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After reviewing the relevant course material, select 3 topics/concepts/tools/theories that stood out for your group from the week 9 lecture and supplementary reading material. Identify and describe each selected topic in detail and elaborate on why these stood out as being important to your group. The purpose here is to reflect on the material presented. The lecture slides are available in the Course Materials section and the supplementary readings (are the same as those for last week) and can also be found under the Course Materials tab on this page and/or in the Course Pack.

Please remember this is a two-part assignment, which requires the following:

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For Part 1, each group is required to submit their top 3 topics/concepts/tools/theories

For Part 2, each individual team member is required to respond to a minimum of two posts with a minimum of 100-150 words per response. These responses can be to initial posts or continuing the conversation within your own group’s thread.

In the first part, you need to read the ppt, and then sort out three paragraphs of extended content about ppt. The word document I gave you was published by another group. This is an example. In the second part, in the word document, please comment on the first and third topics, 100-200 words.

1- Directive and Evaluative Influence of HQ

The HQ of an organization consists of the place where a company is run and its operations are directed. There are 4 different ways by which HQ can influence the underlying businesses, divided in 2 dimensions: One dimension represents the relationship between HQ and its underlying businesses. The second dimension represents the relationship that HQ encourages between those underlying businesses itselves. The first dimension is divided into Directive or Evaluative. In a directive control relationship, HQ is closely involved in all the businesses’ strategic decisions. Whereas, in a evaluative control environment, HQ gives its businesses the autonomy to make their own strategic decisions. HQ just evaluates their decisions from time to time to make sure the business stays in line with their values and financial goals. We found this concept to be important because knowing which relationship an HQ wants to follow can dictate how involved they are in the processes and activities of their underlying businesses. This in turn will allow for better decision making due to the clear cut mission and vision of the HQ.

2- Standalone and Linkage Influence of HQ

The second dimension of influence that HQ can have consists of the relationship it encourages between its businesses. These relationships can be either Standalone and Linkage. A standalone style of HQ does not promote any linkage between the different businesses. This happens when the underlying businesses independently benefit from the relationship with HQ. Much of the synergies that exist between these underlying businesses occur towards the origin of the value chains and are therefore difficult to observe from an outside perspective. One example is P&G. Being a house of brands, P&G serves solely as an umbrella for many different and independent companies. On the other hand, a Linkage style of HQ encourages the underlying businesses to connect with each other. In this case, HQ is just a supervisor overseeing their businesses and its influence is felt through the relationship between these businesses. One example is Gillete. Even though it has many different brands and products, Gillete still encourages the interactions between its underlying businesses. Similar to before, we found it important for firms to understand the different type of relationships in horizontal influences so that they may better allocate energy and resources to their underlying businesses; knowing whether a firm’s underlying businesses are thoroughly linked together, or if they simply share synergies early on in their respective value chains can prove useful when allocating resources amongst them.

3 – Challenges in Resource Allocation by the HQ

There are two challenges that HQ’s encounter when allocating their resources, which are the challenges of synergy and uncertainty. The challenge of synergy can be best described as businesses in a multi-business organization who are not independent of each other, but still interact with each other. Therefore, a firm must understand these interrelationships and how they might affect resource allocation: will giving one business extra resources take away value from the second business as is the case when dis-synergies exist, or will providing resources to one business help uplift the second one as well? The challenge of uncertainty is arguably more complex due to the existence of fundamental uncertainty (when one is unaware of both the future or the possibility of potential outcomes) and uncertainty derived from financial theories when one does not know the future but is in fact aware of the possibility of potential outcomes. This duality of theories quite accurately mimics the duality of man in which there exists both a state of good and bad simultaneously in every individual, constantly at war with each other. Thus, businesses face the obstacle of assessing the synergies that exist between businesses as well as determining which businesses make the best investments for the risk that they pose (aka exploration-exploitation trade off). This is important because recognizing and addressing these challenges will guide resource allocation and decision on how to spread investment across a portfolio of businesses as well as whether or not to invest in a particular business.

