification success—the number of units retained by the company—seems to be as good an indicator as any of the contribution of diversifica- tion to corporate performance. My data give a stark indication of the failure of corporate strategies.2 Of the 33 companies, 6 had been taken over as my study was being completed (see the note on Exhibit 2). Only the lawyers, investment bankers, and original sellers have prospered in most of these acquisitions, not the shareholders. PREMISES OF CORPORATE STRATEGY Any successful corporate strategy builds on a number of premises. These are facts of life about diversifica- tion. They cannot be altered, and when ignored, they explain in part why so many corporate strategies fail. Competition Occurs at the Business Unit Level. Di- versified companies do not compete; only their busi- ness units do. Unless a corporate strategy places primary attention on nurturing the success of each unit, the strategy will fail, no matter how elegantly constructed. Successful corporate strategy must grow out of and reinforce competitive strategy. Diversification Inevitably Adds Costs and Con- straints to Business Units. Obvious costs such as the corporate overhead allocated to a unit may not be as important or subtle as the hidden costs and con- straints. A business unit must explain its decisions to top management, spend time complying with plan- ning and other corporate systems, live with parent company guidelines and personnel policies, and forgo the opportunity to motivate employees with direct equity ownership. These costs and constraints can be reduced but not entirely eliminated. Shareholders Can Readily Diversify Themselves. Shareholders can diversify their own portfolios of stocks by selecting those that best match their pref- erences and risk profiles.3 Shareholders can often diversify more cheaply than a corporation because they can buy shares at the market price and avoid hefty acquisition premiums. These premises mean that corporate strategy can- not succeed unless it truly adds value—to business units by providing tangible benefits that offset the inherent costs of lost independence and to sharehold- ers by diversifying in a way they could not replicate. PASSING THE ESSENTIAL TESTS To understand how to formulate corporate strategy, it is necessary to specify the conditions under which HARVARD BUSINESS REVIEW May–June 1987 3 EX H IB IT 1 D iv er si fic at io n Pr of ile s of 3 3 Le ad in g U .S . C om pa ni es , 1 9 5 0 –1 9 8 6 C o m p a n y N u m b e r To ta l En tr ie s A ll En tr ie s in to N e w In d u st ri e s P e rc e n t A cq u is it io n s P e rc en t Jo in t V e n tu re s P e rc en t S ta rt -u p s En tr ie s in to N e w In d u s- tr ie s Th a t R e p re se n te d En ti re ly N e w Fi e ld s P e rc e n t A cq u is it io n s P e rc e n t Jo in t V e n tu re s P e rc e n t S ta rt -u p s A LC O S ta nd ar d 2 2 1 1 6 5 9 9 % 0 % 1 % 5 6 1 0 0 % 0 % 0 % A lli ed C or p. 7 7 4 9 6 7 1 0 2 2 1 7 6 5 6 2 9 Be at ric e 3 8 2 2 0 4 9 7 1 2 6 1 9 7 0 3 Bo rd en 1 7 0 9 6 7 7 4 1 9 3 2 7 5 3 2 2 C BS 1 4 8 8 1 6 7 1 6 1 7 2 8 6 5 2 1 1 4 C on tin en ta lG ro up 7 5 4 7 7 7 6 1 7 1 9 7 9 1 1 1 1 C um m in s En gi ne 3 0 2 4 5 4 1 7 2 9 1 3 4 6 2 3 3 1 D u Po nt 8 0 3 9 3 3 1 6 5 1 1 9 3 7 0 6 3 Ex xo n 7 9 5 6 3 4 5 6 1 1 7 2 9 6 6 5 G en er al El ec tri c 1 6 0 1 0 8 4 7 2 0 3 3 2 9 4 8 1 4 3 8 G en er al Fo od s 9 2 5 3 9 1 4 6 2 2 8 6 5 9 G en er al M ill s 1 1 0 1 0 2 8 4 7 9 2 7 7 4 7 1 9 W .R . G ra ce 2 7 5 2 0 2 8 3 7 1 0 6 6 7 4 5 2 1 G ul f & W es te rn 1 7 8 1 4 0 9 1 4 6 4 8 8 8 2 1 0 IB M 4 6 3 8 1 8 1 8 6 3 1 6 1 9 0 8 1 IC In du st rie s 6 7 4 1 8 5 3 1 2 1 7 8 8 6 6 IT T 2 4 6 1 7 8 8 9 2 9 5 0 9 2 0 8 Jo hn so n & J oh ns on 8 8 7 7 7 7 0 2 3 1 8 5 6 0 4 4 M ob il 4 1 3 2 5 3 1 6 3 1 1 5 6 0 7 3 3 Pr oc te r & G am bl e 2 8 2 3 6 1 0 3 9 1 4 7 9 0 2 1 Ra yt he on 7 0 5 8 8 6 9 5 1 6 8 1 1 9 6 4 HARVARD BUSINESS REVIEW May–June 1987 EX H IB IT 1 D iv er si fic at io n Pr of ile s of 3 3 Le ad in g U .S . C om pa ni es , 1 9 5 0 –1 9 8 6 (C on tin ue d) C o m p a n y N u m b e r To ta l En tr ie s A ll En tr ie s in to N e w In d u st ri e s P e rc en t A cq u is it io n s P e rc e n t Jo in t V e n tu re s P e rc en t S ta rt -u p s En tr ie