This is a book about corporate strategy written for industrial economists. It is intended for students who have already completed an introductory course in economics, and who, therefore, have some familiarity with the conventional theory of the firm. They may also be acquainted with some of the modern revisions to the conventional theory, although such knowledge can probably be treated as an optional extra.

Corporate strategy is concerned with long-term decision taking. It reflects the firm's need to prepare for an uncertain future in an uncertain environment, which may be subject to almost continual change. By contrast, formal economic analysis often concentrates on equilibrium conditions in a world with little or no uncertainty, and, although equilibrium analysis is a powerful tool, it sometimes seems to be far removed from the world of the corporate strategist. Indeed, in casual conversation I have often heard businessmen explaining why they had to reject an “economic” solution for “strategic” reasons. In reality this conflict is more apparent than real, but the appearance is both misleading and unfortunate: misleading, because it ignores the deep insights into strategic behavior which can be developed from the analytical and empirical work of many economists, and unfortunate, because it simultaneously denies the potential usefulness of those insights. I hope that this book may help to dispel some of this misunderstanding by synthesizing a fairly broad range of economic and management literature and relating the economic analysis directly to its strategic context.

The previous chapter reviewed some developments in the theory of the firm in order to provide some early pointers to the way in which economic analysis may assist our understanding of corporate strategy. In this chapter, we first consider the role of the corporate strategist in a little more detail, and then seek to justify that role in principle (section 2.2) and by reference to the experience of corporate planners (section 2.3). At this stage we are still concerned with a very general view of strategic planning. Specific planning problems will be dealt with in later chapters.

The role of the strategist

Our initial definition suggested that the strategist is concerned to identify policies which contribute to the long-term goals of the organization. Implicit in this definition are several intellectual tasks that must face all managers involved in the formulation of corporate strategy. First, they must identify the value systems and the long-term objectives that are to be sought by the members of the organization, including the obligations that are acknowledged to outsiders. Secondly, they must define the current and expected future state of the environment in which the organization operates, so as to pick out the opportunities which may arise and the threats which may have to be faced. Thirdly, they must consider the organization's relative strengths and weaknesses in responding to those opportunities and threats.

A merger or takeover occurs when two or more firms are combined under common ownership. Sometimes a merger is distinguished from a takeover. A “takeover” is then said to occur when one dominant firm acquires the assets of another, whereas a “merger” produces a new firm from a marriage of two more-or-less equal partners. But, in practice, this distinction may be difficult to maintain, as would happen, for example, if a merger were actually effected by means of a takeover bid in which one of the firms offers to buy the assets of the other. We shall therefore use the terms “merger” and “takeover” interchangeably; and when appropriate, we shall refer to the actual, or potential, buying firm as Beta and to the potential victim, or seller, as Sigma.

Our major purpose is to investigate the contribution which mergers can make to the strategic development of a firm. But if we are to do this satisfactorily, we must have some understanding of the institutional constraints that affect merger activity and of the various factors which influence the costs of a takeover. It may also help to have some background knowledge of the history of mergers. With this in mind, our discussion starts in 7.1 with a general review of the procedures involved in a merger, and follows this in 7.2 with a brief historical survey.

When a firm chooses to become more vertically integrated, it is choosing to take on activities that might otherwise have been covered by a market transaction in which it acted as either customer or supplier. This is in direct contrast to the process of diversification, which involves the addition of activities which were previously outside the firm's areas of direct interest and influence, although the activities may have been related as substitutes or complements in the eyes of consumers.

There are many possible motives for integration, and any attempt to classify these motives may involve some ambiguity. Nevertheless it is often fruitful to recognize at least two broad alternatives. First, integration may be undertaken consciously to reduce the costs of manufacturing or distributing existing items. Second, integration may be undertaken for longer-term strategic reasons, to improve the general competitive position and to reduce the risks faced by the firm. However, almost as a third category, we should note that, in some cases, it may be difficult or impossible for a firm to develop at all unless it does so as an integrated unit, because the existing sources of supply are inadequate and cannot develop quickly enough to offer a realistic alternative.

For example, in the early stages of development of the motorcar industry in the United Kingdom, the domestic light-engineering industry was unable to provide satisfactory component supplies, and car manufacturers had to provide capital and know-how to manufacture their own components.