Corporate Parenting Designing the corporate HQ

MGT 214 Corporate Strategy

Spring 2021

Dr. Paul Kirwan

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Recurring theme…

The goal of the corporate strategist is to exploit synergies through administrative control that cannot be replicated by mere investors.

Corporate advantage comes broadly from either portfolio assembly (“selection”) or portfolio modification (“synergy”).

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Recurring theme…

“Synergy” is an umbrella term to describe the various ways in which the cash flows and discount rates of businesses in a portfolio can be modified through administrative influence.

Synergy is the means through which corporate advantage is created relative to a typical investor who can assemble the same portfolio of investments (without exercising administrative influence over them, as she lacks the decision rights to do so).

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Introduction

This chapter explores how the appropriate influence model for HQ is contingent on the choice of how corporate advantage is being pursued.

The appropriate influence model is defined as the way HQ influences individual businesses in the portfolio

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Introduction

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.

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Understanding HQ

“HQ” refers to:

the corporate HQ in a multi-divisional corporation

any administrative unit making strategic decisions that cut across multiple businesses

Including regional, national, or divisional HQ

the holding company of a portfolio of companies (as in a business group)

the organizational or physical location of shared service units.

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Holding Company Structure, simple example

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Heineken’s Premium Brand Portfolio, simple example

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Basic facts about the corporate HQ

Studies decompose the variance in profitability to:

(1)business unit,

(2)corporate parent, and

(3)industry level factors

Found that the corporate parent factor represents around 10 to 20 percent of total variance (and 20 to 25 percent of explained variance), using the most recent techniques (McGahan and Porter, 2002).

This is in between that for industry and that for business unit.

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Basic facts about the corporate HQ

This may be a significant under-estimate of the impact of the corporate HQ because of data limitations and the methodology, which mainly has to do with the fact that many business unit specific factors actually originate through HQ decisions.

The size of the corporate HQ relative to the total size of the corporation varies enormously across sectors and geographies.

Primary drivers of differences in HQ size are the scale of shared service functions provided to the businesses in the portfolio, as well as the extent of linkage influence exercised by the HQ.

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Basic facts about the corporate HQ

The cost of the corporate HQ in large multi-business corporations can range from 2 percent to 7 percent of sales (Roland Berger, 2013) but may be much higher in terms of operating profit.

Holding company HQs are relatively cheaper than other kinds of HQs.

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Basic facts about the corporate HQ

Most multi-business companies use some form of corporate portfolio management frameworks.

However, their use in actual capital allocation decisions seems limited, and the missing role of portfolio levels effects (i.e., synergies and dis-synergies between businesses) in most existing frameworks is recognized.

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HQ influence in portfolio assembly (selection)

A corporate strategy based on pure portfolio assembly (without any modification of businesses in the portfolio) requires:

being able to systematically spot and access under-valued opportunities,

being able to exit businesses when good opportunities to do so arise.

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HQ influence in portfolio assembly (selection)

The strategic capabilities needed for such an approach include:

Environment scanning for new opportunities

Expertise at M&A and alliances

Expertise at refocusing

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HQ influence in portfolio assembly (selection)

Corporate Management Functions (CMF) exist in a multi-business corporation (especially publicly listed ones) regardless of whether modification of businesses were required after entry.

CMF include tasks such as treasury, risk management, taxation, financial reporting, company secretary and legal counsel, government relations, and investor relations.

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HQ influence in portfolio assembly (selection)

If there are any benefits in consolidating and combining these functions across businesses, then there may be some (almost inadvertent) synergy effects.

In a holding company structure:

these CMFs are not strictly necessary at the HQ

they mostly exist at the individual company level (especially with listed companies)

one could in principle have a very lean corporate HQ.

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HQ influence in business modification (synergy)

Everything we have said above about the influence of the HQ in pure portfolio assembly models is also applicable to cases where corporate advantage is being pursued through business modification (synergy).

Furthermore, there is a whole variety of additional means of influence to consider when the HQ is pursuing a synergy approach to corporate advantage.