s in to N e w In d u s- tr ie s Th a t R e p re se n te d En ti re ly N e w Fi el d s P e rc e n t A cq u is it io n s P e rc e n t Jo in t V e n tu re s P e rc en t S ta rt -u p s RC A 5 3 4 6 3 5 1 5 5 0 1 9 3 7 2 1 4 2 Ro ck w el l 1 0 1 7 5 7 3 2 4 3 2 7 7 4 2 2 4 Sa ra Le e 1 9 7 1 4 1 9 6 1 4 4 1 9 5 2 2 Sc ov ill 5 2 3 6 9 7 0 3 1 2 9 2 0 8 Si gn al 5 3 4 5 6 7 4 2 9 2 0 7 5 0 2 5 Te nn ec o 8 5 6 2 8 1 6 1 3 2 6 7 3 8 1 9 3 M 1 4 4 1 2 5 5 4 2 4 5 3 4 7 1 3 5 6 TR W 1 1 9 8 2 7 7 1 0 1 3 2 8 6 4 1 1 2 5 U ni te d Te ch no lo gi es 6 2 4 9 5 7 1 8 2 4 1 7 2 3 1 7 3 9 W es tin gh ou se 1 2 9 7 3 6 3 1 1 2 6 3 6 6 1 3 3 6 W ic ke s 7 1 4 7 8 3 0 1 7 2 2 6 8 0 3 2 Xe ro x 5 9 5 0 6 6 6 2 8 1 8 5 0 1 1 3 9 To ta l 3 ,7 8 8 2 ,6 4 4 9 0 6 A v e ra g e 1 1 4 .8 8 0 .1 7 0 .3 7 .9 2 1 .8 2 7 .4 6 7 .9 7 .0 2 5 .9 N ot es :B ea tri ce ,C on tin en ta lG ro up ,G en er al Fo od s, RC A , Sc ov ill ,a nd Si gn al w er e ta ke n ov er as th e st ud y w as be in g co m pl et ed .T he ir da ta co ve r th e pe rio d up th ro ug h ta ke ov er bu tn ot su bs eq ue nt di ve st m en ts . Th e pe rc en ta ge av er ag es m ay no ta dd up to 1 0 0% be ca us e of ro un di ng of f. HARVARD BUSINESS REVIEW May–June 1987 5 diversification will truly create shareholder value. These conditions can be summarized in three essen- tial tests: 1. The attractiveness test. The industries chosen for diversification must be structurally attrac- tive or capable of being made attractive. 2. The cost-of-entry test. The cost of entry must not capitalize all the future profits. 3. The better-off test. Either the new unit must gain competitive advantage from its link with the corporation or vice versa. Of course, most companies will make certain that their proposed strategies pass some of these tests. But my study clearly shows that when companies ignored one or two of them, the strategic results were disas- trous. How Attractive Is the Industry? In the long run, the rate of return available from competing in an industry is a function of its underly- ing structure, which I have described in another HBR article.4 An attractive industry with a high average return on investment will be difficult to enter be- cause entry barriers are high, suppliers and buyers have only modest bargaining power, substitute prod- ucts or services are few, and the rivalry among com- petitors is stable. An unattractive industry like steel will have structural flaws, including a plethora of substitute materials, powerful and price-sensitive buyers, and excessive rivalry caused by high fixed costs and a large group of competitors, many of whom are state supported. Diversification cannot create shareholder value Where the data come from We studied the 1950–1986 diversification histories of 33 large diversified U.S. companies. They were cho- sen at random from many broad sectors of the econ- omy. To eliminate distortions caused by World War II, we chose 1950 as the base year and then identified each business the company was in. We tracked every acqui- sition, joint venture, and start-up made over this pe- riod—3,788 in all. We classified each as an entry into an entirely new sector or field (financial services, for example), a new industry within a field the company was already in (insurance, for example), or a geo- graphic extension of an existing product or service. We also classified each new field as related or unre- lated to existing units. Then we tracked whether and when each entry was divested or shut down and the number of years each remained part of the corpora- tion. Our sources included annual reports, 10K forms, the F&S Index, and Moody’s, supplemented by our judg- ment and general knowledge of the industries in- volved. In a few cases, we asked the companies spe- cific questions. It is difficult to determine the success of an entry with- out knowing the full purchase or start-up price, the profit history, the amount and timing of ongoing invest- ments made in the unit, whether any write-offs or write- downs were taken, and the selling price and terms of sale. Instead, we employed a relatively simple way to gauge success: whether the entry was divested or shut down. The underlying assumption is that a company will generally not divest