From Competitive Stratagty to Corporate Advantage

Overview:

In chapter 5 of his book Competition, Michael Porter starts by distinguishing business unit strategy, and corporate strategy. Being the first definition worried about generating competitive advantage in the businesses the company is in, and how to deal with variables and environmental issues, it is mainly about playing the game, the so called narrowly defined business.

The latter definition refers to a wider conception and usually provides the answer to which businesses the company should be in and how the resources should be allocated over those multimarket businesses units in order to create synergies, or make sure that the company as a whole is worth more alive than dead1 (i.e. divesting B.U).

One may state that the misconception between these two concepts, and overestimation of synergies led to massive value destruction. And this is well shown by Mr

Porter research sustaining that at first sight, more than half of new acquisitions destroyed shareholder value. In the apex of its investigation, Porter came up with three main premises, which must be respected if one wants to have a prosperous corporate strategy.

Moreover, if they are bypassed or simply ignored, make the line between success and failure even thinner: Competition occurs at the B.U level, and therefore, corporate strategy must support competitive strategy. Diversification adds costs and constrains B.U's, which can be minimized, but only to some point, as there are certain types of flows that are crucial to be performed, between Corporate and B.U.

And finally, the company must not do things that the market can do in a more efficient way, namely diversifying. Don't try to do something that your shareholders can do by themselves, it is not unique and does not create value, just as a takeaway, it is very hard for corporate to add value through capital allocation if companies operate in well-developed financial markets, being this phenomena more likely in emerging markets, where the financial system is not yet fully developed, and namely, access to junk bonds is inexistent.

Rules Of Engagement:

Porter defined 3 main tests required while contemplating diversification:

Attractiveness, Cost-Of-Entry and Better-Off Test. Let's look into each one of them:

1- Attractiveness Test is about knowing if the industry of the acquisition target is structurally attractive or capable of being made attractive. Therefore the potential acquirer must perform an industry wide analysis in order to assess if there are structural flaws, and what needs to be done to close those gaps in order to capture the value through favourable structures. If one wants to really see the deepness of these definitions, one can look to Warren Buffet's investment strategy, which main rule of thumb