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Figure 10.1 HQ influence has two dimensions (Goold, Campbell, Alexander, 1994)

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Horizontal dimension: standalone influence

The HQ does not encourage any meaningful B2B relationships.

The HQ influence is felt solely through a vertical HQ-to-business relationship.

The businesses independently benefit from, or use a valuable resource or capability that is located at, the HQ.

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Horizontal dimension: standalone influence

The HQ is the locus of intangible resources and capabilities that have Connection/Customization synergies with the business value chains.

E.g. corporate brand; management expertise; functional expertise in finance, HR, M&A, strategic alliances; and other best practices.

These synergies could also be viewed as Consolidation or Combination effects arising from creating these intangibles once at the HQ instead of several times in the portfolio (i.e., for each business).

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Horizontal dimension: standalone influence

Standalone influence models tend to involve portfolios of businesses that look quite distinct from each other to the external observer (prompting the label “conglomerate”) because the synergies across them mostly occur at the back end of the value chains and possibly in corporate management functions.

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Horizontal dimension: linkage influence

The HQ encourages businesses to work together in alliance-like fashion.

The HQ influence is felt through the B2B relationship fostered and administered under the supervision of the HQ (in addition to any vertical influence that the HQ may employ).

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Horizontal dimension: linkage influence

The HQ exerts authority to enable the extraction of synergies of all kinds (Consolidation, Combination, Customization, and Connection) between businesses.

The portfolio is such that it supports active management of inter-business synergies by the HQ (e.g., shared manufacturing, R&D, or sales and distribution), are seen as being more “related.”

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Horizontal dimension: standalone vs. linkage

When the HQ is also the organizational or physical location of centralized functions (e.g., to extract Consolidation and Combination synergies across businesses through shared services units) whose use requires some coordination between businesses, then the influence lies somewhere between pure standalone and pure linkage influences. For example,

IT procurement and real estate management functions across different businesses may be centralized at HQ

In all other matters, the businesses may operate independently from each other.

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Vertical dimension: directive influence

The control that the HQ exerts on businesses by directly influencing their strategic decisions and actions through approving, vetoing, or ordering them.

Resource allocation (e.g., capital budgeting) tends to be a rigorous process with a lot of scrutiny and vetting by the HQ before budget approvals.

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Vertical dimension: directive influence

Capital budgeting becomes the key process through which the strategic decisions at the business level are overseen and controlled by the HQ

Close monitoring of the implementation of decisions via operational targets.

The locus of strategy-making and implementation in each business is at HQ.

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Vertical dimension: directive influence

Directive influence models tend to rely on strategic planning capabilities concentrated at the HQ.

Directive approaches can more easily pursue one-sided synergies (in which one business gains more than the other loses, leaving the aggregate portfolio better off).

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Vertical dimension: evaluative influence

Evaluative influence refers to control by the HQ of businesses, primarily through setting financial performance targets and evaluating outcomes;

The business units may, however, have a high degree of autonomy in terms of their decisions.

Locus of strategy-making and implementation is at the business level.

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Vertical dimension: evaluative influence

Relies more on financial control and performance management, with high degrees of delegation and autonomy on strategic decision-making.

One-sided synergies may be harder to achieve in such settings, and the focus may be mostly on two-sided synergies.

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Vertical dimension: directive vs. evaluative

These are, of course, extreme cases, with intermediate points possibly being much more common (e.g., the HQ decides, business leadership implements, the HQ evaluates outcomes as a measure of implementation success).

The HQ, for instance, may be actively involved both in guiding and approving business unit strategy as well as managing performance through targets and incentives.

For example, GE under Jack Welch was famous for a rigorous capital budgeting and performance evaluation process.

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Table 10.1 Prototypes of HQ influence

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Standalone, evaluative

The standalone, evaluative (SE) influence model comes closest to the pure portfolio assembly model, yet differs from it in the sense that there is some attempt at indirect modification of businesses through evaluative control.

Financial target setting and performance management are key activities in the HQ in this case, besides any CMF that are necessary to meet regulatory requirements.