or close down a successful business except in a comparatively few special cases. Companies divested many of the entries in our sample within five years, a reflection of disappointment with performance. Of the comparatively few divestments where the company disclosed a loss or gain, the divest- ment resulted in a reported loss in more than half the cases. The data in Exhibit 1 cover the entire 1950–1986 period. However, the divestment ratios in Exhibit 2 and Exhibit 3 do not compare entries and divestments over the entire period because doing so would over- state the success of diversification. Companies usually do not shut down or divest new entries immediately but hold them for some time to give them an opportu- nity to succeed. Our data show that the average hold- ing period is five to slightly more than ten years, though many divestments occur within five years. To ac- curately gauge the success of diversification, we calcu- lated the percentage of entries made by 1975 and by 1980 that were divested or closed down as of January 1987. If we had included more recent entries, we would have biased upward our assessment of how suc- cessful these entries had been. As compiled, these data probably understate the rate of failure. Companies tend to announce acquisi- tions and other forms of new entry with a flourish but divestments and shutdowns with a whimper, if at all. We have done our best to root out every such transac- tion, but we have undoubtedly missed some. There may also be new entries that we did not uncover, but our best impression is that the number is not large. 6 HARVARD BUSINESS REVIEW May–June 1987 unless new industries have favorable structures that support returns exceeding the cost of capital. If the industry doesn’t have such returns, the company must be able to restructure the industry or gain a sustainable competitive advantage that leads to re- turns well above the industry average. An industry need not be attractive before diversification. In fact, a company might benefit from entering before the industry shows its full potential. The diversification can then transform the industry’s structure. In my research, I often found companies had sus- pended the attractiveness test because they had a vague belief that the industry “fit” very closely with their own businesses. In the hope that the corporate “comfort” they felt would lead to a happy outcome, the companies ignored fundamentally poor industry structures. Unless the close fit allows substantial competitive advantage, however, such comfort will turn into pain when diversification results in poor returns. Royal Dutch Shell and other leading oil com- panies have had this unhappy experience in a number of chemicals businesses, where poor industry struc- tures overcame the benefits of vertical integration and skills in process technology. Another common reason for ignoring the attrac- tiveness test is a low entry cost. Sometimes the buyer has an inside track or the owner is anxious to sell. Even if the price is actually low, however, a one-shot gain will not offset a perpetually poor business. Al- most always, the company finds it must reinvest in the newly acquired unit, if only to replace fixed assets and fund working capital. Diversifying companies are also prone to use rapid growth or other simple indicators as a proxy for a target industry’s attractiveness. Many that rushed into fast-growing industries (personal computers, video games, and robotics, for example) were burned because they mistook early growth for long-term profit potential. Industries are profitable not because they are sexy or high tech; they are profitable only if their structures are attractive. What Is the Cost of Entry? Diversification cannot build shareholder value if the cost of entry into a new business eats up its expected returns. Strong market forces, however, are working to do just that. A company can enter new industries by acquisition or start-up. Acquisitions expose it to an increasingly efficient merger market. An acquirer beats the market if it pays a price not fully reflecting the prospects of the new unit. Yet multiple bidders are commonplace, information flows rapidly, and investment bankers and other intermediaries work