Introduction: The nature of innovation

Innovation is a process which involves the adoption of procedures or products which are perceived as being new by the adopter. It is therefore concerned with changes in the established ways of doing things. In many cases, it will result from progress in science and technology, which permits new methods of production, new designs for existing products, or completely new products or services. But innovation is not necessarily tied to prior technical change. It may also reflect changes in (say) marketing techniques or management procedures. Perhaps the clearest example is the growth of self-service retailing, which is a significant innovation with a widespread social impact but very low technological content.

In other cases, the technological input may be significant but invisible, as in the spread of credit-card trading, which has been made possible by advances in electronic data processing to handle the centralized accounts. Conversely, even when the innovation has followed from a technical breakthrough, its successful use will depend upon the social and economic environment as well as upon the technical specifications of the product. Further, although technical change sometimes requires significant preinvestment in research and development, this is not always the case.

Introduction

No discussion of the direction of strategic growth can be complete without some reference to the increasing importance of multinational activities. The multinational enterprises (MNEs) which own and control income-generating assets in more than one country account for at least one-fifth of the world's output (excluding the centrally planned economies). In the United Kingdom, about one-third of company profits are derived from overseas operations, and about one-half of the one hundred largest manufacturing firms had a quarter or more of their output produced outside the United Kingdom (Dunning 1974, Stopford 1974).

The MNEs comprise a relatively small number of very large enterprises. The Comparative Multinational Enterprise Project run by the Harvard Business School covered those firms on Fortune's list of the 500 largest industrial companies in the United States in 1968 that had manufacturing subsidiaries in at least six foreign countries (187 U.S. companies in all), together with the 200 firms on Fortune's list of the largest non-American industrial companies in 1970. The project therefore surveyed approximately 400 MNEs. It estimated that in 1970 these enterprises operated nearly ten thousand wholly or partially owned foreign manufacturing subsidiaries. (For a convenient summary see Franko 1976, Chap. 1. For more detail see Vaupel and Curhan 1973). At the same time, some of the largest MNEs, such as General Motors or the Exxon Corporation (then Standard Oil of New Jersey), had annual sales which exceeded the gross national product of many countries, including Denmark and Norway (Tugendhat 1971).

Corporate strategy is concerned with the long-term survival and growth of business organizations. It involves the choice of objectives, the search for developments which may help to meet those objectives, and the identification of those developments which are most likely to be feasible with the organization's existing resources. But the process is unlikely to end with a set of detailed plans or blueprints for the future. It should be more concerned to establish the general form of long-term developments, and to set the guidelines against which future plans can be judged. Formal model building may help in this process, but it will have to be complemented by less formal analysis of a wide range of factors, many of which have to remain unquantified because they cannot be measured in any meaningful way.

The tasks of the strategist are discussed more carefully in Chapter 2, but there are two points which must be emphasized right at the beginning. The first is that strategy is concerned with long-term developments rather than with the cut and thrust of day-to-day operations: that is, it is not concerned with the current production and sale of particular products, but with the possibility of new products, new methods of production, or new markets to be developed for the future. The second point is that strategy is relevant precisely because the future cannot be foreseen. If firms had perfect foresight they could produce a single plan to meet all future developments.

This book is not intended to be a boardroom manual or handbook on strategy formulation but it must pay some attention to the process by which strategic decisions are reached. This may serve two purposes. It will show how strategic decision taking can exploit the conclusions of our general discussion of diversification and integration. It may also help to set the context for our later discussion of mergers and innovation.

There is no single set of universal rules for strategic decision taking, and the discussion which follows draws heavily on the sequence proposed by Cohen and Cyert (1973). In their scheme, the process is divided into three major stages: formulating the strategic program, implementing the program, and using appropriate information and control systems to monitor the progress of the program. The stages are not completely separable. For example, a program that includes too much diversity will prove to be more difficult to monitor. Nevertheless, it is appropriate for our purpose to concentrate on the formulation stage. This may be divided in turn into seven steps: (1) establishing goals; (2) analyzing the environment; (3) assigning quantitative values to the goals; (4) relating company-wide goals and assessments to plans made at divisional or department level; (5) “gap analysis” to compare forecasts and targets; (6) strategic search, to find means to fill the gap between forecast and target, if appropriate; and (7) selecting a portfolio of activities to define the strategic program for the firm's planning horizon.