32

Standalone, evaluative

The management capabilities that underlie evaluative control constitute the intangible assets that generate Connection/Customization synergies with the businesses

The cost of creating and hosting these are economized by hosting them once at the HQ (rather than replicating them across businesses).

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Standalone, directive

The standalone, directive (SD) influence model is associated with a restructuring orientation.

Like pure portfolio assembly, the selection of businesses is an important part of HQ activity

Unlike pure portfolio assembly there is an active attempt at modifying businesses through directive control.

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Standalone, directive

The directive attempts can include changes in:

the business model,

business strategy,

staffing, and

compensation.

Key HR activities include:

Strategic planning

Turnaround management

Any CMF that are necessary to meet regulatory requirements.

35

Standalone, directive

The management capabilities that underlie directive control constitute the intangible assets that generate Connection/Customization synergies with the businesses

The cost of creating and hosting these are economized by hosting them once at the HQ (rather than replicating them across businesses).

36

Standalone, directive

The HQ may also be the physical or organizational location of tangible assets in the form of shared services functions that create Consolidation/Combination synergies across businesses in back office and IT functions.

Conglomerates such as Hanson and Tyco were formerly famous for following this model.

Danaher Corporation, the US equipment manufacturer, is a contemporary example, though its scope is less broad than what one would consider a typical conglomerate.

37

Linkage, directive

The linkage, directive (LD) influence model explicitly focuses on actively managing operational synergies through linkages between businesses by directive control.

Besides the CMF, the HQ in organizations following this model is likely to have:

strategic planning teams,

corporate development functions (M&A and/or alliance teams), and

centers of expertise (in areas like best practices, procurement, etc.).

HQ also the physical or organizational location of shared services functions that create Consolidation/Combination synergies across businesses in back office and IT functions.

38

Linkage, evaluative

The linkage, evaluative (LE) influence model explicitly focuses on managing operational synergies through linkages between businesses, but does so passively rather than actively.

The goal instead is to create a context that allows businesses to collaborate on synergy realization.

The use of corporate development functions at HQ are more elective than imposed.

A strong corporate HR function with an emphasis on building the informal organization that glues the businesses together may be prominent.

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Resource allocation by the HQ

The influence of the HQ is ultimately exerted on the basis of its resource allocation decisions

This holds regardless of which HQ influence model is adopted

The HQ has the power to allocate resources to the businesses, not the other way round.

Resource allocation in directive control takes the form that major capital expenditure commitments (and therefore strategic investments) cannot be made without approval and rigorous screening, regardless of the need for capital rationing.

40

Resource allocation by the HQ

In evaluative control, capital expenditure requests are granted semi-automatically if they clear hurdles, but individual performance related incentives depend on past performance.

Resource allocation by the HQ may do better or worse than resource allocation by individual investors via the capital markets.

The HQ has access to better information about each business and the decisions rights to enforce actions by their subordinates that enhance the value of these investments.

At the same time, it has access to a smaller set of alternatives and is prone to conflicts of interest between the HQ and shareholders.

41

Resource allocation by the HQ

The authors focus on providing guidelines for HQ decision-making about resource allocation under the assumption that the decisions are motivated by a desire to enhance the value of the firm.

Resource allocation in multi-business organizations involves decisions about:

How to spread investment across a portfolio of businesses,

Whether or not to invest in a particular business.

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Resource allocation by the HQ

Which raises two challenges.

1. The challenge of synergy

Businesses in a multi-business organization are not independent of each other

There are interactions between them.

These could be in the form of synergies or dis-synergies.

How should one take these into account when allocating resources across the portfolio?

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Resource allocation by the HQ

2. The challenge of uncertainty

Well developed theories from finance for resource allocation under risk:

Assume that the future is uncertain but we can describe the possible outcomes and the probability of each of these outcomes occurring.

These produce heuristics such as investing in projects only if their internal rate of return (IRR) exceeds their weighted average cost of capital (WACC), or to only invest in positive NPV projects.

