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.