The previous part was concerned with the range of a firm's activities; this one will concentrate on the means by which the range can be modified or extended. Specifically, it is concerned with the choice between mergers and internal expansion in Chapter 7, and with innovation in Chapter 8. Our main purpose is to examine the contribution which mergers and innovation can make to the growth of different firms in different circumstances, and to pick out the major characteristics that might affect any strategic assessment. As in the previous chapters, the treatment draws on a variety of published work by economists and management scientists. Much of this work has been done in the United States, and so American experience is used frequently to emphasize, or contrast with, experience in the United Kingdom, which remains as the main focal point of the analysis.

Each chapter starts with an extended discussion of the nature of the activity in question. In the case of mergers, this discussion seeks to identify the various steps involved in a merger and to give some indication of the laws and codes which affect each step. Similarly, Chapter 8 starts with an overview of the total innovation process and of the possible role of such things as patents and licences in that process. It also seeks to explain why innovation is so much more important in some industries than in others, and why its nature and importance may gradually change with time within a single industry.

The previous chapter concentrated on the strategic effects of integrating vertically related activities in a single organization. We turn now to consider the consequences of lateral growth, or diversification.

Diversification occurs whenever a firm combines two or more activities which are not vertically related to each other, although they may both use the same inputs or be sold through the same outlets. Diversified companies therefore have more than one product line on offer to potential customers, and would normally be found operating in two or more different industries. The definition of industry which is appropriate for this purpose has long plagued economists and statisticians. Clearly, diversification must imply that the firm is taking on different activities, but just how different is different?

Statistical measurement generally relies on data obtained from the Censuses of Production and classsified in accordance with the Standard Industrial Classification (S.I.C.). Different activities within manufacturing industry may be classified into 15 industrial orders, or into 120 or so “three digit” industries, or if data were available, into an even larger number of product groups. (For further details, see Shaw and Sutton 1976, Chap. 1, or Utton 1977, pp. 97–9).

Clearly a very fine classification scheme identifying a large number of industries might suggest a higher level of diversification than would a coarser classification, because individual firms would appear to offer more product lines in the former case. But the appearance could be misleading.

This part discusses the many factors influencing the range of activities which may be undertaken by a firm, and especially the range of final and/or intermediate products. Our main purpose is to see how changes in the range of activities may contribute to the firm's strategic objectives, either by encouraging a more effective use of existing resources, or by developing a more secure and fruitful resource base for subsequent development.

The different activities are usually linked in some way, and it is often convenient to classify these linkages as being either vertical or lateral. Vertical linkages are involved when one activity provides some of the inputs required for another. By contrast, activities are said to be laterally related when they occur at a similar stage in the process of production, and often the activities will share a common vertical linkage with some third activity. For example, lateral linkages exist when two products share a common input or are both sold through the same distribution channels.

Common examples of vertical linkages include the production and refining of crude oil, or the common ownership of breweries and public houses for the production and distribution of beer. Conversely, examples of lateral linkages are common in the chemical industry, in which firms typically produce a wide range of products from a limited number of basic chemical building blocks.

We begin this chapter with a brief critique of the traditional theory of the firm which assumes that firms are motivated to maximize profits in the short run. We then turn to consider the alternative optimizing and behavioral theories so as to pick out the major features to which we shall want to refer in later chapters.

The traditional theory

The traditional focus of economic analysis was the small owner-managed firm which operated in only one industry. The firm was assumed to be a price taker that was forced to pursue its objectives by adjusting output and internal efficiency in the light of a set of prices that it could not hope to influence significantly by its own actions. It was also assumed that the personal motives of the owners and the pressures of an inhospitable environment would combine to enforce a search for maximum profit, and although the emphasis was on long-run equilibrium, the analysis implied that the managers would adopt a short time horizon, because they would know that their current actions could not affect the market prices they would have to face in the future. The traditional analysis was therefore based on models of firms which sought to maximize short-run profits in highly competitive markets, and although it was recognized that a few firms might possess monopoly power, the convenient assumption of profit maximization was generally retained for the analysis of such firms, even though it was then more difficult to rationalize.