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Resource allocation by the HQ

Under fundamental uncertainty:

The future is uncertain and we do not know all the possible outcomes nor their probabilities of occurring

Researchers have recognized that the problem is one of managing the exploration–exploitation trade-off:

how to balance investment in businesses likely to do well (exploitation) vs. investment in businesses with uncertain outcomes (exploration)

If the only way in which one can learn about the value of a business opportunity is by trying it, then some degree of exploratory investment is optimal. But how much?

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The synergistic portfolio framework

To assess the how much question, we use the following framework:

The synergistic portfolio framework tackles both synergies and uncertainty in resource allocation decisions (see Figure 10.2).

The two axes correspond respectively to:

Horizontal axis: Incoming benefit – how much does this business gain or lose in value from belonging to this portfolio?

Vertical axis: Outgoing benefit – how much value do the other businesses gain or lose from the presence of this business in the portfolio?

Figure 10.2 Synergistic portfolio framework

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The synergistic portfolio framework

The total value created by a business being in the portfolio is the sum of the scores on the horizontal and vertical axes.

A proxy for incoming benefit could be a comparison of the NPV of this business when operating within the portfolio, with the expected enterprise value when it is spun-off.

A proxy for outgoing benefit could be the comparison of the sum of the NPVs of other businesses in the portfolio with the expected enterprise value of the corporation after the focal business has been spun-off.

The synergistic portfolio framework

The total value created by a business being in the portfolio is the sum of the scores on the horizontal and vertical axes.

A proxy for incoming benefit could be a comparison of the NPV of this business when operating within the portfolio, with the expected enterprise value when it is spun-off.

A proxy for outgoing benefit could be the comparison of the sum of the NPVs of other businesses in the portfolio with the expected enterprise value of the corporation after the focal business has been spun-off.

The synergistic portfolio framework

When both incoming and outgoing benefits are positive, the business is two-sided synergistic and we call these fits (top right quadrant).

However, one could still want businesses in the portfolio even when they are not in this quadrant.

The synergistic portfolio framework

The 45 degree line through the origin, sloping downwards from left to right, shows the threshold of acceptance for investment opportunities in the portfolio;

If they are above it to the right, it is worth investing in them. Because both improve the overall value of the portfolio:

givers (high outgoing benefit, low but negative incoming benefit)

takers (high incoming benefit, low but negative outgoing benefit)

The synergistic portfolio framework

However the following do not, and should receive little investment or consideration for divestment:

altruists (high and negative incoming benefit, low and positive outgoing benefit)

misfits (negative incoming and outgoing benefit)

parasites (high and negative outgoing benefit, low and positive incoming benefit)

Resource allocation by the HQ

The goal of resource allocation in the portfolio is thus to push businesses further away from the origin toward the top and right, away from the investment threshold.

The movement of each business in the portfolio over time can be traced through this diagram.

We must still account for the uncertainty of investment opportunities.

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Resource allocation by the HQ

We classify each business as best as we can but because such classification depends on assumptions about an uncertain future and we are bound to make errors.

A tractable way to think about this involves distinguishing errors of:

omission (believing an opportunity was below the threshold when in fact it was above) from those of

commission (believing an opportunity was above the threshold when in fact it was not).

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Resource allocation by the HQ: minimizing errors

Minimize both errors by obtaining good information, making sensible assumptions, and following a structured decision process.

To further avoid Commission errors:

Invest only if you were fully convinced that the business would do well but that would imply plenty of omission errors (i.e., missing out investments in businesses that would have been worthy of investments).

To further avoid Omission errors:

Invest even if you were unsure about the viability of a business but that would imply plenty of commission errors (i.e., money wasted on businesses that turn out to go nowhere).

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Resource allocation by the HQ: minimizing errors

You should try to minimize the more costly of the two errors.

Omission costs increase relative to commission costs if there is a unique opportunity to acquire, a decline in the availability of alternatives, a temporary regulatory loophole, or a technology with increasing returns or network externalities.

Higher costs of omission (relative to costs of commission) stimulate exploration.

Figure 10.3 shows how the threshold of acceptance should change location as the costs of omission and commission rise.

Figure 10.3 The cost of omission and commission errors influences the threshold of acceptance

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