aggressively to make the market as efficient as possi- ble. In recent years, new financial instruments such as junk bonds have brought new buyers into the market and made even large companies vulnerable to takeover. Acquisition premiums are high and reflect the acquired company’s future prospects—sometimes too well. Philip Morris paid more than four times book value for Seven-Up Company, for example. Simple arithmetic meant that profits had to more than qua- druple to sustain the preacquisition ROI. Since there proved to be little Philip Morris could add in market- ing prowess to the sophisticated marketing wars in the soft-drink industry, the result was the unsatisfac- tory financial performance of Seven-Up and ulti- mately the decision to divest. In a start-up, the company must overcome entry barriers. It’s a real catch-22 situation, however, since attractive industries are attractive because their en- try barriers are high. Bearing the full cost of the entry barriers might well dissipate any potential profits. Otherwise, other entrants to the industry would have already eroded its profitability. In the excitement of finding an appealing new business, companies sometimes forget to apply the cost-of-entry test. The more attractive a new indus- try, the more expensive it is to get into. Will the Business Be Better Off? A corporation must bring some significant competi- tive advantage to the new unit, or the new unit must offer potential for significant advantage to the corpo- ration. Sometimes, the benefits to the new unit ac- crue only once, near the time of entry, when the parent instigates a major overhaul of its strategy or installs a first-rate management team. Other diversi- fication yields ongoing competitive advantage if the new unit can market its product through the well-de- veloped distribution system of its sister units, for instance. This is one of the important underpinnings of the merger of Baxter Travenol and American Hos- pital Supply. When the benefit to the new unit comes only once, the parent company has no rationale for holding the new unit in its portfolio over the long term. Once the results of the one-time improvement are clear, the diversified company no longer adds value to offset the inevitable costs imposed on the unit. It is best to sell the unit and free up corporate resources. The better-off test does not imply that diversifying corporate risk creates shareholder value in and of itself. Doing something for shareholders that they can do themselves is not a basis for corporate strategy. (Only in the case of a privately held company, in which the company’s and the shareholder’s risk are the same, is diversification to reduce risk valuable for its own sake.) Diversification of risk should only be a by-product of corporate strategy, not a prime moti- vator. Executives ignore the better-off test most of all or HARVARD BUSINESS REVIEW May–June 1987 7 EX H IB IT 2 A cq ui si tio n Tr ac k Re co rd s of Le ad in g U .S . D iv er si fie rs Ra nk ed by Pe rc en t D iv es te d, 1 9 5 0– 1 9 8 6 C o m p a n y A ll A cq u is it io n s in N e w In d u st ri e s P e rc e n t M a d e b y 1 9 8 0 a n d Th e n D iv e st ed P e rc e n t M a d e b y 1 9 7 5 a n d Th e n D iv e st ed A cq u is it io n s in N e w In d u st ri e s Th a t R e p re se n te d En ti re ly N e w Fi e ld s P e rc en t M a d e b y 1 9 8 0 a n d Th e n D iv e st ed P e rc e n t M a d e b y 1 9 7 5 a n d Th e n D iv e st e d Jo hn so n & J oh ns on 5 9 1 7 % 1 2 % 1 0 3 3 % 1 4 % Pr oc te r & G am bl e 1 4 1 7 1 7 1 1 1 7 1 7 Ra yt he on 5 0 1 7 2 6 1 3 2 5 3 3 U ni te d Te ch no lo gi es 2 8 2 5 1 3 1 0 1 7 0 3 M 6 7 2 6 2 7 2 4 4 2 4 5 TR W 6 3 2 7 3 1 1 8 4 0 3 8 IB M 7 3 3 0 * 3 3 3 0 * D u Po nt 1 3 3 8 4 3 7 6 0 7 5 M ob il 1 7 3 8 5 7 9 5 0 5 0 Bo rd en 7 4 3 9 4 0 2 4 4 5 5 0 IC In du st rie s 3 5 4 2 5 0 1 5 4 6 4 4 Te nn ec o 5 0 4 3 4 7 1 9 2 7 3 3 Be at ric e 1 9 8 4 6 4 5 5 9 5 2 5 1 IT T 1 5 9 5 2 5 2 4 6 6 1 6 1 Ro ck w el l 5 5 5 6 5 7 2 0 7 1 7 1 A lli ed C or p. 3 3 5 7 4 5 1 1 8 0 6 7 Ex xo n 1 9 6 2 2 0 * 5 8 0 5 0 * Sa ra Le e 1 3 5 6 2 6 5 3 9 8 0 7 6 G en er al Fo od s 4 8 6 3 6 2 1 9 9 3 9 3 Sc ov ill 3 5 6 4 7 7 1 1 6 4 7 0 Si gn al 3 0 6 5 6 3 1 5 7 0 6 7 A LC O S ta nd ar d 1 6 4 6 5 7 0 5 6 7 2 7 6 8 HARVARD BUSINESS REVIEW May–June 1987 EX H IB IT 2 A cq ui si tio n Tr ac k Re co rd s of Le ad in g U .S . D iv er si fie rs Ra nk ed by Pe rc en t D iv es te d, 1 9 5 0– 1 9 8 6 (C on tin ue d) C o m p a n y A ll A cq u is it io n s in N e w In d u st ri e s P e rc e n t M a d e b y 1 9 8 0 a n d Th e n D iv e st ed P e rc e n t M a d e b y 1 9 7 5 a n d Th e n D iv e st ed A cq u is it io n s in N e w In d u st ri e s Th a t R e p re se n te d N e w Fi e ld s P e rc e n t M a d e b y 1 9 8 0 a n d Th e n D iv e st e d P e rc en t M a d e b y 1 9 7 5 a n d Th e n D iv e st ed W .R . G ra ce 1 6 7 6 5 7 0 4 9 7 1 7 0 G en er al El ec tri c 5 1 6 5 7 8 1 4 1 0 0 1 0 0 W ic ke s 3 8 6 7 7 2 1 5 7 3 7 0 W es tin gh ou se 4 6 6 8 6 9 2 2 6 1 5 9 Xe ro x 3 3 7 1 7 9 9 1 0 0 1 0 0 C on tin en ta lG ro up 3 6 7 1 7 2 1 5 6 0 6 0 G en er al M ill s 8 6 7 5 7 3 2 0 6 5 6 0 G ul f & W es te rn 1 2 7 7 9 7 8 4 2 7 5 7 2 C um m in s En gi ne 1 3 8 0 8 0 6 8 3 8 3 RC A 1 6 8 0 9 2 7 8 6 1 0 0 C BS 5 4 8 7 8 9 1 8 8 8 8 8 To ta l 2 ,0 2 1 6 6 1 A v e ra g e p er co m p a n y † 6 1 .2 5 3 .4 % 5 6 .5 % 2 0 .0 6 1 .2 % 6 1 .1 % * C om pa ni es w ith th re e or fe w er ac qu is iti on s by th e cu to ff ye ar . † C om pa ni es w ith th re e or fe w er ac qu is iti on s by th e cu to ff ye ar ar e ex cl ud ed fro m th e av er ag e to m in im iz e st at is tic al di st or tio ns . N ot e: Be at ric e, C on tin en ta lG ro up ,G en er al Fo od s, RC A ,S co vi ll, an d Si gn al w er e ta ke n ov er as th e st ud y w as be in g co m pl et ed .T he ir da ta co ve r th e pe rio d up th ro ug h ta ke ov er bu tn ot su bs eq ue nt d iv es tm en ts . HARVARD BUSINESS REVIEW May–June 1987 9 deal with it through arm waving or trumped-up logic rather than hard strategic analysis. One reason is that they confuse company size with shareholder value. In the drive to run a bigger company, they lose sight of their real job. They may justify the suspension of the better-off test by pointing to the way they manage diversity. By cutting corporate staff to the bone and giving business units nearly complete autonomy, they believe they avoid the pitfalls. Such thinking misses the whole point of diversification, which is to create shareholder value rather than to avoid destroy- ing it. CONCEPTS OF CORPORATE STRATEGY The three tests for successful diversification set the standards that any corporate strategy must meet; meeting them is so difficult that most diversification fails. Many companies lack a clear concept of corpo- rate strategy to guide their diversification or pursue a concept that does not address the tests. Others fail because they implement a strategy poorly. My study has helped me identify four concepts of corporate strategy that have been put into prac- tice—portfolio management, restructuring, transfer- ring skills, and sharing activities. While the concepts are not always mutually exclusive, each rests on a different mechanism by which the corporation cre- ates shareholder value and each requires the diversi- fied company to manage and organize itself in a different way. The first two require no connections among business units; the second two depend on them. (See Exhibit 4.) While all four concepts of strategy have succeeded under the right circum- stances, today some make more sense than others. Ignoring any of the concepts is perhaps the quickest road to failure. Portfolio Management The concept of corporate strategy most in use is portfolio management, which is based primarily on diversification through acquisition. The corporation acquires sound, attractive companies with compe- tent managers who agree to stay on. While acquired units do not have to be in the same industries as existing units, the best portfolio managers generally limit their range of businesses in some way, in part to limit the specific expertise needed by top manage- ment. The acquired units are autonomous, and the teams that run them are compensated according to the unit results. The corporation supplies capital and works with each to infuse it with professional management techniques. At the same time, top management pro- vides objective and dispassionate review of business unit results. Portfolio managers categorize units by potential and regularly transfer resources from units that generate cash to those with high potential and cash needs. In a portfolio strategy, the corporation seeks to create shareholder value in a number of ways. It uses its expertise and analytical resources to spot attrac- tive acquisition candidates that the individual share- holder could not. The company provides capital on favorable terms that reflect corporatewide fundrais- ing ability. It introduces professional management skills and discipline. Finally, it provides high-quality review and coaching, unencumbered by conventional wisdom or emotional attachments to the business. The logic of the portfolio management concept rests on a number of vital assumptions. If a company’s diversification plan is to meet the attractiveness and cost-of-entry test, it must find good but undervalued companies. Acquired companies must be truly under- valued because the parent does little for the new unit once it is acquired. To meet the better-off test, the benefits the corporation provides must yield a signifi- cant competitive advantage to acquired units. The style of operating through highly autonomous busi- ness units must both develop sound business strate- gies and motivate managers. In most … 4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 1/3 Article Notes 3   Bendle, N. T., & Bagga, C. K. (2016). The metrics that marketers muddle. MIT Sloan Management Review, 57(3), 73-82. Despite their widely acknowledged importance, some popular marketing metrics are regularly misunderstood and misused. One major reason for marketing’s diminishing role is the difficulty of meaning its impact: The value marketers generate is often difficult to quantify. The main goals of this article are to understand how these marketing metrics are used and understood and to develop ideas to help marketers unmuddle their metrics. The authors conducted surveys from managers from all functions across the business-to-business and business-to-consumer industries.   5 Best Known Marketing Metrics: -       Market share -       Net Promoter Score (NPS) -       The Value of a ‘Like’ -       Consumer Lifetime Value (CLV) -       Return on Investment (ROI) Market Share Market share is a popular marketing metric. One reason for why manager value market share is that research from the 1970s suggested a link between market share and ROI; however, the linkage may be less clear: the studies have found it is often correlational rather than causal. The survey found that there were two ways managers used market share: as an ultimate objective or as an intermediate measure of success. Increasing market share is not a meaningful ultimate objective for maximizing shareholder value and stakeholder management: If the aim is to maximize the returns to shareholders, increased market share offers no benefits unless it eventually generates profits. In some markets, bigger can be better; however, economies of scale do not automatically apply all markets. Unmuddling Market Share: The authors suggest a simple set of rules for the appropriate use of the market share metric: -       Managers should not consider market share as the ultimate objective or as a proxy for absolute size. -       Managers should evaluate it from the competitors’ and consumers’ point of view. If an increase in market share is not going to get positive feedback from competitors and consumers, then an increase in market share will not lead to a productive result. -       Managers should analyze whether market share drives profitability in your industry. Companies with superior products tend to have high market share and high profitability because product superiority causes both. 4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 2/3 This means that the two metrics are correlated, BUT it does not necessarily mean that increasing market share will increase profits.   Net Promoter Score (NPS) This metric is used to measure customer loyalty to a firm. Companies among diverse industries have embraced NPS as a way to monitor their customer service operations while NPS also has been seen as a system that allows managers to use the scores to shape managerial actions. One of the advantages of NPS is its simplicity: It is easy for managers and employees to understand the goal of having more promoters and fewer detractors. However, there are weaknesses: E.g., in the net promoter literature, a customer’s worth to Apple has been described as the customer’s spending, ignoring the costs associated with serving the customer. It is also easy to imagine how to increase the net promoter score (such as making customers happier) while destroying even to-line growth (by slashing prices). Another problem with NPS as a metric is the classification system: The boundaries between scores of 6 and 7 (detractors and passives) and 8 and 9 (passive and promoters) seem somewhat arbitrary and culturally specific. Unmuddling NPS: The value of NPS depends on whether a manager sees it as a metric or as a system. The authors suggest that the NPS metric cannot change the marketing performance. However, they advise using this metric as a part of a system employed in evaluating the performance which might lead to a cultural shift within the organization.   The Value of a ‘Like’ This metric is used for measuring the social media capital of the company. New approaches are being developed all the time and they have the potential to aid understanding of how social media creates value. It is measured as the difference between the average value of customers endorsing the company and the average value of the customers who are not endorsing the company. The majority of managers link between their social media spending the value of a ‘like’. However, it does not mean that the cause of the differences in users’ value is attributable to a company’s social media strategy. And the reason that social media strategy shouldn’t be seen as the driver of value difference between fans and nonfans is because customers who are social media fans will differ from nonfans for reasons unrelated to the company’s social media strategy. Unmuddling the Value of a ‘Like’: This difference between two groups of consumers does not suggest an effect of online marketing activity or lack thereof. It should be investigated thoroughly by the managers. If the management is using the revenue to measure customer value, then this marketing metric does not give a good estimate. However, if the company does want to understand the impact of social media marketing, they should use randomized control experiments to derive causal answers. Consumer Lifetime Value (CLV) Consumer lifetime value (CLV), which is the present value of cash flows from a customer relationship, can help managers in decision making related to investment in developing customer relationships, as it is used to measure the value of the current customer base. If the management is using the customer value in their decision-making process, then CLV is a useful tool for them. Unmuddling CLV: 4/24/2020 onlinetext.html file:///Users/matthewfisher/Downloads/MKTG064903-S20R-Article Notes The Metrics that Marketers Muddle-359053/Marina Hamagaki_504182_assignsubmission… 3/3 The authors suggest that CLV calculations should not include the customer acquisition cost and the estimated CLV should be compared to the estimated acquisition cost to derive conclusions. The bigger the difference between the estimated CLV and the estimated acquisition cost, the better the acquisition campaign. Return on Investment (ROI) Return on investment is a popular and potentially important metric allowing for the comparison of disparate investments. A critical requirement for calculating ROI is knowing the net profit generated by a specific investment decision. According to the authors, there is confusion within management over the use of ROI. However, as ROI is understood across disciplines, it is a powerful metric to communicate across the organization. Unmuddling ROI: The authors advise that if a manager is assessing the financial return on an investment, then ROI is an appropriate metric and can be calculated by dividing the incremental profits by the investments. Agribusiness marketing managers who are passionate about establishing the credibility of the value created through marketing should be thorough in their use of metrics. Most importantly, they should be able to understand the metric, its use and what it represents.